Royce & Associates Goes Back To School With Scholastic

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According to a 13G filed with the SEC, as of October 31 Royce & Associates, a fund managed by Chuck Royce which tends to invest in smaller-cap value stocks (see stocks that Royce & Associates owned at the end of June), owned 3.1 million shares of Scholastic (NASDAQ: SCHL). This gives the fund ownership of just over 10% of the outstanding shares, and represents an increase from the end of June when Royce & Associates reported a position of 2.6 million shares in its 13F filing. Scholastic is a $1.1 billion market cap publishing and media company focused on providing educational content for children.

In the first quarter of Scholastic Corp’s fiscal year (the quarter ending in August), the company reported an 8% decline in revenue compared to the same period in the last fiscal year. Expenses were down but Scholastic still ended up with a somewhat larger net loss than a year earlier- losses per share were $1.02 versus 87 cents. Scholastic’s business is quite seasonal, picking up in the fall and spring, and so this poorer performance shouldn’t be overemphasized by investors.

The company’s pricing, however, suggests that the market is a bit pessimistic about Scholastic’s future prospects. The trailing P/E is only 11, with the forward P/E rising to 12 as analysts expect lower earnings per share in the fiscal year ending in May 2014 than what the company has been turning in recently. It’s easy to see why Royce likes the stock: those multiples place Scholastic Corp in value territory, and it has a small enough market capitalization that larger funds might ignore it. Our data suggests that the next largest hedge fund position in the stock at the end of the second quarter was the 340,000 shares owned by Renaissance Technologies, founded by billionaire Jim Simons. Cliff Asness’s AQR Capital Management had a slightly smaller position (find more stocks from Renaissance Technologies and from AQR Capital Management). We’re worried about the fact that the sell-side is being so negative (as well as the fact that 16% of the shares outstanding are held short), and with the lower earnings last quarter we’d like to wait for the crucial results from the fiscal quarter ending in November to come in.

Scholastic’s peers include publishers The McGraw-Hill Companies (NYSE: MHFI), Pearson (NYSE: PSO), and John Wiley & Sons (NYSE: JW-A). These companies’ forward P/E multiples are in the 12-14 range, so Scholastic is at the lower end of this peer group in that regard. McGraw-Hill and Pearson are significantly larger in terms of market capitalization, and both of these companies currently operate financial information businesses (McGraw-Hill is in fact planning to spin out its education division) which we think are more attractive businesses. McGraw-Hill also saw its earnings tick up rather than down in its most recent quarter versus a year ago, while Pearson actually has a decline in earnings built into its price given that it is trading at only 11 times trailing earnings. Either of these two companies looks more attractive at first glance, though given that they are in the publishing industry we’d have to look at them very carefully. Wiley- which while smaller than the other two still has over twice Scholastic’s market cap- saw its revenue drop 5% in its most recent quarter compared to the same period in 2011, which combined with lower margins drove earnings down 29%. We’d prefer McGraw-Hill, as that company carries only a small premium but seems to be in a better position business-wise.

Scholastic can also be compared to children’s curriculum developer K12 (NYSE: LRN). K12 is more of a growth company, with its revenue and earnings rising, but it trades at high earnings multiples as investors are depending on that growth to continue for some time in order to justify its current price. At a market cap of about $740 million, it trades at 30 times expected earnings for the current fiscal year (ending in June 2013). Like Scholastic, K12 is a target for short sellers and we’d avoid it as well.

There’s something to be said for Royce increasing its position in Scholastic, but that fund is outnumbered by short sellers who are willing to invest in the company being overvalued at the current price. We wouldn’t quite recommend a short- the P/E multiple is quite low- but think that investors should stay away from buying as well for now.


This article is written by Matt Doiron and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool owns shares of The McGraw-Hill Companies. Motley Fool newsletter services recommend John Wiley & Sons and K12. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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