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Reed Elsevier’s Profitable Portfolio Shift

March 25, 2014 | About:
Patricio Kehoe

Patricio Kehoe

7 followers

Reed Elsevier PLC (RUK) is one of the oldest publishers and information providers in the market, and with time has grown to be a diverse and solid business. The firm’s essential operating segments are Scientific, Technical, and Medical (35% of sales), Risk Solutions (15%), Legal (26%), and Exhibitions (14%), with most of annual revenue generated in North America and Europe. Last quarter, investment gurus John Hussman (Trades, Portfolio) and Sarah Ketterer (Trades, Portfolio) bought the company’s shares, and given the positive developments of fiscal 2013, I’m not surprised. So, let’s see where this publisher is heading in the long run.

Some Better Than Others

Unfortunately, Reed is not necessarily a well-rounded and balanced company, something which management has been addressing over the past few years. The Scientific/ Medical/ Technical business segment, for example, is doing very well, due to the aging population and government’s financial incentive to invest in research so as to improve the nation’s health. Furthermore, the company holds a 25% market share in this area of the publishing industry, outranking its rivals Thomson Reuters Corporation (USA) (TRI) and McGraw-Hill.

In fact, Reed’s material (200,000 research articles in over 1,100 journals annually) includes the all-time top-selling medical reference Gray’s Anatomy, which is essential for medical professionals and is one of a kind in its nature. Moreover, the company just launched the redesigned digital medical reference and learning platforms, Expert Consult and Student Consult. These online platforms will allow users consistent search structure and social media interaction, as well as direct access to Reed’s digital library. The cloud publishing platform Inkling will contribute by managing the textbook content, making it easier to locate on Google Inc. (GOOG), which will undoubtedly boost Reed’s customer base and sales.

While the publisher’s Legal segment has been growing proportionally to the global increase in lawyers, the Risk Solutions sector has benefitted greatly from the recent focus adjustment on risk managing in the post-financial crisis scenario. Thus, the Business Information and Exhibitions segment are the growth-stompers. Despite a failed attempt to sell the Business area in 2009, management is intent on shedding its structurally disadvantaged businesses, in order to improve long-term market positioning. However, until then the publishing and legal segments, which account for 60% of turnover, and are management’s main focus, will drive growth via their structural advantages.

Valuation

Reed’s diverse quality businesses and strong intangible assets in niche market segments are certainly not to be underestimated, garnering the firm with a narrow moat rating. Furthermore, while returns on capital have averaged in the 20% range over the past decade, fiscal 2013 marked a high peak ROA of 45.2%, which should continue looking forward. Revenue growth, on the other hand, is expected to reach only 1% for 2014, but as academic and government budgets improve should reach 4% in 2015, averaging at 3% over the next five years offset by the heavy competition in the Exhibitions segment.

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Management’s efforts to shift the company’s portfolio toward its stronger businesses, cost reductions, and growing sales should contribute to operating margin expansion, driving 2013’s 22.3% to 24.5% by 2018. EBIDTA has also shown strong recovery since 2010, sporting a 21.1% growth rate, similar to that of EPS, which has jumped from 2010’s $1.11 to a current $3.2. Therefore, I recommend investors to buy shares now, while the stock’s current trading price is on point of the industry average of 18.9x trailing earnings, as this price could trend upwards in the future.

Disclosure: Patricio Kehoe holds no position in any stocks mentioned.

About the author:

Patricio Kehoe
A fundamental analyst at Lone Tree Analytics

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