Sep 12, 2012
The world’s leading advertising company, Ireland’s WPP, released its first half results for the current year and profits increased by 12% year over year but in the same breath reduced its annual growth forecast from 4% to 3.5% based on the worry that American and Western European customers are becoming increasingly cautious with their marketing budgets.
Revenues went up by 5.5% year over year to $7.8 billion. However, WPP reported a 0.6% drop in U.S. revenue in the second quarter after a 1.4% increase in the first quarter. In essence, U.S. sales are, at best, flat, which are only the least of their worries.
WPP was expecting a large boost from both the London Olympics and EuroCup 2012 and only four months ago guided as such. When one adds the U.S. elections to the mix, the lowered guidance came as quite a shock. This underscores the seriousness of the situation on a global scale. While the central banks keep hope to keep their economics alive through various money printing exercises: LTRO, QE, indefinite swaps with currency pegs, etc. the reality is that there is no growth happening in the productive portions of the major economies; a state that is likely to continue.
WPP operates in 108 countries and has dozens of subsidiaries all around the world, but its business is focused on Europe, which contributes more than two-thirds to its revenues. The US market, where Omnicom (NYSE:$OMC) is dominant, is gearing up for the presidential election. Ad buys for this quarter should be strong because of the money at stake, but what happens after that?
This year’s major events have been kind to the multinational advertising firms. The negative impact of low US employment numbers, the European recession and declining Chinese and Indian production/consumption was offset by these enormous distractions, which pulled scarce resources out of the productive economy and into their bread and circuses.
Profits next year are likely to decline without these events, despite positive GDP forecasts for Western Europe and North America, because GDP forecasts are as much advertising as what WPP and Omnicom produce. WPP has admitted that 2013 will be “challenging.” However, the industry is looking to 2014, and the FIFA World Cup to be held in Brazil, one of the few growth markets left currently. To that we can add the 2014 Winter Olympics and the less-important U.S. mid-term elections.
Both companies are using their cyclical spike in revenues do some M&A, particularly in digital media and expansion into emerging markets. Omnicom has acquired dozens of firms including Japan’s leading medical communications firm MCI, the PR firm Marina Maher Communications and a majority stake in India’s Mudra Group. Similarly, WPP has also bought Guernsey based Acceleration Holdings, South African based Acceleration eMarketing, Who Digital in Vietnam and has new joint ventures in the Philippines and Indonesia.
WPP has seen strong growth outside the U.S. and the EU, with second quarter revenues up 6.2% nominally and 11.1% constant currency basis, thanks to an abnormally strong U.S. dollar, which will not continue now that the FOMC has admitted that another round of QE is inevitable.
Leading non EU growth were the BRIC Nations that contributed $1.1 billion to revenue, while Asia Pacific’s ‘Next-11’ (excluding Iran; Bangladesh, Egypt, Indonesia, South Korea, Mexico, Nigeria, Pakistan, Philippines, Vietnam and Turkey) accounted for $350 million.
WPP’s Indonesian subsidiary Wunderman recently launched a new digital agency in the country, partnering with local firms. Earlier this month Media Innovation Group (popularly known as MIG) established an office in Singapore, entering Asia for the first time. Currently earning 29% of their revenues from emerging markets outside of the U.S. and E.U. their strategy is to push that to 35%-40% by 2016.
WPP is best represented by the SPDR S&P International Consumer Discretionary Sector ETF (AMEX:$IPD) which has perfectly tracked the SPDR S&P 500 ETF (AMEX:$SPY) year to date albeit with more volatility. IPD is heavily weighted to auto sales, with Toyota (NYSE:$TM) the top holding and 5 automakers in the fund’s top 10. Automakers are big ad spenders and a good bellwether for the sector’s revenue. While car sales in the U.S. have been strong this year with Toyota recovering nicely, the other big markets, like China (2.2%) and Germany (0.6%) and Brazil (-0.3%), are flat year to date. Once the U.S. is done turning over its aging auto fleet, the average age is 10.8 years old, car sales will slump there and rising markets like Thailand and Indonesia are not big enough yet to take up the slack. Japan’s auto sales are up but not back to pre-Fukishima levels. Ad agencies like WPP and Omnicom will be facing shrinking ad buys in cheaper markets.
Omnicom is up 15.3% year to date, trading at a P/E of 15.3 and carrying a 2.3% yield. WPP has an OTC ADR, ticker symbol WPPGY, which is trading at a P/E of 11.9 with a 3.1% yield. Both are high beta stocks (1.24 for OMC and 1.44 WPPGY) that reward active investors looking to generate alpha through the use of timing.
2012’s solid performance so far has given these firms considerable cash to smooth out future cyclical revenue curves by helping them push into emerging markets. But since 2013 looks difficult at best globally that makes these stocks value traps as ad revenues from insulated markets will not be enough to offset the fiscal and monetary messes taking shape in the West. There is no compelling reason for long-term investors to choose them over the broad index. Traders can use the high beta to their advantage if they are so inclined.