Pearson’s (PSON) first-quarter update today contained few surprises and was ultimately in line with Morningstar expectations for the full year. Underlying revenue rose 1%; however, excluding the impact of 2017 exceptional revenue in the growth division, the picture looks somewhat better, with revenue up just over 3% year on year.
We do not expect to make any material changes to our forecasts on the back of these results and reiterate our 800p fair value estimate, against a current share price around 866p. Following a strong recovery in the share price since third-quarter 2017, we believe the shares are currently fairly valued. The company has a narrow moat, which means that it has a limited competitive advantage.
US higher-education courseware, the area that led to the large revenue declines in 2016, saw growth over the period for the first time in almost two years, as the levels of high book returns that we had witnessed finally arrested. While the company continues to face challenges in this area, including lower college enrolments and increasing book rental, we believe the danger of large overnight losses has passed.
We were also encouraged by the performance of the core business, which includes large markets such as the UK and Australia. Here, revenue growth reached 6%, a significant improvement on the 2% delivered in full-year 2017, with strong growth in online learning and testing.
Strong Market Position
Our thesis for Pearson is predicated on the company’s strong market position as the largest educational provider globally, its ability to generate and control content, and the switching costs involved in regulated areas such as courseware and testing. As we have stated in previous notes, we believe that if management can stabilise client retention and stay on top of distribution trends, such as book rental, then it should be able to capitalise fully on its leading market position.
Pearson now finds itself at a crucial juncture. Having shed predictable but declining publishing businesses such as the FT and The Economist, Pearson’s portfolio is now focused on the educational sector. As digital learning slowly replaces traditional textbook-based learning, there is a large structural opportunity for Pearson to not only transition to a higher-margin product but also further integrate itself with schools and universities, increasing the sustainability of its revenue stream.
As the largest educational provider globally, Pearson is in an advantageous position. Given its ability to outspend peers, we believe the company will be at the forefront of digital development. The risk surrounding the shift to digital is also mitigated in some regard by the fact that Pearson has been slowly managing the shift to digital for a number of years, and 40% of its business is now digital. Pearson’s ability to manage this and its experience in doing so should prove crucial over the coming years.
Pearson now finds itself at a crucial juncture. Having shed predictable but declining publishing businesses such as the FT and The Economist, Pearson’s portfolio is now focused on the educational sector. As digital learning slowly replaces traditional textbook-based learning, there is a large structural opportunity for Pearson to not only transition to a higher-margin product but also further integrate itself with schools and universities, increasing the sustainability of its revenue stream.
