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Pearson facing enduring headwinds in key US education business

Half the brokers that cover Pearson are neutral on the stock, and a third are sellers.
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Jefferies became the latest City firm to throw the book at the educational publisher

Pearson PLC (LON:PSON) has not received much love since focusing more on publishing for the education and science sectors.

US broker Jefferies became the latest City institution to take a sceptical stance as it downgraded the stock to ‘underperform’ from ‘buy’ and slashed its price target from 880p to 540p.

The publisher faces enduring structural issues, and although mitigating factors such as cost cutting and portfolio change have been flagged by management, these are likely to prove the proverbial Elastoplast solutions.

Visibility on a return to top-line growth is limited, Jefferies believes, and the broker is cautious on the mid-term prospects.

“At 70% of profit, the trends in US Education are pivotal to the business. There is a consensus that the operations are structurally challenged and we explore the major trends in US Courseware (38% of US revenue): falling enrolment, shift to rental, emergence of Open Educational Resources, shift to digital, the selling model and the inventory correction,” Jefferies said as it added Pearson to its research coverage universe.

“Management have stated that cost cutting will be executed across the business, but have given no quantum. We are below consensus on the top line but assume £35mln cost savings in 2017 in the division and [we] are therefore above consensus on profits,” the broker said.

In all probability, the stake in Penguin Random House will be sold, opening up the possibility of a cash return via buyback – good for buffing up the earnings per share and making the management look good – or a special dividend (good for shareholders).

Jefferies reckons the sale of the stake is factored into the current share price of 632p.

“Valuing Pearson's stake at £1.9bn and assuming 10% is distributed implies a special dividend of 20-30p, with a 3%-4% dividend yield. A further restructuring programme is also expected; however, is not yet in consensus forecasts. When announced, this is likely to lead to a bounce in the share price, particularly if short interest is high at the time; however, the mid-term structural issues would remain,” Jefferies concluded.

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