- Pearson is well-positioned for changing educational, training and assessment needs. That should help it grow.
- Its share price fall means I now see it as fairly priced.
- There is a decent dividend and some potential for share price increase in the coming year in my view.
- But I still don't think it's cheap and execution risk remains, with recent results being a mixed bag. So I remain neutral.
Education provider Pearson (NYSE:PSO) has had a challenging few years and its share price has continued to decline lately. I like the company’s investment case and see the potential for some share price recovery. But I regard it as okay value, not great value, and remain neutral on the name.
Business Performance Continues to be Underwhelming
The company’s results last year were predictably weak in some areas. That said, basic earnings per share did grow and the company held its dividend flat which while unexciting is better than a cut.
Source: company annual results
What’s concerning to me, as I have explained in previous pieces on the company, is that Pearson’s business revenue declined during a time when online education boomed. That reflects its business mix, including assets such as examination businesses which saw postponed exams, but also belies the idea that Pearson’s online education business is a white knight for the business in the here and now. There’s a lot more work to be done in that regard. The company’s increased strategic move towards online education could yet position it well for future growth and resilient profitability. At the moment, however, online education remains an interesting part of the investment case but insufficient on its own given there are multiple competitors with a pure focus on that space.
Source: company trading update
Again, I find this pretty underwhelming. The period in question had weak comparative figures and 10% while decent is not that great in my view. Last year, the first nine months saw a 14% contraction. So the 10% growth this year doesn’t even get Pearson back to where it was before the pandemic. For a company touting its online educational solutions at a time when online education has boomed, I find that disappointing.
The company has maintained its guidance for the full year, which was for year on year revenue growth with adjusted operating profit of £377m at USD:GBP 1.36. While that would be an improvement on last year, it would only be 65% of 2019 levels.
Set against that more positively, the business mix does feel like it is looking to the future not the past. From virtual learning to workforce skills, Pearson is involved in the sorts of areas which should grow in importance in an increasingly digital, skill-based economy. The company makes that point in its most recent annual report and I do think it has merit.
Source: company annual report
What does this mean for growth? The picture seems mixed, using the company’s own strategic expectations. It doesn’t expect margin growth in three of its five business areas. While exact comparison is hard due to a business unit reorganisation, the 2019 margin in what was then global online learning was 14%, less than half the margin in the global assessment unit, for example. So one of the two areas in which the company foresees increasing margins vs. 2019 (virtual learning) is basically one in which its margins lagged badly compared to other parts of the business before.
Growth is expected to be “strong” in only two of the five areas (both of which are expected to record mid to high single digit growth in the market as a whole).
Source: company full year results and strategy update announcement
I don’t think that’s very exciting but I also don’t think it’s necessarily that bad. One view is that the company has identified five market areas, which should either be flat or show growth in coming years. Within those five areas, it expects either to maintain its profit margins or improve them. So that suggests that, in the long-term, Pearson should have larger, growing revenues and better profitability than it did several years ago. With its asset base, experience and relationships, I see the company as a credible contender to deliver that.
So, is this an exciting high-growth opportunity either in education generally or in virtual learning specifically? I don’t think so and I think there are better opportunities out there with those focuses. But if it is priced on sale, could this be a solid enough company with growth opportunities albeit mostly driven by broad growth in its end markets rather than anything specific to itself? I think it could. That doesn’t excite me sufficiently as an investor, but I do think it could mean that there is value to be had in buying and holding Pearson shares for the long-term at the right price.
That brings us to valuation. Since my neutral July note Pearson: Virtual Learning Powers Likely Growth, But Only Modestly, the shares have fallen 28%. Given its long-term history of value destruction (a share bought at the end of 2011 has halved in value a decade later), one hesitates to take a positive view on Pearson.
Source: Google Finance
Nonetheless, after the recent fall, might a fresh valuation be in order?
The current P/E using 2019 earnings would come out at around 18x. If Pearson delivers on its strategy and overall margins increase, alongside growing market size enabling its own revenue growth, then it ought to be able to get back to 2019 earnings per share levels in a couple of years, allowing for continued disruption in 2022 due to the pandemic. In fact I would expect it to beat the 2019 EPS numbers, both because of the revenue and margin growth and some cost-cutting it has undertaken over the past couple of years, but with the company’s mixed record on delivery I wouldn’t take that for granted.
So the current valuation suggests a prospective P/E ratio hovering in or slightly above the mid-teens. I don’t think that’s expensive, especially as Pearson does own some attractive educational assets. If it delivers on its current strategy successfully, I would expect to see the share price rise over time - if trading is strong in the first half of 2022, for example. Meanwhile the current dividend yield is 3.2%. But there are execution risks, and it may take some years before one can confidently say that the reformed Pearson business is performing smoothly. On that basis, while I don’t think the prospective P/E looks expensive, I also don’t think it’s compelling value. For that reason, I maintain a neutral stance for now.
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