McGraw-Hill Outlook Murky

The outlook for McGraw-Hill Companies’ (MHP) Financial Services segment is murky as the mortgage-backed securities and CDO markets have dried up. Financial Services operating income is shrinking at high-teens rate (down 18% in 3Q08) and we don’t think it will trough until at least 4Q08, and will likely remain weak through 2009. Rising mortgage defaults and the resultant drop-off in the U.S. residential mortgage-backed securities market will not likely reverse itself for many quarters.

The Education segment is also declining in the low single-digit range, driven by lower discretionary spending by schools facing budgetary pressures. This weakness in Financial Services (down 12% in 2008) and Education segment (down 2%) should be slightly tempered by mid-to-high single-digit growth in the Information & Media segment (6% to 8%), and the company’s increased focus on non-transaction revenue.

The stock is trading at a discount to our estimate of its 5-year growth rates and the yield is attractive (3.6%) but, in our view, visibility in Financial Services is low and therefore creates additional risk to our estimates.

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