2023-04-06 15:27:51 ET
Summary
- Pearson plc is a global education company that provides educational courseware, assessments, and services across various regions.
- Revenue has been declining due to lower college enrollment and a change in spending habits. Management is attempting to revitalize the product suite.
- Margins have contracted but as the business becomes more digital, this should reverse.
- The balance sheet is solid and the outlook is positive, with the key risk being the execution of the turnaround.
- Pearson's current valuation leaves little upside for investors.
Company description
Pearson plc ( PSO ) is a global education company that provides educational courseware, assessments, and services across various regions including the UK, US, Canada, Asia Pacific, and Europe.
The company "operates through five segments: Assessment & Qualifications, Virtual Learning, English Language Learning, Higher Education, and Workforce Skills". Pearson offers a variety of services such as Pearson VUE, virtual schools, online program management, Pearson test of English, higher education courseware, and workforce skills training.
Share price
Pearson's share price has trended down in the last decade, driven by a decline in services provided over time, as consumer trends shift. Pearson has responded by looking to innovate and change its business profile, which remains an active process. I believe this is to prove management was correct by rejecting a £7BN takeover attempt by Apollo.
Financial analysis
Presented above is Pearson's financial performance for the last decade.
Revenue
Revenue has grown at a CAGR of (3)%, with Pearson seeing negative growth in 6 of the last 11 years and 0-2% growth in 3 years.
One of the factors driving a decline in sales is the second-hand textbook market. Pearson has seen its core higher education division struggling with declining sales as consumers seek more cost-effective ways of studying. This has been accelerated by the lack of a value proposition. Many textbooks receive a regular "update" which essentially changes very little, done so to encourage new students to purchase these editions rather than second-hand ones.
Another factor that has contributed to a fall in sales is a declining rate of college enrollment in the US, which looks to be a trend initiated following the GFC. There are many reasons why this has occurred, with costs certainly a leading reason for rising tuition and living costs. With a lower number of consumers attending further education, there is reduced demand for products and services in this space. Interestingly, things are projected to improve in the coming years, which could bring a reversal of fortunes. The issue with this is that they are just that, projections, with current evidence suggesting otherwise.
Pearson's response has been quite good in our view. The business has launched Pearson Plus, a platform giving access to all Pearson’s textbooks for $14.99 a month. This has the potential to make Pearson the undisputed digital choice for textbooks, with the service operating similarly to Spotify (SPOT) or Netflix (NFLX). Furthermore, this segment will come with a much higher margin, as the additional cost to provide the service is minimal.
An additional segment Pearson has been focusing on is upskilling training, workplace training, and re-training consumers. Across the West, many industries are in desperate need of people, with the Government encouraging people to re-train in these sectors as a means of plugging the gap. Furthermore, people in employment are looking for greater training as they progress in their careers, with most employers supporting this move. With fewer people seeking the college route, this "post-higher-education" segment will continue to grow.
We are currently experiencing softening economic conditions as inflation remains unsustainably high. Consumers are seeing their incomes decline as a greater portion of spending is committed to living costs, as well as debt servicing as rates remain high. This is harming many industries, but we expect that Pearson should remain robust. The education sector is generally well insulated as consumers maintain spending, due to the importance of progression and the risks around failing exams. For this reason, Pearson is a good defensive pick during such times as we would expect revenue to be resilient in the coming 12-24 months.
Our view is that Pearson's revenue will continue to be unsteady in the near term as it continues to develop its new product segments, however, we are positive in the long term. Education is not going away, things are just changing and it is Pearson's responsibility to respond in kind.
Margins
Pearson has seen its margins slip in the last decade, with GPM declining 9ppts. and EBITDA-M declining 4ppts. Management has done well to find operational efficiencies where possible, allowing for some degree of offsetting, but nevertheless, this is a poor performance.
In the most recent period, a portion of this was due to inflationary pressures, with property cost savings offsetting the impact. With Management investing in attempting to revitalize the business, there will be a degree of inefficient spending.
Finally, with a large amount of the company's revenue generated from the US, the PLC has an outsized exposure to the Dollar. It is in Pearson's best interest that the Dollar remains strong against the Sterling, allowing a greater amount of GBP to be reported once earnings are converted. The trend in the last year has been two-sided. Initially, the Dollar was gaining substantially, but now we are seeing the opposite.
Balance sheet
Although margins have slipped, ROE/ROA remains at good levels compared to what was historically achieved, against displaying Management's desire to improve efficiency as growth struggles.
Dividend payments have also declined alongside profitability, which is a positive thing to see (given the situation) as in many cases, Management will leverage the business as a means of maintaining dividends.
Pearson is well capitalized in our view, with a ND/EBITDA ratio of only 1.3x. Our view is that 3x is a good maximum and so the business has good flexibility. This is important as the business has been making small acquisitions as part of the turnaround effort and so it is good to know that debt can likely be utilized without fear.
Outlook
Presented above is Wall Street's consensus view on the coming 5 years.
Growth is expected to return from FY24 onward, achieving a rate of 5% by FY27. This will likely be on the back of a successful commercial turnaround, with a pivot away from traditional higher education.
Margins are also expected to improve, with EBITDA-M increasing by over 1%. This will likely be from greater digital services offered, which generally come at a lower cost than their alternative. This to us looks like an eventuality based on how Pearson is positioning its product/service portfolio. The question becomes how far margins can be pushed upward in the next decade.
Peer comparison
Presented above is a comparison of Pearson to a cohort of consumer discretionary businesses.
Despite the declining profitability, Pearson still scores extremely well, outperforming its peers across the top and bottom lines. The delta is not substantial but is enough that we concur with the B+ rating.
Pearson also scores well from a growth perspective, primarily because of the gains made YoY. We care more about the forward view, which is less good. Revenue and EBITDA growth are expected to be far below the peer group, reflecting Pearson's continued improvement efforts. This does mean our argument that Pearson is a good defensive choice is less strong when factoring in that peers will probably perform better during an economic slowdown on average.
Based on this assessment, our view would be that Pearson is justified in trading at a slight premium to its peers. The company is marginally more profitable while growing slightly slower.
Valuation
Pearson's valuation rating is the weakest of the three, reflecting what is a premium valuation.
On a forward earnings basis, Pearson is trading at a 15% premium. On an EBITDA basis, on the other hand, an 11% discount. This to us suggests Pearson is close to its fair value, potentially slightly undervalued.
Final thoughts
Pearson should be a robust business due to the importance of education in modern-day society. This has not shown to be the case, primarily because of a change in the way education is being consumed. Management is looking to right this and is making the right moves in our view, yet it remains too early to conclude on such a point. Margins have room to move positively which is good news, giving the potential for the lost ground to be returned in the coming decade. When compared to peers, the business looks quite attractive but its valuation leaves more to be desired. With a lack of near-term catalysts, investors are essentially taking on execution risk without getting much value for it.
For further details see:
Pearson: Turnaround In Progress