Upward trend to continue: Why we think HMHC is a buy


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When Houghton Mifflin Harcourt Co (NASDAQ: HMHC) announced that it had completed the sale of its consumer book publishing business in early May, industry analysts revised their share price forecast upward.

Why is that? What's the reason behind the growing interest in the 189-year-old publishing house?

Apparently, it's not just the US$349 million in cash that the company received from the sale which piqued the interest of analysts, industry observers and investors alike.

hcmc hot stock shares

The more important issue at play is what HMHC intends to do after divesting one of its core business assets.

Like many companies, HMHC were forced to adjust their business operations when the COVID pandemic hit. Instead of physical publishing, HMHC is now focused on digital delivery of educational materials, instructions and guide books, reference works and assessment modules for young and adult readers.

This is despite the resilience shown by the book printing industry over the past several years amid the growth of digital reading platforms. It looks like HMHC is well and truly ready to let go of its 19th-century heritage.

What is HMHC and what does it do?

Founded in 1832 (yes, it's been around since the 19th century), HMHC was one of the leading publishing houses that started in Boston, Massachusetts.

You may not know it, but HMHC was instrumental in publishing some of the famous literary, academic, technical and instructional books over the years. Some of the well-known titles published by HMHC include:

  • The Little Prince and Mary Poppins
  • J.R.R. Tolkien's The Lord of the Rings
  • Rachel Carson's Silent Spring - one of the first books to document the impact of chemicals on the environment
  • American Heritage Dictionary
  • Educational materials on algebra and chemistry, and thousands of cookbooks
  • Virginia Wolf's To The Lighthouse and Mrs Dalloway.

Focus on digital learning and education delivery

However, with advances in technology and the changing user preference for everything digital, HMHC has gradually turned its focus away from physical print. Fortuitously, it was already changing toward digital before the pandemic hit.

In October 2020, when most of the world was still in lockdown and students were forced to attend classes online and access online educational materials, HMHC put its strategic restructuring in fast-track mode.

The sale of its consumer book publishing business (to NewsCorp) is part of its focus to go digital.

In his statement when the sale was announced, HMHC CEO Jack Lynch said: "This divestiture enables us to focus singularly on serving the large and growing K -12 education market."

According to Lynch, the company's digital technology platform will enable it to deliver digital learning to approximately 90% of schools in the US.

Currently, HMHC serves more than 50 million students and 3 million educators in 150 countries.

Strong financial results

When it reported its latest financial results for the period ending March 31, 2021, HMHC showed some strong numbers that include:

  • Trailing 12-month free cash flow of US$72 million, which demonstrates a strong positive free cash flow generation
  • Rapid year-over-year growth of 80% in annualized recurring revenue (ARR) 2 to US$65 million.
  • Connected Sales made up 51% of billings for the trailing 12 months ended March 31, 2021
  • 42% of billings were digital for the trailing 12 months ending March 31, 2021
  • Cost of sales: Overall cost of sales decreased by US$12 million to US$86 million, primarily due to lower print costs, increased virtual delivery of products and services and lower amortisation expense.

Commenting on the financial results, CEO Lynch said: "We entered the new year keenly focused on executing our Digital First, Connected strategy. As our market stabilizes, our first-quarter results represent a strong start to the new year."

Following the strong results, industry analysts adjusted their HMHC share price forecast. Industry observers also noted institutional investors accumulating and increasing their holdings of HMHC stocks.

For example, analysts at BMO Capital Markets have increased their share price forecast for HMHC from US$8.00 to US$11.00 in a report released in mid-May.

Recent share trading results showed some big institutional buyers including:

  • Alliancebernstein L.P. boosted its holdings in HMHC by 3.7% in the first quarter. Alliancebernstein L.P. now owns 8,896,537 shares
  • BlackRock Inc. lifted its stake in HMHC by 1.8% in the first quarter. BlackRock Inc. now owns 8,104,087 shares
  • Bank of New York Mellon Corp lifted its stake in HMHC by 48.5% in the first quarter. Bank of New York Mellon Corp now owns 5,174,222 shares

HMHC share price performance

After five years of disappointing share price performance, the gains achieved so far in 2021 reflect a significant re-rating of the stock by market participants. From lows of less than US$2 just a year ago, HMHC is now on track to retest highs around US$10 to US$10.50, last seen in early 2019.

Although trading volumes have been comparatively light, the gains achieved over the past six months have been relatively stable with the exception of a brief corrective dip in March.

Recent probes above the consolidation zone of May point toward a continuation of upward momentum in the near term. If the current trajectory can be maintained, the next major targets will be in the region of US$14, which would mark a retracement of approximately 50% of the fall from the 2015 highs above US$27.

Outlook for the industry

In a recent article about the growth in online education, Entrepreneur magazine listed HMHC and two of its competitors (Chegg and GP Strategies) as the leading players in the growing market segment.

The article highlighted HMHC's sale of its consumer book publishing business as a strategic move to focus on digital learning programs.

Another online education industry report said the publishing and printing trends of 2021 will continue to drive more people away from print and a larger audience online.

Given the continuing move towards digital delivery of most services - including education and learning - and its well-established presence in the industry, HMHC is in a strong position to take advantage and lead the way to more growth.

It looks like the uptrend which emerged from the lows of 2020 has the potential to go a lot further.

We consider HMHC a buy.

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Alex Douglas is managing director of Monex Securities Australia (AFSL 363 972), and is responsible for the overall growth of Monex in this region. He has held senior executive positions with numerous financial services companies both in Australia and Asia over the past three decades. Early roles in the industry included being a foreign exchange voice broker, a trader on the floor of the Sydney Futures Exchange and a senior analyst with Standard & Poor's in Singapore.  Alex is a Certified Financial Technician (CFTe) and former board member of the International Federation of Technical Analysts (IFTA) as well as a sought-after author, speaker and market commentator.