We think the agency holding company model is an attractive and defensive way to play accelerating economic growth. Ad agencies are agnostic to changing technologies and customer behaviors and continue to be the connective tissue between market data and emotive brand concepts - a value that remains relevant today despite competition for customer analytics. Holding companies like Omnicom (OMC) and Interpublic Group (IPG) are able to limit industry/client risk through a portfolio approach, leaving investors with the systemic risk of business cycles within key markets. Coupled with effective management and ~6% yields on capital returns, we believe these are resilient businesses without the secular uncertainties of Media companies.
Growth --> Margins
To be frank, big agency holding companies like OMC, IPG, WPP and Publicis are more alike than they are different. But, there are differences in terms of regional revenue exposure, mix, margin opportunity and valuation. We think regional economics are the primary drivers of organic growth, along with net new business, so we tend to prefer agencies with more leverage to higher-growth North America and Asia Pacific markets, and proportionally less revenue weighting towards more challenged regions including Europe and Latin America. We think organic acceleration, led by economic forecasts for the US, could lead some agencies to grow faster than expectations, which should lead to outperformance on margin expansion. Applying this screening approach, IPG stands out amongst the group.
While every investment has risk, we think agencies will be most appealing to lower-risk TIMT investors given their well-run HoldCo models, business diversity and cash returns. This is most apparent at OMC on 16x CY17 P/E—our most expensive stock in Media+Agencies—as we think investors increasingly view large-cap agencies as having defensive, staples-esque characteristics. The biggest risk for all of them, in our view, is key accounts getting lost in reviews, but contract turnover is an enduring risk for any services business. Heightened review levels in 2015 are now behind the big agencies, and while there's always business up for grabs, we think we're entering a more stable period where execution will drive stock sentiment. If the S&P is working, we think the likes of OMC will at least work with it.
IPG is our Top Pick in Agencies+Media
We initiate with IPG as our Top Pick across all Ad/Media coverage with a $27 price target (25% upside potential). In our view the setup couldn't be better for IPG with our 2017 EPS estimates 6% above consensus, and we think rev acceleration and strong earnings will drive consensus higher and expand the multiple above the S&P. We think OMC is a top-class company but it's already getting a premium valuation, and with major recent wins (e.g. AT&T, McDonald's) further rerating catalysts are few—we initiate at Sector Perform with an $87 target (5% upside potential). Finally, MDCA has significant potential for upside as and when growth reaccelerates, but following some recent challenges we're taking a 'Show Me' approach with an initial $12 target and Sector Perform, Speculative Risk rating.
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