Better Stock in Book Publishing: Scholastic Corp. or Houghton Mifflin Harcourt Co?

By Fool.com

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.

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But despite those challenges, two big book publishers, Scholastic and Houghton Mifflin Harcourt , 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.

ScholasticScholastic is the market leader in theschool book market, which is well-insulated from the oversaturated consumer book market. 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 unitto 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 risejust 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.

Scholastic's top-selling books. Source: Scholastic.

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 HarcourtScholastic rival Houghton Mifflin Harcourt publishes best-selling titles like The Lord of the Rings, Life of Pi, and the Little Prince. In addition to publishing mainstream books through its trade publishing unit, Houghton runs an educational products business which provides educational software and tech services to schools. 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% infiscal 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. HMH also notably lacks Scholastic's entrenched position in school systems.

On the bottom line, HMH posted a net loss in both fiscal 2013 and 2014. Looking ahead, analysts expect HMH to growits earnings per share at just 5% annually over the next five years. That's considerably lower than Scholastic's expected earnings growth rate. Due to that bottom-line weakness, HMH doesn't buy back stock or pay a dividend.

The winner: ScholasticScholastic 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 stickier 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.

The article Better Stock in Book Publishing: Scholastic Corp. or Houghton Mifflin Harcourt Co? originally appeared on Fool.com.

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