Investors dumped Pearson (LSE: PSON) shares Thursday morning, after the company issued an update flagging weak 2019 profits. The education firm expects adjusted operating profit of around £590m, at the lower end of previous guidance.
The price slumped almost 14% at one point during the morning, before settling at a loss of around 10%.
Pearson has released a string of profit warnings concerning US higher education courseware, and we saw further weakness there. That segment, accounting for 24% of revenue, fell by 12%. Students, not surprisingly, are increasingly favouring eBooks, and print sales are declining steadily.
Better
The rest of the company performed better, Pearson said, recording an aggregate 4% rise. The firm’s Online Program Management and Professional Certification materials both grew by 10%. And the Pearson Test of English Academic gained 17%.
Analysts are expecting an EPS fall of nearly 20% for 2019, and the firm has confirmed lower profits are expected in 2020 too. Pearson expects adjusted operating profit to drop to between £500m and £580m.
In another shock, Pearson said chief financial office Coram Williams has resigned, and deputy CFO Sally Johnson will take over the role. This is the second high-profile departure in recent months, after chief executive John Fallon announced his retirement in December. He’ll step down some time in 2020.
In this update, Fallon described Pearson as “now a simpler, more efficient company, with strong financial foundations.” But I see the company as something of an enigma.
Trend
The trend away from printed books and towards online educational material is clearly well established, and Pearson is chasing it. But it’s not yet seeing enough growth in that sector to compensate for the fall in print. I also don’t see that Pearson has a significant competitive advantage as it moves away from its previous core strength.
The financial situation does seems solid enough, though. Pearson is preparing to sell its remaining 25% of Penguin Random House, and that’s expected to complete sometime in the first half. The proceeds from that, coupled with annualised savings of £335m by the end of 2019, are enabling a share buyback.
The company has decided to return £350m to shareholders via that route, which implies confidence in the future. It also suggests Pearson sees its shares as undervalued at the moment, but I’m not sure I agree.
Based on further forecast EPS falls, its shares are on a prospective P/E of 10.4 for 2020. With the uncertainties surrounding the company at the moment, I think that’s probably about right. Certainly not a screaming buy, in my view.
Buybacks
I’m unconvinced when companies in difficulty engage in share buybacks to return surplus capital. In this case, I’d rather Pearson refrain from such speculation and just pay out the excess cash as dividends. Leave investors, who are best placed to judge, to decide if the shares are cheap.
I do think Pearson could once again become a top long-term income investment. But I expect a few more tough years before we see the shape of the revamped company, and further share price weakness.
Until I see some clarity, and can gain some confidence in Pearson’s strategy, I’m keeping away.