Summary
- Pearson plc published a trading update today and the share price reaction on the LSE was positive. The share price closed 8% up today and has risen 53%+ this year.
- Pearson Management guided towards an adjusted operating profit of £416 million for the year on the assumption that GBP/USD is at 1.37.
- As a UK company earning revenue primarily in U.S. dollars, Pearson plc benefits from a weaker pound against the dollar.
- This article will look at the factors affecting the GBP/USD exchange rate and whether it will continue falling.
Overview
Pearson plc is a multinational publishing and education company headquartered in London, England.
Pearson plc has a primary listing on the London Stock Exchange and is a constituent of the FTSE 100 index. It also has a secondary listing on the New York Stock Exchange in the form of American depositary receipts.
Key highlights from the trading update
Pearson plc published a trading update today (Monday 10/24) and the share price reaction on the LSE was positive. The share price closed 8% up today and has risen 53%+ so far this year.
Total sales increased 7% for the nine months ending 30 th September. All divisions except for Higher Education showed positive increases.
Pearson plc also reaffirmed its 2022 outlook as it remains on track to deliver group sales and adjusted operating profit expectations.
Management guided towards an adjusted operating profit of £416 million for the year on the assumption that GBP/USD is at 1.37.
However, this guidance is conservative given that GBP/USD trades at 1.13 today. Pearson plc also stated that every 1c move in GBP/USD equates to approximately £3m in adjusted operating profit.
Therefore, the adjusted operating profit calculated using an exchange rate of 1.13 would increase the guidance to £488 million, an additional £72 million purely from the exchange rate gain.
In its latest annual report, Pearson plc stated that the Group’s principal currency exposure was to the US dollar, which represented more than 60% of the Group’s sales.
Overseas profits are converted to sterling to satisfy cash outflows such as dividends at the prevailing spot rate at the time of the transaction.
As a UK company earning revenue primarily in U.S. dollars, Pearson plc benefits from a weaker pound against the dollar.
In the next section, we will look at why the pound is falling and whether it might continue falling.
Will Pearson plc continue benefiting from a weak pound?
The exchange rate between GBP and USD changes constantly. It is affected by many things, including:
1. Capital flows: Successful economies have strong currencies because other countries want to invest there. They need the local currency to do so, increasing demand and its value. The U.S economy was able to bounce back from the COVID-19 pandemic more effectively than the UK. The UK registered a 0.2% decline in real GDP compared to its pre-pandemic level whereas the U.S. economy was able to grow 3.5% in real terms.
2. Interest rates: The Federal Reserve has been increasing interest rates faster and higher than the Bank of England. This encourages financial institutions to move their cash in USD which increases demand and its value.
3. Export – Import: Nearly 90% of international transactions in 2019 were settled in U.S dollars. Due to its safe-haven status, people trust the U.S dollar more than other currencies, which drives strong demand for the currency.
4. Public finances: A currency is essentially backed by a government’s bank balance hence its economic credibility affects the demand for that currency. We have seen this with the UK’s mini-budget announcement last month which announced a series of unfunded tax cuts which would require a large amount of borrowing to sustain government expenditure.
5. Speculation: The exchange rate is highly vulnerable to currency speculators such as hedge funds or banks who buy and sell USD/GBP based on expectations of future events. In times of macroeconomic uncertainty like now, investors will flock to safe-haven currencies such as USD.
I believe that the USD will keep on appreciating over the GBP based on points 1, 2 and 3.
On point 4, the announcement of Rishi Sunak as the new UK Prime Minister will help stabilize the GBP against the USD but it will not by itself solve the never-ending list of problems facing the UK economy.
To name a few, the UK’s still got Brexit, weak public finances, a cost-of-living crisis and a potential recession.
Conclusion
Pearson plc's share price action has been strong this year. The company’s business model benefits from a weaker pound against the dollar, which is ideal in the current environment.
I believe that management’s guidance was conservative and that there is a strong possibility of financial outperformance from exchange rate movements.
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Pearson Benefiting From A Falling GBP/USD