Ian Whittaker
Ian Whittaker
A view from Ian Whittaker

Investor view: Where now for agency groups after pandemic bounceback?

Ian Whittaker is starting a regular Campaign column, Investor view, about the advertising and media landscape from a financial standpoint. This month, he examines the recent half-year results of the big agency groups.

This is the first of my columns for Campaign covering the world of media, tech and everything related. By way of introduction, I was a City analyst covering the space for 20 years so I have seen a lot of change in that time.

I will be taking a look at the landscape from a bigger picture view and from a financial and investors’ standpoint. Given that, I thought I would start off by looking at what the agency results so far tell us about the future for the groups.

First, the good news; the agency groups seem to be back on track. No surprise that all of them have shown strong growth; the more important point is how they compare with 2019 and there the news is positive.

WPP said its Q2 organic revenues were 1.3% higher than Q2 2019 (0.5% for H1), with Publicis Groupe pointing to a 2% improvement over the quarter and Interpublic with a very strong 7.9% improvement over Q2 2019.

That is important for several reasons. First, the trend is your friend and, for the agencies, it suggests a better trend than pre-pandemic when the agency groups were mainly seeing organic revenue declines. That may lend weight to the argument advertisers have recognised the value of agency services.

Second, it hints that some of the pricing pressure on services may be lessening and the reduced repitching activity (as highlighted by WPP) may suggest a desire for stability from advertisers.

That back-on-track view is also reinforced by the raising of guidance by most of the groups (Omnicom has been more circumspect). So WPP and Interpublic raised top-line guidance from the mid-single-digit organic revenue growth to 9-10%, and both Publicis and WPP said they should be back to pre-pandemic levels by year end, one year earlier than expected.

In some ways, that is no surprise as companies would have been conservative in guidance, but it does also reflect the growing strength of the advertising recovery, as shown not only by increasing advertising forecasts but also the very strong advertising rebound not only in online but also television.

One interesting point, though, is the agencies are not seeing much of this come through to the bottom line and there are already clear signs of costs re-entering the system, particularly on incentives and, to a lesser degree, staff numbers.

So, while the agencies have generally raised top-line guidance, in some cases considerably, their margin upgrades have been more muted. Interpublic upped its margin guidance by 50 basis points (0.5%), Publicis by the same or slightly more but WPP stuck to its range, although it said it would be at the top end of the range.

The fact is incentives are coming back sharply. For WPP, the increase in incentive payments (£48m in H1 2020 to £244m in H2 2021) alone created a 400bps headwind in margins. Despite appearances to the contrary, the outlook for staffers might be quite positive.

Another thing that is clear is the continuing importance of the media businesses to the agency groups. Only WPP really gives enough information to hazard an educated guess at how much media contributes to profitability but the short answer is a lot. WPP stated in H1 that Group M made up 36% of group revenues, implying around £1.76bn of revenues. Assuming an operating margin in the low twenties, that suggests Group M made around £390m of operating profits or two-thirds of WPP’s overall H1 profit number.

While there may be some differences in some of the other groups (particularly with Omnicom, given its slightly unusual revenue mix), the general message remains the same: media is vital for profitability for the groups.

More glass half-empty than half-full?

Now to the less good news. First, it is evident that the agencies have rebounded but also that they are losing share to other entrants. One obvious candidate is Sir Martin Sorrell’s S4 Capital and, while there is some fierce debate on the relevance between the two categories, there is no doubt that when it comes to the pace of growth, S4 is the speedboat and the global agency groups the oil tankers.

S4 raised its organic revenue growth forecast for 2021 from 30% to 35%, having raised it previously from 25%. Margins are also generally higher. While not as high profile, other groups such as You & Mr Jones and Next 15 are also making inroads.

Second, the creative business remains a not particularly attractive business model for the agency groups, yet one that still has to be part of the repertoire of agency groups.

I have used WPP again, not to pick on them but because – rightfully – they provide enough transparency to crunch the numbers and they are a good proxy for all the groups. Based on the H1 report, their creative-focused businesses probably made less than 5% operating margin, thus dragging down the overall margins for the groups. There is not a clear answer yet as to how that can change.

Third, and this is more of a minor point although more strategic, China looks as though it will never fulfil the hopes of the agency groups as a major engine for their businesses.

Go back a decade or more, and the agencies were extolling the potential seismic opportunity in China (and other markets such as India and Brazil). Yet, for most agency groups, it is only mid-single digits of their overall revenues and far less important to their groups than markets such as the UK or even Germany.

Moreover, China is the one market where, while advertising growth is expected to be strong at over 20% in 2021, the agencies are not seeing meaningful growth coming through.

That suggests the agencies have failed to penetrate the domestic market and are relying more on international groups that might be more cautious spending on advertising in China than, let’s say, the United States.

These issues are also reflected in the stock market valuations. While the agency groups have recovered from last year (Interpublic’s share price is up nearly 100% from one year ago, with Publicis up 86%, WPP up 59% and Omnicom up 38%), their price/earnings (P/E) valuations remain muted and low by historic standards.

Publicis trades at less than 11 times the consensus P/E for FY22E, according to Refinitiv data, with WPP and Omnicom at under 12 times, although Interpublic is higher at over 14 times P/E. However, compare that with S4 Capital – which, interestingly, has risen just marginally higher than Interpublic over the past year – which trades at over 40 times consensus earnings for this year.

When it comes to investors, the view for the agency groups is more half-empty than half-full. The question is whether this can change?

Generally, I think the agencies are perhaps in a better position than the consensus thinks, but it is clear it will take time to turn things around, and in an environment where competition is increasing. Perhaps investors do have a solid reason for erring on the side of caution at this particular time.

Ian Whittaker is founder and managing director of Liberty Sky Advisors, an advisory and consulting firm, and twice City AM Analyst of the Year. You can sign up for his distribution list at ianwhittakermedia.com