Broker tips: Stagecoach, Pearson

Bus and rail operator Stagecoach got a boost on Friday as Citi upped its stance on the shares to 'buy' from 'neutral' as it argued there is too much negative sentiment priced in.

The bank, which cut its price target to 155p from 177p, pointed out that the shares are now trading at their lowest level in 15 years following the recent reset, with price-to-earnings ex-rail at around 10x and EV/EBITDA excluding rail at 5.5x for 2019 estimates.

It noted that since the peak in June 2015, the shares have fallen just over 70% due to slowing passenger growth in the UK and falling margins, significant profit warnings in its rail franchises, the underperformance of its North American division and a cut in the dividend payout.

"However, with the impending exit from the beleaguered UK rail sector and the sale of the underperforming North American division, we see a significantly de-risked portfolio with a cash generative UK business with stabilising operating profits and which has scope for opex efficiency gains to offset further negative demand or opex inflation."

Citi said the share price is now sufficiently low that it appears the market is pricing in negative earnings growth for the foreseeable future.

"If we focus on Regional Bus (which accounts for more than 90% of our valuation) this negative growth assumption seems at odds with the realities of a division that should see operating profit stabilise and which generates a return on invested capital around 13% on our estimates, some way above a weighted average cost of capital of circa 8%."

Analysts at Shore Capital upgraded shares of UK technology and publishing outfit Pearson from 'hold' to 'buy' on Friday, noting it was "encouraged" by the group's "solid start" to the year as outlined in its first-quarter trading update published earlier in the session.

Pearson's trading statement indicated a strong start to the year, with total underlying revenue growth of 2% and an "on track" operating performance. The Cambridge-based firm also confirmed that it was on course to deliver cost savings of more than £330m by the end of the trading year.

Underlying revenues for Pearson's North American and core segments were ahead 2% and 4% year-on-year, respectively, while its growth segment posted a flat performance.

Looking forward, Pearson indicated that it would continue to accelerate its digital transformation programme and highlighted "momentum in key structural growth opportunities". Full-year guidance was unchanged with operating profits pegged to come in around £590m-£640m.

Discussing the update, ShoreCap said: "We are encouraged by the solid start to FY19F indicated in this morning’s release and are positive on the potential for PSON to tap into long-term growth in global learning spend.

"Although the company still has a few trading issues to overcome and a fair degree of organisational change to execute, most of its underlying businesses appear to be gaining traction – as does its digital transformation strategy."

With Pearson's current P/E and DPS valuations not appearing to be so demanding relative to its expectations for a "solid three-year EPS and DPS progression" and strong cash generation, the broker decided to upgrade its recommendation from 'hold' to 'buy' and reiterate its 865p target price.