Media Just a blip in growth

2017 has been an unexpectedly challenging year for media agencies. At the beginning of the year, marketing agency GroupM had forecasted 2017 global ad spend growth to be 4.4%. However, by August 2017, this was reduced to just 3.0%. It was well known that 2017 would be a tougher YoY comparison, as 2016 was a maxi-quadrennial year (Rio Olympics, UEFA Euro Football championships and the US presidential elections). However, the extent of impact from ad budget reduction by FMCG/packaged food companies wasn’t anticipated by neither media agency managements nor the markets. Consequently, when these companies missed their guidance in the recent results, the stock price reaction was sharp. WPP having higher exposure to FMCG was more adversely hit with the stock being down 27% YTD, as compared to Publicis (-17% YTD).

Investors need to appreciate that this impact is not structural but more of a short-term phenomenon. We would like to highlight that while the FMCG spend reduction has created near-term pressure; it is expected to create opportunities as well. In its 2Q17 call, the Unilever management indicated that it had reduced its 1H17 agency fees by 16% YoY. However, in an analyst meet in September, the Unilever management highlighted that it was undertaking cost cutting, in order to offset the slower revenue growth, which it was facing currently. The Unilever CFO Graeme Pitkethly also quoted, “Some of the basic things, like reducing advertising production and reinvesting that behind media still apply, but in a much more fragmented and granular sense now.” All of the above comments clearly indicate the short-term nature of the ad cuts that provide scope for growth in the coming years. Moreover, FMCG companies have shown their intention to reinvest savings that they derive from advertising efficiencies into brand investments, though the timing of reinvestment may be delayed. Also, FMCG companies have been looking to consolidate the number of agencies that they deal with. Procter & Gamble CEO David Taylor mentioned in a September 2017 conference that: “We've cut the number of advertising, PR and other agencies supporting our business by 50%”. This would be a definite positive for agencies such as WPP and Publicis, given their global scale and expertise. In our view, the markets have tended to under appreciate the value creation that large media agencies are delivering through acquisitions and by consolidating the media industry. To put this into a perspective, WPP has mentioned that its 188 acquisitions were generating organic growth of +4.0% and return on capital of +10.0% vs. its WACC of 6.3% as of 2Q17.

The impact of FMCG ad spend cuts is likely to be visible in 3Q17 results as well. However, WPP and Publicis should be able to deliver a turnaround from 4Q17 onwards, with receding impact of ad cuts by FMCG companies combined with robust new business wins for media agencies. WPP has won USD 4.2 bn of net new business in 1H17 vs. USD 3.0 bn in 1H16. These new wins should ensure a higher growth in the coming quarters. With 2018 being a quadrennial year with events such as FIFA world cup and Winter Olympics, the backdrop for media agencies looks far more positive than in the previous quarters.

Within media sector, we looked at stocks that are likely to witness better growth prospects, having attractive valuation and a strong history of shareholder returns. Our selection includes Publicis and WPP.

Saurabh Lohariwala

Equity Expert

Data & recommendations as of 30 October, 2017 close

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