View the article online at http://citywire.co.uk/money/article/a640502
Smart Investor: Scardino's off but Pearson still delivers
Shares are cheap and the publishing and education company is in good shape.
As the owner of the Financial Times, Penguin books and publisher of a wide range of education materials and books, FTSE 100 listed Pearson (PSON.L) is a company which the vast majority of us will have come across at some point in our lives. However, as the saying goes; ‘familiarity breeds contempt’ and so, just because its products are viewed as ‘useful’ and ‘trustworthy’, it does not mean that investing in Pearson should be taken as given.
So, with that thought firmly in the forefront of our minds, is Pearson a sound investment at its current share price?
Buying and selling
Although its future can be traced back to when Thomas Longman founded his now well-known company, Longman, in London in 1724, it is Pearson’s recent past which is most interesting and relevant for investors.
The company has acquired a large number of companies and stakes in companies over the past five years, notably eCollege, Harcourt Education (both in 2007) and, most recently, Embanet Compass. It has also recently announced the merger of Penguin with rival Random House to create the world’s largest trade publisher.
However, whilst doing so it has sold off substantial stakes in other businesses, including its 50% share of the FTSE group and 61% stake in Interactive Data. Therefore, debt levels are surprisingly low, with the company’s debt to equity ratio being just 34%, whilst interest cover is very comfortable at 18.5.
Furthermore, the company’s track record over the past five years is fairly impressive, with a net profit being made in each year and growing from £337 million in 2007 to £956 million in 2011. This is an annualised growth rate of around 30% and, when the challenging economic circumstances are taken into account, should be viewed as highly resilient. Indeed, return on equity averages 10.8% over the five year period, being 16.1% last year and, particularly when the aforementioned low debt levels are taken account, these figures are acceptable.
Meanwhile, shares currently yield 3.5% from a payout ratio of 35%. This is slightly disappointing, since the yield is in-line with the FTSE 100 average, although dividends per share have increased in every year since 1997, which is encouraging. Indeed, a yield of 3.5% combined with dividend growth still keeps Pearson open as an option for income-seeking investors.
In terms of an economic moat, Pearson has invested heavily in recent years to ensure that its content is sector-leading. This has inevitably helped the company to not only increase revenues but also to be viewed as a trustworthy brand which produces high quality content. This has generated increased brand loyalty through customers viewing its publications as useful and of a consistently high quality.
Furthermore, Pearson is embracing the digital world and now offers many of its titles online, as well as providing online learning solutions. This is an important step for the company to take as print has been in decline for a long while and digital is where growth, higher margins and, ultimately, future profit lies. Although only one-third of revenue is derived from digital, this is likely to increase substantially in future.
Of course, Pearson’s marketplace enjoys very few barriers to entry: almost anyone could compete with the company and whilst it believes that there are growth opportunities in regions such as Asia and Latin America, there remain significant unknowns when attempting to expand into such regions. Furthermore, lower cost (and even free) alternatives are available. However, its brands are well-known, respected and command substantial customer loyalty. Therefore, whilst its economic moat is not vast, Pearson does benefit from at least a partial moat.
What about Scardino?
As of the New Year, Pearson will also benefit from a new chief executive, with Marjorie Scardino being replaced by John Fallon, the current CEO of Pearson’s International Education division. Whilst some investors see change at the top of a company as a major downside, in reality it could prove to be better, worse or the same. An obvious statement, but it is yet another known unknown whose existence should be reflected in terms of a discount in the company’s share price.
With shares priced at £12.05 at the time of writing, Pearson trades on a price to earnings (P/E) ratio of 10.1 and a price to book ratio of 1.65. Both of these figures indicate that shares are cheap. Furthermore, when the company’s track record, acceptable ROE, debt levels, economic moat and growth potential are taken into account, Pearson offers a sound long term investment opportunity at a very reasonable price. In addition, uncertainty surrounding the new CEO appears to be fully priced in at current levels.
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