Updated on March 15th, 2019 by Jonathan Weber
The book publishing industry is undergoing rapid changes. The business model that remained relatively unchanged for decades is rapidly moving towards new technologies such as e-books, while traditional books lose market share. The distribution channels through which the publishers sell books are shifting as well.
Traditional book stores are increasingly closing down, whereas sales of books via e-commerce platforms are growing.
Amazon (AMZN), which started out as an online book store and expanded into many other product categories since, is the largest online book seller.
Amazon is not only selling books, it has also moved into publishing books itself, which puts some pressure on traditional publishers such as Random House.
Despite these factors the publishing industry still has some positives: NPD reports that physical book sales rose by 2.5% during 2018, so even in this segment there is some growth that publishers can benefit from.
The global book publishing market is expected to continue to grow over the next couple of years, hitting $123 billion by 2020.
In this article we will look at the three biggest publicly traded book publishing companies: Scholastic (SCHL), John-Wiley & Sons (JW.A), and Pearson plc (PSO), which is the parent company of Random House.
All three of these companies pay dividends to shareholders, and are included in our list of 674 consumer cyclical stocks.
The three stocks are ranked by estimated total returns over the coming five years. More data on each company is available through the Sure Analysis Research Database.
Book Publishing Stock #3: Scholastic (SCHL)
Scholastic is the smallest company among the three we will look at in this article, as its market capitalization is just $1.4 billion. Scholastic, which publishes children’s books, teaching material and magazines, was founded in 1920 and is headquartered in New York.
Scholastic has grown its revenue at a low-single digits pace in recent periods, including 1.1% growth last quarter. Due to the high amount of children book sales, which make up ~60% of total sales, the company’s revenue is relatively seasonal throughout the year. Sales are also impacted by the timing of new book releases from its most attractive series.
During the most recent quarter Scholastic reported strong profits, as its adjusted earnings-per-share totaled $2.09 during the second quarter of fiscal 2019.
Source: Scholastic Investor presentation
Scholastic forecasts earnings-per-share of $1.65 during the current fiscal year. Since the company has already earned more than $2 per share during Q2 alone, the company is forecasting that it will not be profitable during the coming two quarters.
This can be explained by the cyclicality of sales for its children book segment, where revenues are heavily weighted towards Scholastic’s fiscal Q2, which includes the holidays.
Scholastic’s profitability has seen ups and downs throughout the last decade, in total profits during 2019 will be ~33% higher than they were in 2009, when earnings-per-share totaled $1.24.
We forecast that profitability will increase substantially over the coming years, though, due to several positives: The first one is the strong line-up of brands & content in the children’s book segment, where Scholastic arguably holds the number one franchise, Harry Potter.
The original series finished about ten years ago, but new stories in the franchise, such as Harry Potter And The Cursed Child or Fantastic Beasts & Where To Find Them will continue to drive sales for Scholastic. Scholastic also publishes other successful series such as I Survived and Dog Man.
Scholastic’s Education segment has generated low-single digits revenue growth in recent quarters, which should be possible in future years as well, the company recently has invested in its sales force to keep its positive sales momentum intact and to capitalize on market opportunities.
Scholastic’s International segment has produced the highest growth rates over the last couple of years, but in the most recent quarter sales were flat after factoring in an accounting change. Adverse currency rate movements had a negative impact, though.
The long-term outlook for the segment is not bad at all, as the overall book market is growing at higher rates in many of the countries Scholastic targets compared to the U.S.
Due to strong growth rates primarily in Asia the International segment has a good chance of producing meaningful growth over the next couple of years.
Tevenues should grow by a low- to mid-single digits pace annually going forward, but earnings will likely grow even faster, thanks to the impact of cost controls (the company targets paper & printing spend, freight costs, etc.) that should help make the company more profitable going forward.
On top of that Scholastic buys back about 3% of its shares annually at the current pace of repurchases, which boosts earnings per share growth by ~3% as well.
Scholastic has a strong balance sheet, its net debt totaled just $345 million at the end of Q2, which was down $30 million year over year. Scholastic also holds a $360 million cash position that will allow it to continue with investments into technology while also keeping shareholder returns via dividends and share repurchases at a high level.
Due to its exposure to consumer spending, thanks to a high portion of children’s book sales, Scholastic was hurt during the last financial crisis, when profits were roughly cut in half. In a major recession the impact on Scholastic would most likely be severe again.
Scholastic’s shares are, unfortunately, trading at a quite high valuation. With a share price of $41 shares trade at ~25 times this year’s earnings. This is a huge premium over the broad market’s valuation as well as relative to Scholastic’s valuation in the past.
Multiple normalization (we forecast that shares will trade at 19 times earnings by 2024) will be a major headwind for total returns over the coming years.
Through a combination of earnings per share growth (6%-7% annually), multiple compression headwinds (-5% annual impact on total returns) and a dividend that yields 1.5%, we forecast annual total returns of just ~3% for Scholastic through 2024.
Book Publishing Stock #2: Pearson plc (PSO)
Pearson plc is the biggest book publishing company in the world, with annual sales of ~$6 billion and a market capitalization of $8.5 billion. Pearson is headquartered in the U.K., and the company was founded in 1944.
Pearson is active in consumer publishing, education content and business information markets.
Source: Pearson Investor presentation
Pearson achieved strong results during 2018, as the company was able to grow its operating profit by 8% year over year, while also reducing its net debt levels by roughly two thirds. Pearson’s earnings-per-share grew by 30% versus 2017, which is a highly attractive growth rate, and the company has also increased its dividend by 9%.
The only negatives were that Pearson’s cash generation remained below the prior year’s level during 2018, and revenues were down slightly.
Pearson has made significant progress towards its goal of becoming a leaner, more efficient, and more profitable company that has a highly sustainable business due to transforming it towards the digital age.
Pearson’s performance will likely improve through the coming years, as the company is tackling costs while investing for new (digital) growth opportunities.
Pearson’s transformation towards a digital-first publishing company is almost complete, as the company generated 62% of its revenues via digital or digitally enabled products during the most recent fiscal year, the highest level in its history.
Pearson is targeting costs and has set aggressive goals for cost reduction. During 2018-2020 Pearson wants to cut expenses by almost $400 million, all else equal this would result in a 40% boost to Pearson’s operating income.
Since there are other factors at play, though, such as inflation and lower trading profits, we forecast that profits will grow at a substantially lower pace (past cost saving programs and restructurings were less impactful than one would have guessed at first sight).
Nevertheless the cost savings program will most likely result in meaningful earnings growth during the coming years, especially when combined with lower finance costs due to Pearson’s progress in lowering its debt levels.
The company has cut its dividend twice during the last couple of years, which has brought down Pearson’s dividend yield to 2.0%, which, in combination with the unconvincing dividend track record, makes Pearson a rather unattractive income investment.
Pearson has made a lot of progress in lowering its debt level, as debt declined from $1.4 billion in 2016 to less than $200 million in 2018. This is an opportune move during times of rising interest rates, and the lower interest expenses Pearson will endure going forward will be a positive for its profitability in the long run.
Pearson’s valuation is significantly lower than that of Scholastic, Pearson trades at ~13 times this year’s expected earnings. Relative to its historic valuation this is a small discount, which provides some multiple expansion tailwinds as long as Pearson’s valuation rises back towards the historic range.
Through a combination of annual earnings per share growth of 4%-5%, multiple expansion (that will positively affect Pearson’s total returns by ~3% annually) and a dividend that yields 2.0% Pearson’s shares will deliver total returns of 9%-10% annually through the next five years, we believe.
Book Publishing Stock #1: John Wiley & Sons (JW-A)
John Wiley & Sons is a publishing company with a strong focus on the professional & scientific community, its products include research journals (scientific, technical, medical & scholarly), reference books, manuals, databases, scientific and education books, test preparation services, and more.
The company also offers services such as development and assessment services for businesses and services for higher education institutions. John Wiley & Sons was founded in 1807, the Hoboken-based company is currently valued at $2.6 billion.
Students as well as professionals have to read the material that John Wiley & Sons publishes, which makes John Wiley & Sons’ business less cyclical than that of its peers that are more reliant on consumer spending on books that they read for entertainment.
The company recorded a small revenue decline during the most recent quarter (fiscal Q3 of 2019), but that was due to adverse currency rate movements, at constant currencies John Wiley & Sons would have generated positive top line growth.
John Wiley & Sons’ profits also were under pressure during the most recent quarter, which is why fiscal 2019 will in all likelihood be less profitable than fiscal 2018, which was a record year for the company.
John Wiley & Sons’ business model – offering publishing and other services to the professional and scientific community – is less cyclical, less seasonal and less vulnerable to competition than the more consumer-oriented business models of Pearson & Scholastic.
John Wiley & Sons generates a significant portion of its revenues from journal subscriptions, which means that about 40% of John Wiley & Sons’ top line comes from recurring revenues.
John Wiley & Sons delivers about 70% of its products in digital form, the company therefore is among the leaders in reshaping its business model towards the digital age. With most of the transformation completed, investments into digitalization will slow down in the future, which bodes well for John Wiley & Sons’ margins.
Through a combination of revenue growth, incremental margin improvement and some share repurchases John Wiley & Sons should be able to grow its earnings per share at a relatively attractive pace of 5%-6% annually going forward.
John Wiley & Sons pays a dividend that yields 2.9%, the dividend has grown by 10% annually throughout the last decade. More recently the dividend growth rate has slowed down, though, as John Wiley & Sons has been investing heavily into digitalization.
Going forward the dividend will likely grow relatively in line with the company’s earnings. John Wiley & Sons’ balance sheet looks healthy. Despite a liabilities to assets ratio of ~60% the company has strong interest coverage, earning 14 times its annual interest expenses during 2017.
Shares of the company are trading at roughly 15 times this year’s earnings, representing a discount versus John Wiley & Sons’ historic valuation of ~17 times net profits. We see the company’s multiple expand towards that level over the coming years, which results in a ~2.5% annual tailwind for the company’s total returns going forward.
We forecast that shares of the company will provide the highest total returns among the three companies covered in this article, at 10%-11% annually, through a combination of earnings per share growth (5%-6%), dividends (2.9%), and multiple expansion (2.5% annually).
Due to offering the most promising total return outlook, combined with the best growth track record and the lowest cyclicality, John Wiley & Sons looks like the best publishing company right now.