Authored by Justin Hartwig
November 24th, 2021
Scholastic Doesn’t Jump Off the Page
Overview:
Scholastic Corporation (SCHL) is the world’s largest publisher and distributor of children’s books, as well as a provider for educational materials in schools from pre-K through 12th grade. The company is in the publishing industry within the communication services sector. The stock is priced at $39.20 on November 24th, 2021, valuing the company at a market cap of $1.366 billion. Scholastic will release its earnings for the second quarter of FY2022 between December 15th and December 20th, 2021.
Introduction:
As many might remember from elementary school, the word “Scholastic” signalled a swell of anticipation and excitement. Each student would receive a book catalog advertising both new offerings and childhood staples. A few weeks later, the school library would be transformed into a world of books for students to explore. Unfortunately, like many things children love, we eventually outgrow these juvenile pursuits. So it follows with Scholastic. While children may love this publishing company, investors should not find much comfort in its current stock price. Trading at a price of $39 a share at writing, Scholastic Corporation is currently overvalued, and I would recommend investors sell the stock ahead of earnings in mid to late December 2021. Scholastic last reached a similar price in 2019—well before any pandemic-related disruptions to its business model. To justify this valuation, Scholastic will need to prove it can adequately recover from steep revenue declines during the pandemic while simultaneously staving off headwinds in its industry at large. The company’s second quarter 2022 earnings will be a key juncture at which at least one of those questions will be answered. With the market seemingly convinced that Scholastic is back on track, there is ample room for disappointment when December rolls around.
Scholastic’s current stock price of $39 is nearly identical to its price in December 2019, despite its revenue and profit declines during the pandemic. Scholastic’s major revenue stream, publishing and distribution, suffered in a school environment that was either hybrid and online in many places. In addition, enhanced restrictions in many schools caused by COVID-19 likely had an effect on income from the company’s trademark book fairs and book clubs. In FY2019, the last year unaffected by the pandemic, Scholastic posted revenues of $1.654 billion. In FY2021, revenue was only $1.300 billion. As the pandemic subsides and elementary school-age children become eligible for vaccination, it is reasonable to assume that Scholastic’s revenues may return to previous levels. However, as alluded to above, merely returning to previous revenue is virtually required to justify its current valuation. Underwhelming earnings in the short term could reverse the stock’s fortunes. On a larger level, it is difficult to imagine that Scholastic can overcome the anemic growth of the publishing industry writ large while simultaneously recovering from COVID-related business disruptions.
The current price bakes in some assumptions about the growth of Scholastic’s business that may prove to be unfounded. Scholastic is not in a position where it can justify a higher stock price post-pandemic. Even before COVID, Scholastic was in no way a company known for its blockbuster success. In 2012, the company brought in over $2 billion. It has not done so at any point since then. Revenue declined from $1.742 billion in 2017 to $1.628 billion in 2018 before a negligible increase in 2019. In 2020 and 2021, revenue dropped precipitously. All of this is to emphasize that Scholastic is not a company aggressively pursuing growth; if anything, the company is sailing toward choppy seas regardless of pandemic conditions. Much of this feeble outlook is a result of general weakness within the entire physical publishing industry. As more and more consumers turn toward digital media, print publishing companies of all stripes have suffered. Analysts project a CAGR of 2% through 2025 in the print media industry—an underwhelming prediction to say the least. A middling company in a declining industry all adds up to a recipe for mediocrity, and mediocrity is incompatible with Scholastic’s current valuation.
Thesis:
Scholastic is priced as if the pandemic is over when there still exists significant uncertainty around how receptive schools will be to reinvigorating their partnerships with Scholastic. Thus, Scholastic’s stock has few catalysts driving its current price and a substantial possibility for downward movement, especially before it reports earnings for the second quarter of FY2022. Since this quarter should encompass revenue from the first part of the school year, earnings will be a clue as to if Scholastic can follow through on its prior business performance post-pandemic. Already, there may be warning signs on the horizon. On the company’s first quarter 2022 earnings call, CEO Peter Warwick mentioned that bookings for Scholastic’s book fairs were still below pre-pandemic levels. One contributing factor could be plummeting school budgets exacerbated by the pandemic recession. In the face of budget cuts, book fairs could be one of the first items on the chopping block. Supply chain issues are yet another challenge to overcome in the recovery period. The company’s 2021 annual report highlighted supply chain disruptions in Asia as a potential source of higher costs in the coming year. With a business model focused on fast distribution, high fuel costs and general logistical breakdowns in shipping could result in increased operational costs. Additionally, the cost of paper—obviously key for a book publisher—has risen in the past year as supply declined during the pandemic. These supply chain factors present thorny obstacles for Scholastic to quash on its road to pre-COVID business.
An unexpected factor complicating Scholastic’s return to normality is inside the boardroom. The company recently mourned the passing of its longtime CEO and Chairman, Dick Robinson. Surprisingly, Robinson bequeathed majority control of the company to Iole Lucchese, a senior executive and possible romantic partner, instead of to his two sons. Robinson’s sons are currently exploring legal avenues to regain control of the family business, but Scholastic is currently outside of Robinson family control for the first time ever. At the same time, board member Warwick was made CEO. The executive suite shake-up represents yet more tumult as Scholastic attempts to return to pre-pandemic performance. Again, this turmoil presents only downside for a stock that seems to have a complete return to normal already priced in.
Even if these challenges are overcome, Scholastic’s current valuation seems to be close to its ceiling in the last decade; in other words, there is much more room to fall than there is to rise. At the time of writing, the stock trades at a steep 296x P/E ratio in a media and publishing industry with an average ratio of 15x. Granted, that ratio is calculated off a lower EPS than should be expected in the future. If earnings per share were to rise to above 1, as they did in 2017 and 2016, then Scholastic may be more fairly valued than it currently appears. Unfortunately, the company has not reached those heights since, posting -0.14 and 0.44 dollars per share in 2018 and 2019 respectively. If we look at recent years, earnings data appears even worse, with the company earning -1.27 dollars per share in 2020 and -0.32 dollars per share in 2021. Even if the pandemic is ignored completely, the recent track record of Scholastic’s core businesses in non-COVID times does not inspire confidence around returning to the earnings of nearly half a decade ago. The price may be that of 2015, but the profits are not.
Risks:
While I am bearish on Scholastic, there are risks that could make Scholastic an attractive buy opportunity. The company’s new leadership may deviate from the Robinson family’s long-standing policy to keep Scholastic independent. As consolidation takes the publishing industry by storm—look no further than Penguin Random House’s attempted merger with Simon & Schuster—Scholastic could be an attractive acquisition target for a bigger player in the industry. New leadership can also be an opportunity for innovation just as much as it can be a risk for uncertainty. As an executive, Lucchese was involved in a number of projects to expand Scholastic beyond its core business of print publishing. For example, she championed an ultimately-rejected venture to use Scholastic’s web features more effectively during the pandemic. Other digital features Lucchese embraced included expanding Scholastic’s literacy and educational material to include more online options, especially during the pandemic. If Scholastic can continue to grow its digital capabilities, it could break from the rest of its print media rivals. In doing so, the company could avoid the worst effects of its industry’s broader decline and increase its own growth at the same time. While the company seems committed to its core business of print publishing and distribution, and no acquisition seems imminent as of now, the boardroom shakeup is only a few months old and plenty can change in the months and years to come.
Conclusion:
At its current price point, I believe Scholastic is overvalued given the company’s current revenue and weak industry growth profile. While the stock currently trades at a price nearly identical to its price four years ago, its revenue and earnings have not yet recovered to the same level. If a return to pre-pandemic business is baked into the stock price, this represents a significant opportunity in the event that Scholastic faces headwinds in its recovery. These challenges could range from school budget cuts, volatility in the executive suite, or a general decline in sales as digital media overtakes the print publishing industry. With this in mind, Scholastic has less room for continued upward trajectory and a lot of potential to fall in the near future. Therefore, I give Scholastic a sell rating.