Omnicom: Modest Organic Growth - Pivotal Research Group

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BOTTOM LINE: Omnicom (OMC) reported 2Q16 results this morning which were slightly above our organic growth expectations, although below StreetAccount consensus. While margin improvements were in line with expectations, total profitability was slightly higher than we forecast for the quarter, although not meaningfully so. With minor 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 2Q16, headline organic growth at Omnicom of +3.4% was slightly faster vs. our +3.2% expectation, although slower than the +3.6% implied by consensus as tracked by StreetAccount. By region, North America organic growth was reported up by +3.2%, while Europe was up by more at +3.9% - aided by Spain and Germany, but constrained by France and The Netherlands. Organic growth in APAC was similar at +4.5%, while Latin America – helped by Mexico, but hurt by Brazil – and the Middle East & Africa were both relatively weak at +1.7% and -8.3%, respectively.

Operating margins were up by 30bps in line with management's guidance for the full year's results, representing a continuation of what was posted in the first quarter, and in line with the company's guidance for the year. Earnings per share came in at $1.36 for the quarter, which was slightly better than our $1.33 expectation.

Looking towards the remainder of the year, management's guidance for organic growth remains at +3.0% to +3.5%, although our forecast remains slightly higher at +3.6%. Second half revenues may be hampered to a degree by advertiser skittishness in Europe as a consequence of Brexit, but other factors – such as the new P&G media account covering the North America market – should allow for some modest acceleration in organic revenue growth.

Interpreting Omnicom's quarterly results remains somewhat challenging when comparing them vs. peers given the scaled, but generally non-specified presence of principal-based pass-through activity in organic revenue figures at Omnicom. These activities 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) as well as activities in the company's CRM businesses. Although growth at Accuen accounted for $18mm in new revenue – or +0.5% of total organic growth – 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 probably impacted by a heightened reliance on these likely higher margin businesses within the advertising reporting line. The company's full year 30bps margin expansion targets remain very do-able in our minds, at least in part because of this revenue mix shift.

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 16.5x 2016 P/E, using a 7.9% short-term cost of capital, a 10.9% long-term cost of capital and 4.0% long-term growth rate.

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


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