One of the biggest fears facing investors right now is counterparty risk – and not just in the ailing financial sector. Areas such as the oil-rich Middle East, especially Dubai, are also suffering. For example, Mouchel, Hyder Consulting and Lamprell, large contractors in the region, have all reported problems collecting debts. It seems that local customers are refusing to settle invoices – a cash-flow drought that began in November and has not yet broken. With the number of insolvencies rising, more problems in other once-resilient sectors will arise. Cautious investors should stick to sectors with historically low levels of debt defaults – such as education.
Pearson (LSE:PSON), rated OUTPERFORM by BNP Paribas
Take Pearson. As well as owning the Financial Times (16% of turnover) and Penguin Books (20%), it also runs a first-class education unit (64%) offering school, student and professional literature and exam-testing services. The latter has proved robust in past downturns because it tends to outperform when job prospects are poor as more people seek further education and retraining. But that is only part of the story. Ear-marked within US president Barack Obama’s $787bn stimulus package is $100bn for education. This nearly doubles last year’s spend and should give Pearson’s local operation a boost.
Pearson’s chief executive, Marjorie Scardino, said on 19 January that the group had met, or beaten, its previous guidance in all its businesses and that full-year 2008 earnings growth of 20% was expected, indicating that earnings per share (EPS) would rise from 46.7p to about 56p. Despite the worsening economic climate, the board was also confident about 2009, with the City pencilling in sales and underlying EPS of £5.2bn and 56.5p respectively, rising to £5.4bn and 57.1p in 2010. As such, the stock trades on an undemanding p/e ratio of 11.4, and pays a 5% yield.
So what are the risks? Well, the FT is exposed to the parlous advertising sector, although this only represents around 5% of turnover. And one of Pearson’s closest rivals in America, McGraw-Hill, recently complained of declining state funding for school textbooks. Yet this softness should be more than offset by the forthcoming $100bn spending spree. The group’s net debt of about £1.1bn also needs to be watched, although given Pearson’s strong cash flows, its dividend and interest payments both look well covered.
All told, with little exposure to bad debts, large overseas interests (80% of sales) and defensive positions in counter-cyclical markets, I rate Pearson a buy. Preliminary results are due out on 2 March.
Recommendation: GOOD VALUE at 642p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments.