Why Pearson just rocketed 17%

Few expected much from education publisher Pearson's regular January update. "Tough trading conditions, a cut dividend, restructuring and retrenchment," is how one analyst teed it up yesterday. And it really wasn't pretty, but there is enough here to satisfy the bulls and, having halved since March last year, the shares blasted 17% higher Thursday.

"We have undertaken a rigorous, bottom-up review of our markets, our operations and our financial plans," explained the blue chip firm. "As a result, we are taking further action to simplify our business, reduce our costs and position ourselves for growth in our major markets."

After doing the maths, Pearson, which sold both the Financial Times (FT) and its 50% stake in the Economist Group last year, also provides earnings guidance for 2016 and tells out where it wants to be by the end of 2018.

For 2015, bosses steer us toward adjusted operating profit of about £720 million, giving adjusted earnings per share (EPS) of 69-70p. Management had previously pencilled in 70p-75p, and 75p-80p before the profits warning on 21 October.

Crucially, the dividend, which looked to be in massive danger, rises 2% to 52p. It also expects to keep it at that level until it rebuilds profits to sufficiently cover the payout.

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Restructuring, most of which should be complete by "mid-year", does not come cheap - it will cost £320 million this year - although annual savings are put at £350 million, a chunk of which will materialise in 2016, with the remaining £100 million coming through next year.

Pearson thinks it will make £580-£620 million underlying profit this year, giving EPS of 50-55p. That's because restructuring benefits still don't offset lost profit from the FT and Economist Group, and difficult markets. It's lost testing contracts in the US, too. Operating profit including restructuring costs will be £260-£300 million. Get it right, and profit could jump to at least £800 million in 2018.

"Whilst it is disappointing to see further restructuring costs and little, if any, improvement in underlying markets, we are broadly encouraged that Pearson has decided to redouble its efforts to meet external and internal challenges," writes Roddy Davidson at Shore Capital.

Having plunged to 644.5p midweek, its lowest since 2009, Pearson's share price traded as high as 768p Thursday. "While it is undoubtedly a time for tin hats, much of this is already in the share price at 8 times [cash profit]," explains Panmure Gordon's Jonathan Helliwell.

These levels are the best we've seen since Christmas Eve, but still a long way from the 1,500p registered in March 2015 and the 1,200p we saw just before the October warning.

We are, however, at an interesting point in terms of the charts. Our technical analyst John Burford said earlier this month that the "odds favour a sharp rally soon". He added that this would be "counter-trend, at least until I see a particular wave pattern develop". If the rally does build a head of steam, "a gigantic short squeeze should take the market to the £11 at least". Watch this space.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.