Published on June 29th, 2018 by Jonathan Weber
The book publishing industry is undergoing rapid changes. While the book-publishing business model remained relatively unchanged for decades, it is steadily moving towards new technologies, such as e-books. In addition, distribution channels are also shifting. Traditional book stores are closing, whereas sales of books via e-commerce platforms are growing at a high rate.
Amazon (AMZN), which started out as an online book store before expanding into many other product categories, is the largest online book seller. Amazon is not only selling books; it has also moved into book publishing, and is infringing on the traditional publishers such as Random House.
Despite this, the publishing industry still has several positives. Market research firm NPD reports that physical book sales rose by 1.9% during 2017, so even in this segment there is some growth that publishers can benefit from. The global book publishing market is also forecasted to continue to grow over the next couple of years, supposedly 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), the parent company of Random House.
All three stocks pay dividends to shareholders, and are among 674 dividend-paying consumer cyclical stocks.
They are ranked by estimated total returns over the coming five years in this article, and 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 major publishers, with a market capitalization of $1.5 billion. Scholastic, which publishes children’s books, teaching material and magazines, was founded in 1920 and is headquartered in New York, NY.
Scholastic grew revenue by 3% in the last reported quarter, but the company has struggled to maintain profitability. Due to the high amount of children book sales (which make up ~60% of the company’s revenues) total revenues are 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 had to report a small net loss ($0.30 per share), but the company is nevertheless forecasting relatively solid profitability for the whole year.
Source: Scholastic Investor Presentation
Scholastic forecasts profits of $1.40 per share for the current fiscal year, a significant decline from $1.83 in 2017. Scholastic’s profitability has seen ups and downs throughout the last decade, as 2018 expected earnings-per-share are only slightly higher than they were in 2009 (earnings of $1.24 per share).
However, we forecast that profitability will increase substantially over the coming years, due to several positives. First 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 has 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, since the company has invested into its sales force. International revenue is a separate catalyst, with 8% international growth last quarter.
Total revenue should grow by a low-to-mid-single digit 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 profitable on a consistent basis. 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 very strong balance sheet, with total debt of just $8 million, compared with approximately $360 million in cash and cash equivalents. The high net-cash position (relative to the company’s size) will allow Scholastic to continue with investments into technology, while also keeping shareholder returns via dividends and share repurchases at a high level.
Scholastic shares are, unfortunately, trading at a very high valuation. Despite profits declining during 2018, shares have risen more than 30% from their 52-week low. At a share price of $44, shares trade at ~31 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 2023) will be a major headwind for total returns over the coming years.
Through a combination of 13%-14% earnings per share growth, price-to-earnings ratio compression, and a 1.4% dividend yield, we forecast annual total returns of 4%-5% for Scholastic through 2023.
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 $8.9 billion. Pearson is headquartered in London, United Kingdom, and the company was founded in 1944. Pearson is engaged in consumer publishing, education content, and business information markets.
Last quarter, Pearson grew revenue by 1%, and the company had previously issued guidance for earnings of $0.65 to $0.70 per share during 2018.
Source: Pearson Investor Presentation
When we look at Pearson’s results during 2017, we see that most things moved into the wrong direction. Underlying revenue declined slightly, while operating profit and earnings-per-share declined by close to 10% each. Strong cash generation and lower debt levels were positives, but declining profits – a trend that has been intact since 2011 – remain the biggest challenge for Pearson.
Pearson’s performance will likely improve through the coming years, though, as the company’s sales performance is improving and since Pearson is tackling costs at the same time. The first-quarter update, which included a sales increase of 1%, is not overwhelming at first sight, but when we take a closer look we see that the company is moving into the right direction. Sales in North America were up by 3%, while sales in the Core segment (U.K., Australia, and Italy) grew by 6% year over year.
The Growth segment was the only one with a negative performance, down 12% year over year, which can be explained by an unusually large order from the South African educational system during Q1 2017. Adjusted for that, the Growth segment would have generated positive top line growth.
In order to stop its profits from declining further Pearson is targeting cost reduction, and has set aggressive goals. During 2018-2020 Pearson aims to cut expenses by almost $400 million, which would result in a 40% boost to operating income. Since there are other factors at play, such as inflation and lower trading profits, we forecast that profits will grow at a substantially lower pace.
Nevertheless, its cost savings program, combined with a solid revenue growth outlook, will most likely bring Pearson back on growth track in 2019.
The company has cut its dividend twice throughout the last two years, which has brought down Pearson’s dividend yield to 2.0%. Combined with the unconvincing dividend track record, Pearson is an unattractive income investment.
Pearson has paid down a significant amount of debt through 2017, lowering its long term debt position from $1.4 billion to $600 million. This is a good financial decision to make, since interest rates are rising. 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 stock trades at ~17 times this year’s expected earnings. Through a combination of annual earnings per share growth of 5%-6%, multiple compression of 1%-2% annually, and a 2.0% dividend yield, Pearson’s shares will deliver total returns of ~6% annually through the next five years.
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. 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, and has a market capitalization of $3.7 billion.
Source: John-Wiley & Sons Investor Presentation
The company recorded solid revenue growth during the first three quarters of fiscal 2018. Its earnings-per-share have grown by 8% annually over the last three years, and profitability is substantially higher than it was ten years ago.
John Wiley & Sons’ focus on the professional and scientific community is less seasonal, and less vulnerable to competition than the more consumer-oriented business models of Pearson and 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 share repurchases, John Wiley & Sons should be able to grow its earnings per share by 6%-7% annually going forward.
John Wiley & Sons stock also offers a 2.0% dividend yield, and the company has increased its dividend by 10% per year over the last decade. Dividend growth has slowed down more recently, as John Wiley & Sons accelerated its digital investments. Going forward the dividend will likely grow relatively in-line with the company’s earnings growth rate.
Shares of the company are trading at roughly 18 times this year’s earnings, which is not a very high valuation, but it is slightly higher than John Wiley & Sons’ historic valuation. We see the company’s multiple decline to 17 over the coming years, which results in a small headwind to 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 ~7% annually, through a combination of earnings per share growth and dividends, partially offset by multiple contraction (a 1.5% annual headwind).
Due to its highest total return potential, combined with the best growth track record and the lowest cyclicality, John Wiley & Sons appears to be the best publishing stock today.