Shares in education and media company Pearson (LSE: PSON) sank by as much as 15% yesterday morning, after it lowered its full-year profit guidance in a third quarter update, while it’s down a further 9% today at the time of writing.
While it had previously guided towards earnings per share (EPS) of between 75p and 80p, it now expects the figure to be at the bottom end of a new range of 70p to 75p, owing to continued challenges in its operating divisions.
For example, in the third quarter sales fell by 2% in headline terms, and 5% at constant exchange rates, as the persistent cyclical and policy related headwinds that have been a feature of Pearson’s recent past continued.
And, while the sale of the FT, Economist and PowerSchool has caused EPS forecasts to fall by around 5p, today’s share price fall is mainly due to Pearson stating that it now expects profit to be at the bottom end of its updated guidance range as it battles tough trading conditions in key markets, with lower Community College enrolments in the US and lower purchasing in certain provinces affecting textbook sales in South Africa.
Furthermore, the updated guidance is dependent on exchange rates remaining at their current level until the end of the year, no further acquisitions or disposals, a tax rate of 15%, and an interest charge of £70m.
So, with external problems seemingly unlikely to drastically change in the months ahead, it would be somewhat unsurprising if Pearson were to further downgrade its guidance for the short to medium term. This could put its shares under further pressure in the coming months.
But despite the disappointing news, Pearson continues to make good progress relative to its peers. For example, it has posted market share gains across all of its major markets in the first nine months of the year. This should allow it to increase profitability in the long run and place it in a stronger position for when external challenges begin to fade. And, while earnings growth is set to be lower than previously expected, EPS of 70p would still represent a rise of 5% versus last year which is roughly in-line with the wider market growth rate.
Although Pearson’s earnings are due to come in below previous guidance, the company’s dividend is still set to be covered 1.3 times by profit. This is a reasonable level of cover and, with Pearson yielding 5.5%, it remains a very appealing income play. And, with a forward price to earnings (P/E) ratio of 14.4, Pearson seems to be reasonably priced relative to the wider index.
Clearly, yesterday’s update has proven to be bad news for the company and its short-term share price outlook. However, it presents an opportunity to buy a relatively high-quality, high-yielding business with growth potential in the education sector for a fair price.
In the short run, its shares are likely to come under further pressure and further changes to its guidance would not be a major surprise given the challenging trading conditions for its key divisions. But, with it gaining market share and positioning itself for future growth opportunities, it appears to me to to be a sound long-term buy.
