Pearson rallies as Morgan Stanley says another warning unlikely

Education publisher Pearson got a boost on Tuesday as Morgan Stanley reiterated its ‘overweight’ rating on the stock and 1,050p price target, saying the market’s expectations of another profit warning are unlikely to materialise.

MS said the stock is too cheap, now down 25% from its highs and with a 2018 free cash flow yield of about 10% versus a price-to-earnings of 10x.

It added that Pearson shares are the worst-performing large dollar earners in the UK post the Brexit vote.

It said the shares have fallen since the first-half results on worries that lower H1 gross sales and higher returns in the US college business will lead it to miss its 2016 guidance of pre-restructuring cost EBITA of £580m-£620m, to abandon its 2018 £800m EBITA target and to cut its thinly covered dividend.

“Our view is that Pearson has structural challenges. I thas too much print (35%), it does not have enough proprietary content and there is customer resistance to the high price of US college textbooks,” the bank said.

However, while accepting these shortcomings it also argued that the US College downturn will not be enough to cause Pearson to reduce its guidance for 2016, after it was already cut by around £400m in January 2016.

In addition, it said next year is likely to be an up year for the company as the US Schools adoption market bounces back, the effect of lost US testing contracts falls away, the UK qualifications business picks up and the US college market improves.

“We expect Pearson to reiterate its guidance at Q3, including an unchanged dividend payment of 52p and both its £580m-£620m pre restructuring EBITA guidance for 2016 and its £800m 2018 EBITA guidance.”

At 0917 BST, Pearson shares were up 4.9% to 800.50p.