Time to book Pearson profits

Pearson; Novar; ReNeuron
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The Independent Online

Four years ago Marjorie Scardino took the helm at Pearson, vowing to boost earnings per share by at least 10 per cent every year and to double the share price within five years. As poor performers and peripheral businesses were sold, much effort was expended to build scale in educational publishing, TV and financial information.

The refrain was simple: if the company couldn't be a top three global player in a business, it would get out. With the group remade, investors are set to get the pay-off with 2001 earnings per share forecast to surpass 40p for the first time. Next year the impact of declining investment costs and continued gains in educational publishing are forecast to push EPS over 55p.

Since we reviewed Pearson in December, when the shares were judged fully valued at 1,622p, the environment for media stocks has worsened. New evidence from across the Atlantic that recruitment advertising has gone off a cliff is likely to stall the path to profitability of the Financial Times in the US. Internet costs will impair profitability further. But the string of recent investment notes paring EPS forecasts miss the longer-term concern.

Education now accounts for more than 60 per cent of Pearson's sales and though revenue grew strongly last year, that masked weak gains in operating profit and highlighted Pearson's dependence on acquisitions. With debt of £2.3bn and further progress reliant on integration targets being met, the group is vulnerable to execution risk. As so often with stocks, it is better to travel hopefully than arrive

Another downbeat broker note yesterday pushed Pearson shares down 38p to 1,121p, its worst since July, 1999. But that is still 70 per cent higher than when Ms Scardino took over.

It trades on a prospective price/earnings ratio of 28, falling to 21 in 2002. That valuation, while more realistic than at any time in the past year, encapsulates the upside in forecast EPS growth. Given the high volatility of media stocks and deteriorating investor sentiment, the likelihood is that Pearson will under- rather than outperform the market. Investors who have held the stock for some years should consider booking profits, while those who bought during the TMT boom should cut losses.

Novar

The discount applied to Novar's share price because it is a conglomerate just got bigger, following a profit warning in one corner of the sprawling North American group.

A third of its business is in shaping aluminium for use as windows and doors and truck parts, and for use inside computers and in the cable TV industry. And a trading statement yesterday revealed that to be a very sick business indeed.

The market for these types of aluminium products was down 27 per cent in the first quarter and, surprisingly, not much better in the second. With the US automotive industry still on the hard shoulder, the cable industry scaling back infrastructure products, and PC sales slowing, the outlook doesn't look great either. Novar is planning a wave of new factory closures, spending over £30m this year on restructuring ­ some 50 per cent more than analysts had been forecasting.

Novar, when it was known as Caradon, came under attack from the activist investors Julian Treger and Brian Myerson, whose break-up bid was rejected by shareholders in January. Today's profit warning is sure to reignite demands for the company to focus more clearly on its stronger fire and building security business, perhaps selling its security printing division and returning cash to shareholders.

Yesterday's fall sent the stock down 18p to 141.5p and leaves the stock on a 2001 p/e of 11, according to one analyst who had adjusted his forecast. There is likely to be more weakness in the coming days as analysts rejig their models and institutional investors consider their positions, but the rating is now undemanding and the stock is a speculative restructuring play.

ReNeuron

News of a setback for ReNeuron, the biotech seeking a treatment to repair the brain damage done by a stroke.

The company's gene technology prompts stem cells taken from the brains of foetuses to multiply, providing the billions needed for transplant into a damaged human brain.

But the cells become genetically unstable after too many doublings, and it is going to take at least a year of extra research to overcome the problem. Its hopes for a 2008 launch appear to have been dashed.

The new timescale means ReNeuron will plough more cash and effort into trying to develop stem cells from parts of the foetus other than the brain. Good news on this front is one of the best hopes for a share price spike but yesterday the stock was off 9p at 117.5p.

The latest disappointment is a reminder of the daunting ethical and scientific hurdles ahead. This is not one for squeamish investors.

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