Scholastic Q1 Earnings: Not A Phenomenal Showing

Scholastic's (NASDAQ:SCHL) price tanked yesterday, keeping it within its broad trading range between $45 and $33. The earnings were announced, and while it wasn't good, it's in a quarter that usually isn't great since it's before the back to school season. We're not too impressed with fixed cost inflation, which is where we think there is the primary problem on an ongoing basis for the company. The guidance is decent, although not good enough to justify the previous valuation. At least there's no debt to hamper earnings as rates rise, but the fixed cost inflation, tepid guidance justifies the decline. However, now it looks fair, and we think a decent back to school season is coming.

Q1 2024 Breakdown

The Q1 is out now, which demarcates the period just before the back-to-school season which is coming next quarter.

Some housekeeping comments. Inventory is large as is usual before the back to school season, which begins with a lot of activity and book fairs that helps drive strong quarters for the company. Gross margins aren't too bad, since a lot of the inventory was built recently for new publications that would've come out pretty recently. The Q1 already shows pretty stable GM performance, and we expect that to continue in the back to school Q2. The reason things have been decent on the GM side is that freight costs and other input costs have come down. The rising energy prices isn't such a good thing though and offsets some of the benefits of the deflation in freight.

The bigger issue is in SG&A. Note that it is up by more than 10%. This is mostly from labour inflation, but it is also slightly from the fact that a benefit related to renting to outside tenants is no longer offsetting the SG&A. However, Scholastic is apparently opening up a lot more headquarter office space in order to make some new income from outside tenants. Several floors have been rented out and around $2.4 million is now coming in from rental revenue, which is larger than the benefit lost in SG&A since a lot of these new leases have been recently signed.

Fixed costs coming up due to employee related costs is an issue. Some of it is headcount increases, but it's also because there has been secular growth in employees utilising medical costs since the end of the pandemic. We expect this to continue, and if the company clamps down on it for severance costs to rise associated to turnover. It's difficult to price beyond this, and it has become somewhat of an enduring issue for the company in our eyes.

Finally, on revenues, they are down in their totality by 18%. It's not great at all, but this is an exceptionally weak season for the company. It's easy to get volatility when sales are so light anyway around now. Still, while somewhat noisy, it is a bit of a worrying signal for the coming season, although there are some major new releases coming out, things by Dave Pilkey, Suzanne Collins' Hunger Games prequel which should also come with an anticipated movie. They continue to milk Harry Potter as well, a new Harry Potter cookbook is out among other things.

Bottom Line

There's also the guidance. They are basically guiding for a flat EBITDA evolution into the FY 2024. That is a bit concerning. Excluding some restructuring costs it would be up around 5% according to the guidance, but we're including it. It does signal maybe somewhat limited expectations for new sales, although sales growth is necessary for any EBITDA evolution at all given the higher fixed costs. We have some faith in some of the new titles coming out, especially the Hunger Games prequel, but the tepid guidance on a pretty steep forward PE as of prices before yesterday makes it pretty understandable that markets would reprice the stock back to the lower end of its trading range. The forward PE around 13x is a lot more appropriate.

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