Pearson finals

An international media and education company, providing educational materials, technologies, assessments and related services to teachers and students.  Owner of The Financial Times and part owner (47%) of Penguin Random House.  I have a holding in my income portfolio (epic code: PSON).

Pearson announced their final results yesterday and reported sales down 3.8% to £4.9bn, but up 2% at constant exchange rates. 

Reported operating profit was down 13.1% to £398m, but adjusted operating profit (excluding Mergermarket and intangible costs) was up 8% to £720m. 

Reported EPS was down 17.6% to 29.9p and adjusted EPS was down 4.9% to 66.6p in line with their guidance on 21 January (see here) and at the top end of the guidance they gave at the beginning of 2014 of 62-67p.  

An interim dividend of 34.0p is proposed making 51p for the year an increase of 6.25%.  Pearson have a strong history of increasing their payout, as demonstrated by the chart below, which represents a CAGR of 6.5% pa over 17 years. 

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Underlying growth was essentially flat, but progress was made in operating profits due to action taken on restructuring:

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Restructuring charges during the year totaled £84m off-set by savings of £40m.  In 2015 restructuring charges are expected to be lower at £30m, that will be more than off-set by the additional savings of £45m.  

By line of business there was good growth in Higher Education which has the higher margins of 19.6% (excluding reorganisation costs):

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Free cash flow at £284m was an improvement on last year's £204m, but was still insufficient to cover the dividends paid of £397m.  Net debt was increased by £0.2bn to £1.7bn and represented gearing of 28.1% that in isolation that looks very safe, but net debt was 2.1x EBITDA and operating cash flow was just 27.1% of net debt.  Three to four years ago PSON was in a much stronger position, but restructuring costs have taken their toll.

Mangement have stated that they expect adjusted EPS of between 75p and 80p in 2015, so growth in the range of 12.6-20% on a prospective P/E of 18.9-17.8 and expected yield of 3.7% at yesterday's close of 1420p.  Good value for a business that has gone through the pain of restructuring and is starting to see the benefits from the greater use of digital learning in its educational markets.  There is also the growing exposure to emerging markets that have increased from less than 7% in 2007 to currently over 16%:

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The next task for the management of Pearson, following the major restructuring, is to return their free cash flow generation to over 70p per share from the current 35p.  Over the last three years they have returned just 5.2% FCF on their average capital employed compared to their weighted average cost of capital of 9%.  Their operating income ROCE this year is at a similar rate to the FCF return, even if you exclude the intangible costs, the return is just above their cost of capital.  Lower restructuring costs in 2015 will help in improving this as will increasing educational budgets in their main markets.