I first heard about WPP Group Plc (NASDAQ:WPPGY) when I received its annual report from PrecisionIR, a free annual reports service. WPP Group Plc is a global communications conglomerate headquartered in the UK.
WPP stands for "Wire and Plastic Products" and was founded in 1971. WPP Group operates in four segments: Advertising and Media Investment Management, Consumer Insight, Public Relations & Public Affairs, and Branding & Identity, Healthcare, and Specialist Communications. The segments grow mostly by acquiring and integrating companies into existing segments. Most famous brands working under WPP insignia are Grey Group, Ogilvy & Mather Worldwide, Young & Rubicam Brands, JWT, Burson-Marsteller, Cohn & Wolfe, Mindshare, MEC, BMRB, Added Value, Kantar Video, Indian Market Research Bureau, Millward Brown, Management Ventures Inc., Research International, TNS, and many others. In total, the company controls about 170 firms within its 4 segments.
What caught my attention about WPP is its outstanding revenue, profits, dividends, and equity growth over the last 15 years. The company has been growing dividends at a rate exceeding 20% CAGR (Compounded Annual Growth Rate), paying them twice a year (typically, June and October). Revenues have been growing at a rate of over 12% CAGR since 1997, the earliest available report date. Operating Profit has grown from $337M in 1997 to over $2B in 2012, a compound rate of 12%. WPP leads among its major 5 competitors (Omnicom Group Plc, Publicis Groupe, Interpublic Group of Companies, MDC Partners, and Havas SA) in EBITDA of $2.7B. Among its peers WPP Group has the highest current EV/EBITDA multiple of 10.6X. Since 1997, the company has invested over $14B in assets and generated almost $19B in operating cash flows, yielding around $4.3B in Free Cash Flow. Current dividend yield on WPP Group's stock is almost 2.5%.
Historical Financial Analysis
Below is presented a chart illustrating WPP Group's profitability trends since 1997. The actual numbers as well as the overall analysis can be found in the workbook available for download here:
(click to enlarge)
In 2012, Revenues were over $16B with a Gross Profit of slightly higher than $15B. This gave an operating profit margin of just above $2B. Revenues and Gross Profit have been moving in tandem on quite a steep trend, while Operating Profit and Net Income have been growing closely together. Here is a snapshot of revenues generated by different segments:
The company generated 41% of its revenues from the Advertising & Media segment of its business, followed by Branding and Healthcare (26%), Information and Consultancy (24%), and PR & Public Affairs (95). Historically, revenues by segment looked the following way:
Advertising & Media in conjunction with Branding & Healthcare seem to have had a sharp decline during the recession of 2008-2009, while Information & Consultancy had a surge in revenue during the same time period. PR & Public affairs have been growing steadily over the years.
When looking at large conglomerates such as WPP Group it is important to keep in mind the most vital indicator of a company's strength: cash flow generation. Below is presented a chart showing historical cash flows of the company since 1997 to present day:
WPP Group has generated cash from operations (CFOs) on a steady pace since 2002, peaking in 2010. Investing cash flows have been mirroring CFOs for the most part, while Free Cash Flows have been volatile since the beginning.
Now to the company's balance sheet. I was unable to compile figures for the company's segments' assets, liabilities, and equity before 2007, although consolidated figures are available for users since 1997. Below is given a chart of the company's balance sheet dated from 2007 to 2012:
As seen in chart, equity has been steadily growing (except 2008), having slightly decreased its rate of growth in the past year. In addition to this, below is provided a snapshot of the firm's historical leverage metrics since 2007:
WPP Group is highly leveraged, which has been partly a recipe for its success and extraordinary returns. Combining data from the balance sheet and historical income statements, we can now construct a picture of the company management's efficiency:
Return on Assets (ROA), which measures how effectively management uses assets to generate operating profits, declined somewhat in 2009 only to see a rebound in 2012. The numbers are above the pre-crisis levels by now. Surprisingly, Return on Equity (ROE), which measures how much return shareholders receive on a dollar invested in the company's equity, declined significantly in 2009 only to see a steady incline over the past four years. Nevertheless, the actual numbers are still below figures from pre-crisis years.
The table below provides data on historical Asset Turnover from 2007 - 2012:
Asset turnover measures how many dollars of revenue a dollar of assets brings. Since WPP Group is a conglomerate, its revenues are driven by assets (companies that make up the firm) rather that people actually employed by WPP Group. We can see that the numbers have been steadily increasing for the past 6 years. This means that the management has become more effective, assets are managed more efficiently, and/or new assets acquired bring more revenue per unit of their cost.
We have successfully analyzed the company's performance and found that it has been in a strong position over the years through 2 business cycles (2000 - 2011 and 2008 - 2009). Now the time has come to use the data to value WPP Group. We will be using 5 valuation techniques summarized in a Football Field Chart, which maps the company's valuations in a neat way.
1. DCF Analysis
WPP Group has sufficient data to construct a Discounted Cash Flow analysis. Growth rates and discount rates can be effortlessly determined thanks to fifteen annual reports and data from Reuters, Bloomberg, and other sources. First, let us determine the company's Weighted-Average Cost of Capital (OTC:WACC):
Below are given projections of the company's FCFs:
The outputs of the model are given below:
The model shows that the fair value of WPP Group's share ranges from as low as $94 (Perpetuity Growth Method) to as high as $144 (Terminal EBITDA Multiple Method). As a consensus, I think it is fair to give the stock a target of $100 - $130 using these methods.
2. Sum-of-the-Parts Method (SOTP)
Because the company is a conglomerate, it is reasonable and fair to value it by dissecting and evaluating each segment of its holdings. As a result, the four segments are valued separately by applying DCFs to each of them. In valuing each segment I used the same multiples as for the full company's DCF due to the lack of transaction data for similar businesses to those that constitute the segments. To save the reader time I will only demonstrate the output:
The SOTP method values WPP Group more generously. In fact, of the five valuations methods I used this one offers the highest value per WPP's share. In this scenario, WPP Group share's fair value ranges from about $180 to $220 per share.
3. Comparable Companies' Analysis
For this analysis I have chosen WPP Group's five direct rivals (Omnicom Group, Publicis Group, Interpublic Group of Companies, MDC Partners, and Havas SA) and ran a market value comparison:
Applying average EV/EBITDA multiple to WPP Group's valuation translates into stock value ranging from $38 per share to $63. Of course, this can be explained by the fact that WPP already has the highest valuation among its peers.
4. LBO Method
The Leveraged-Buyout method of valuing a company is based on the estimates of the maximum price per share LPs can pay in order to satisfy their required return on investment. The outputs of the quick LBO analysis are given below:
The LBO analysis values WPP Group at $85 to $120 per share. Higher values per share can be expected if a multiple expansion is factored into the calculations.
5. EV/EBITDA - Trading
This is the simplest valuation method that takes into consideration actual market valuation of the company during the last 52 weeks (high and low). Results are: 8.4X at the 52 week low and 11.5X at the 52 week high. This converts into $65 and $97 per share, respectively.
Football Field Analysis
Now it is time to present the summary chart for the five valuation methods:
The blue line shows current market valuation of the company's equity of $87.91 per share as of Friday, June 14, 2013.
In conclusion, I state that WPP Group's stock has a fair value ranging from about $120 per share to at least $150 per share. To be more aggressive, a valuation of $190 per share is attributable. This translates into 35% - 115% potential upside given current discount to fair value.
Margin of Safety
WPP Group's shares are trading about 14% higher than the maximum achieved in 2007, pre-crisis time. The company has grown significantly since then while keeping double-digit growth rates in Revenue, Operating Income and EBITDA. It is also trading at a slight discount to its 52 week high of ~$90 per share. The current market value is also at about 30% discount to the average fair price obtained from the DCF model. Cash and Receivables amount to $33 per share, while the value of Net Assets is approximately $25 per share. In my opinion, given the 52 week low, the downside potential does not exceed 35% from the current price, while the upside is at least 2-2.5 times higher.
WPP Group is a long-term investment with a horizon of at least 5 years. Given strong financial position and outstanding growth, WPP's shares are an attractive investment for medium-risk buy-and-hold investors. Current dividend yield is significant compared to the TMT sector, while it is also above the current inflation rate in Canada and USA.