Pearson PLC (PSO, Financial), the $6 billion education publishing company, issued a warning of weaker earnings and a possible dividend cut Wednesday, according to the Wall Street Journal.
The company still expects its operating profit for fiscal 2016 in line with its guidance. The market reacted negatively and sent Pearson shares down 28%.
Valuation
Shares of Pearson bounced back 1.4% on Thursday giving it a trailing price-earnings (P/E) ratio of just 4.95 times (industry median 16), price-book (P/B) ratio of 0.74 times (industry median 1.4) and price-sales (P/S) ratio of 1.1 times (industry median 0.9), according to GuruFocus data.
The London-based company also had a trailing dividend yield of 9.94% with a 0% payout ratio and 0.1% share buyback ratio.
Market performance
According to Morningstar data, Pearson had one- and five-year total returns of negative 17.2% and negative 10.3%. On the other hand, investing in the broader Standard & Poor's 500 index gave full returns of 23% and 13.9%.
Pearson
Pearson was incorporated about 119 years ago and re-registered as a public limited company in the United Kingdom in 1981 (2). Pearson is an international education company with its principal operations in the education and consumer publishing markets.
In its filing, Pearson creates and manages its intellectual property, which is then promoted and sold to its customers under well-known brand names. Pearson delivers its products through a variety of channels including books and online services.
As of fiscal 2015, Pearson operated its business in 70 countries with most – 63% or 2.8 billion British pounds ($3.44 billion)Â –Â of its sales coming from the U.S. Pearson also earned 15% of its sales from Europe.
In addition to its educational and learning technologies, Pearson also owned 47% of Penguin Random House. The 90-year-old company is the world’s largest general-interest paperback publisher. The publisher was formed in 2013 upon the agreement of Pearson and Bertelsmann to merge their respective publishing companies.
Pearson reports its business performance through three segments: North America, growth and core.
North America
Pearson is the largest provider of educational assessment in the U.S. with nearly 50% of U.S. schools using one of the company’s tools as an aid for learning.
Pearson’s North American business serves educators and students in the U.S. and Canada from early education through elementary, middle and high schools and into higher education.
Pearson’s solutions include learning assessments to help gauge how students learn, talent assessments to help growing companies develop their workforces and clinical assessments to help psychologists and speech/language/hearing/occupational and physical therapists diagnose and monitor patients.
In fiscal 2015, North America business grew by 1.2% to 2.94 billion pounds and contributed 66% in Pearson’s total continuing operations sales. The segment also had a 3.8% operating margin excluding any adjustments found in the company’s 20-F.
Growth
Pearson provides educational products and services and applies them at scale in fast-growing economies such as Brazil, South Africa, China, India and other countries.
In fiscal 2015, the growth segment had a negative 4.4% change in total sales down to 692 million pounds compared to 724 million pounds the year prior. The segment also had been losing more money on a year-over-year basis and delivered an operating loss of 595 million pounds in fiscal 2015 – worst among the recent three fiscal years beginning 2013.
Core
Pearson’s core markets business involves operations found in the U.K., Australia, Germany, France, the Benelux countries (Belgium, the Netherlands and Luxembourg) and Italy.
In fiscal 2015, Pearson’s core segment had a negative 8.1% change to 836 million pounds in sales and had a 3.6% operating margin, compared to 11% the year prior.
Stake sales
In 2015, Pearson began selling its stakes in different companies. Pearson sold its stake in the Financial Times Group for 844 million pounds followed by selling its 50% stake in the Economist Group, the publisher of The Economist, for $730 million.
According to a CNBC interview, stakes were sold to help Pearson’s push into education and become "one of the great global growth stories of the next decade."
During that period, it was rumored that Pearson may also sell its Penguin Random House stake. Two years later, Pearson plans to sell.
Overall, Pearson had five-year sales, profit growth and operating margin averages of -4.63%, -8.7% and 8.16% (3).
Cash, debt and book value
As of June 2016, Pearson had 1 billion pounds in cash and short-term investments and 2.4 billion pounds in debt with a debt-equity ratio of 0.38 times compared to 0.49 times the year prior (1). Pearson also had 55% of its 11.8 billion pounds of assets in goodwill and intangibles while having a book value of 6.46 billion Ă‚ pounds compared to 5.4 billion pounds the year prior.
Cash flow
As of June 2016, Pearson had negative 323 million pounds in cash flow from operations compared to negative 374 million pounds the year prior, leaving the publishing company with negative 435 million pounds free cash flow for the period.
Pearson did not take any debt during its six months operations in fiscal 2016 but instead repaid 246 million pounds of it. In addition, Pearson provided 277 million pounds in dividends – similar the amount it provided to its shareholders the year before.
Conclusion
Pearson’s brand name resounds well as it is the most widely used product in examinations worldwide yet selling assets to focus on online education early on would have produced good business growth for Pearson but has failed to show in its financials.
In addition, Pearson’s growth segment acted quite contradicting as the segment delivered bigger and bigger losses, without adjustments, in recent years.
(Cash flow, Morningstar Data)
Pearson’s leveraged balance sheet remained acceptable despite this ongoing endeavors, but cash flow demonstrated a different story.
As shown in the image above, Pearson definitely should consider trimming its dividend payouts as it now has negative free cash flow – unless the publishing company would want to borrow money to continue providing its payouts.
As observed, Pearson has received several downgrades since September 2016 including one from Macquarie Wednesday.
Unfortunately, the company’s share price discount to book value – the most conservative valuation – still presented limited value given Pearson’s goodwill and intangible total asset contribution.
In summary, Pearson is a pass.
Notes
(1) I use Morningstar data, semiannual figures which were only accurate as of June 2016. Pearson released its management statement for its nine months fiscal 2016 operations on Oct. 17, 2016.
See: Pearson nine-month interim management statement
(2) The information here moving forward was gathered from Pearson’s recent 20-F unless specified.
(3) Morningstar data.
Disclosure: I do not have shares in any of the companies mentioned.
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