Editor's note: This article has been corrected to indicate that Houghton Mifflin Harcourt does have a share repurchase program and that education is HMH's main focus.
Times have been tough for traditional book publishers. The rise of online self-publishing has leveled the playing field for writers, cheap e-books have lowered price expectations, and used book sales have reduced publisher revenues. Research firm PWC estimates that global books revenue will grow at a compound annual growth rate of just 1.3% between 2014 and 2019.
But despite those challenges, two big book publishers, Scholastic (NASDAQ:SCHL) and Houghton Mifflin Harcourt (NASDAQ:HMHC), have actually outperformed the market. Over the past 12 months, Scholastic has rallied 22%, while Houghton has gained 4%. Let's take a closer look at both companies to see which is a better investment in the book publishing industry.
Scholastic is a market leader in the school book market, which is well-insulated from the oversaturated consumer book market. The company's education segment includes the "publication and distribution to schools and libraries of children’s books, classroom magazines, supplemental classroom materials, custom curriculum and teaching guides and print and on-line reference and non-fiction products for grades pre-K to 12 in the United States," according to Capital IQ. It publishes popular book series like The Hunger Games and Harry Potter (in the United States) and generates a stable stream of revenue from book fairs. Scholastic previously sold educational software through its Educational Technology division, but it sold that unit to Houghton Mifflin Harcourt earlier this year for $575 million.
In fiscal 2015, Scholastic's revenue from continuing operations rose 4.8% annually to $1.64 billion. Children's Book Publishing and Distribution revenue climbed 7.4% to $959 million, while Education revenue rose 8.2% to $276 million. Its international revenue dipped 3% to $401 million, but growth at the other two segments offset that decline. A major risk for Scholastic's children's division is waning interest in the Hunger Games and Harry Potter, due to the conclusion of both film series. As a result, analysts expect Scholastic's revenue to rise just 1.5% in fiscal 2016.
Scholastic's diluted earnings per share from continuing operations rose 12.2% to $0.46 per share in 2015. Looking ahead, analysts expect Scholastic to post annual earnings growth of about 9% over the next five years. Based on that forecast, Scholastic's current forward P/E of 22 and 5-year PEG ratio of 2.9 indicate that the stock is currently overvalued. But in October, Oppenheimer analysts stated that Scholastic might sell three floors of its Manhattan headquarters for over $350 million, which would produce $250 million ($7.31 per share) in after-tax proceeds and boost its earnings growth.
Over the past 12 months, Scholastic has spent 14% of its free cash flow on buybacks and 20% on dividends. That conservative use of its FCF indicates that it has room to grow both to boost shareholder value in the future.
Houghton Mifflin Harcourt
Scholastic rival Houghton Mifflin Harcourt publishes best-selling titles like The Lord of the Rings, Life of Pi, and the Little Prince. Like Scholastic, Houghton publishes mainstream books through its trade publishing unit. However, 88% of Houghton's revenue last year came from its educational business, which provides core curriculum books, materials, educational software and tech services to K-12 classes. The company says it provides the core curriculum books and materials for the majority of K-12 students in the U.S. The company also develops programs that could be aligned to state standards and customized for specific state requests and offers standardized testing products, according to Capital IQ. Therefore, Scholastic and Houghton's education businesses generally complement one another instead of directly competing for the same market.
The publisher went public in late 2013 at $12 per share, closed over $16 on its first trading day, and trades at about $20 as of this writing.
In fiscal 2014, HMH's revenue slipped 0.5% annually to $1.37 billion. Education sales stayed nearly flat at $1.21 billion, while trade publishing revenues fell 4.7% to $163 million. However, the aforementioned acquisition of Scholastic's Education Technology unit should boost HMH's top-line growth. That unit generated $249 million in revenues in fiscal 2014 and $175 million in the first nine months of 2015. Thanks to that boost, analysts expect HMH's revenues to rise 5% annually this year and 8% in fiscal 2017. But as HMH notes in the "risk factors" part of its most recent 10-K filing, the educational software and services business could be disrupted by curriculum changes in the controversial Common Core program in the U.S.
On the bottom line, HMH posted a net loss in both fiscal 2013 and 2014. Looking ahead, analysts expect HMH to grow its earnings per share at just 5% annually over the next five years. That's considerably lower than Scholastic's expected earnings growth rate. HMH bought back $240 million in stock in the first nine months of 2015, but doesn't pay a dividend.
The winner: Scholastic
Scholastic is clearly a better book publishing stock than HMH. The company has better top- and bottom-line growth, room to boost buybacks and dividends, and a more flexible customer base across schools. However, investors should note that the stock's valuations are getting a bit high, and its children's publishing revenue could slip if it fails to secure a new best-selling series like The Hunger Games.
Leo Sun has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.