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Pearson plc slumps 20%+ on profit warning and dividend cut

Education specialist Pearson (LSE: PSON) is among the biggest fallers today after it released a profit warning. The company has experienced a challenging fourth quarter of the year in its North American higher education courseware business and while its operating profit for 2016 is in line with guidance, 2017’s figures are now due to be lower than previously expected. Could this prove to be a buying opportunity, or is it a stock to avoid at the present time?

A difficult period

For 2016, Pearson expects to report adjusted operating profit of £630m despite an 8% fall in revenue. This has primarily been caused by the weakness within its North American higher education courseware business, with other business units performing as expected. Its net revenues within the North American higher education courseware business fell by 30% during the final quarter of the year, which meant they declined by 18% for the full year. Around 2% of this was caused by lower enrolment, 3%-4% by an accelerated impact from rental in the secondary market, and around 12% from an inventory correction.

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Clearly, this news has caused investor sentiment to weaken. The company expects the difficulties experienced in the fourth quarter to continue into 2017. As such, operating profit is expected to fall to between £570m and £630m. For 2018, the company has withdrawn its operating profit goal due to portfolio changes and the uncertainty it now faces, which highlights the degree of difficulties being experienced. It will also rebase its 2017 dividend to reflect its updated earnings guidance.

An improving business

While today’s news is clearly disappointing, Pearson has made good progress with its turnaround plan. For example, it has delivered its 2016 restructuring programme in full and the financial benefits have been slightly higher than planned. It has the potential to make further progress in its strategy of accelerated digital transition, while also managing the decline in print and reshaping its portfolio. In the long run, such changes could improve the performance of the business, although its near-term future remains highly uncertain.

It may be prudent to avoid Pearson at the present time. It could be worth buying once more details are known regarding its future performance, but for now its shares look set to remain volatile and continue their downward trend.

Turnaround potential?

Of course, other media stocks are performing much better than Pearson, with Sky (LSE: SKY) being an obvious example. It’s due to record a rise in its bottom line of 18% in the next financial year, which puts its shares on a price-to-earnings growth (PEG) ratio of only 0.8. This indicates that Fox is buying the company on what is a very lucrative valuation. That’s especially the case since Sky is a much stronger and better diversified business following its merger with Sky Italia and Sky Deutschland.

Like Pearson, the company has experienced a difficult period and posted a fall in earnings in 2014 and 2015. However, it has delivered a strong turnaround since then. Pearson has the potential to do likewise, but it may take time for it to deliver rising profitability and a higher dividend.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.