Omnicom: Margin Improvements on Track -- Pivotal Research

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Omnicom reported 1Q16 results this morning which were slightly below our expectations in organic growth and profitability terms, but which also delivered on margin improvements that are consistent with management’s guidance for the full year. With alterations to our model post-today’s call, we retain our valuation on Omnicom at $79 per share on a YE2016 basis, and continue to rate the stock Hold.

During 4Q15, headline organic growth at Omnicom of +3.8% was slower vs. our expectation of +4.5% and the prior quarter’s organic expansion of +5.4%. Operating margins were up by 30bps in line with management’s guidance for the full year’s results, representing the best pace of margin expansion for the company since 2012. Earnings per share came in at $0.90 for the quarter, which was below our expectation but above consensus. By region, North America organic growth was reported up by +4.5%, while Europe was up by only +0.6%. Organic growth in APAC was -0.7% and Latin America was -10.1%.

Interpreting these results is somewhat challenging when comparing Omnicom vs. its peers given the scaled presence of principal-based pass-through activity in organic revenue figures at Omnicom. These activities which can extend beyond the company’s trading desk, Accuen to include revenue streams associated with entities such as Icon (barter) and OmNet (proprietary trading of traditional media). Although growth at Accuen accounted for $25mm in new revenue during the quarter, our guess is that the other sources of principal trading growth amount to a substantially higher figure. Overall, the quarter’s results were undoubtedly impacted by a heightened reliance on these North American-skewed and likely higher margin businesses within the advertising reporting line and also impacted by a diminishing reliance on lower margin and relatively European-skewed CRM and Specialty-reporting line business units such as Sellbytel and related retail sales outsourcing units.

Although ongoing efforts to find operating improvements are undoubtedly a factor, with these results we are also inclined to believe that the company’s full year 30bps margin expansion targets may be accomplished at least in part because of a revenue mix shift. In part because of this expectation we are diminishing our organic revenue growth forecast for 2016, from +4.5% to +3.7%, which remains slightly above the company’s implied guidance for the year of +3.0% to 3.5% growth. One other change of note to our model following from the earnings call is for higher interest expense, which management indicated would be $20mm higher vs. last year. Accounting for these factors and other minor alterations, we continue to value the company at $79 on a YE2016 basis and retain our Hold rating on the stock.

VALUATION. At $79, our OMC target equates to a 16.6x 2016 P/E, using a 7.2% short-term cost of capital, a 11.1% long-term cost of capital and 4.0% long-term growth rate.

RISKS. Agency risks relate to blowback from the rebate issue, squeezing fees from clients, competition from adjacent industries, reduced competition between marketers and demand for advertising services.


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