As Sentiment Worsens, Ad Agency Stocks Get Cheaper

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Includes: IPG, OMC, WPPGY
by: Morningstar

By Michael Corty

In our Stock Strategist published in early May we declared it was not the right time to buy ad agency stocks despite their recent stellar financial results. Sure enough, over five months later, with heightened concerns about an economic slowdown, all three stocks-- Interpublic Group (NYSE:IPG), Omnicom (NYSE:OMC), and WPP Group (NASDAQ:WPPGY)--are trading at lower prices (down 20% on average). To date, there has been little evidence that a material pullback in corporate spending on marketing is imminent. However, the level of growth in 2012 remains an open question as most corporations are in the process of budget planning for next year. We think the stocks are trading at attractive levels now, but the stocks could get even cheaper (and become an even better long-term investment) if the macroeconomic outlook for 2012 turns even more negative in the coming months.

We assume an overall deceleration of ad growth in 2012 and forecast low-single-digit growth for the ad agency firms in 2012, realizing our forecast could be equally too optimistic or pessimistic. However, our approach to valuing stocks does not depend on one given year, which is why we have previously recommended these stocks at the same time the near-term outlook appeared bleak.

As we've stated many times, ironically, the most opportune time to invest in the advertising holding companies occurs when the advertising market is weak or in decline, as the market has a habit of extrapolating recent results too far into the future. Between late 2008 and early 2009, the share prices fell to recessionary lows when advertising trends were rapidly declining (and we had 5-star ratings on all three stocks).

Advertising and marketing growth in any given year can fluctuate with the swings in the economy, so it difficult to precisely forecast near-term ad agency revenue growth. However, we have a high degree of confidence in our narrow economic moat ratings for the global advertising holding companies. We believe they will remain a vital partner for large global corporations over the next decade. Omnicom, Interpublic, and WPP Group each own hundreds of individual agencies around the world, focused on specific verticals such as ad creation, brand strategy, media planning, and public relations. These three firms, along with Publicis, garner roughly two thirds of global spending for advertising and marketing services.

A broad service offering allows these holding companies to provide their clients with global, multiplatform, integrated marketing campaigns. Although most large corporations have internal marketing departments, they still outsource the majority of their marketing needs to specialized agencies because of the complexity and scale of their campaigns. As a result, the large global footprint and broad portfolio of services these firms can offer make it very difficult for smaller rivals to compete for large, integrated marketing campaigns.

Furthermore, we believe the expanding number of advertising choices actually makes it more difficult for companies to manage and allocate their marketing spend, and strengthens the relationships between ad agencies and their clients. Most corporations need integrated advertising and marketing campaigns that use multiple mediums. For example, online advertising has become more complex than ever with the number of options growing--search, pre-roll video ads, overlay video ads, display through publishers, ad networks, and ad exchanges, among others.

The emergence of Facebook and other social networking websites creates another layer of digital advertising opportunities as well as challenges in how to approach a new audience. Therefore, we believe corporate marketing teams will continue to turn to ad agencies for help in managing the various options available today and in the future.

Let's use Apple (NASDAQ:AAPL) as a quick example of the long relationships that often exist between agencies and clients as well as the need for outside help despite internal expertise. The late Steve Jobs was known for product innovation, but many experts would argue that he was a marketing genius as well. In fact in a recent Advertising Age article, Apple co-founder Steve Wozniak stated "I would say marketing was his [Jobs'] greatest strength." Jobs was known for staying involved in every aspect of marketing yet he relied on one ad agency, TWBA (an Omnicom agency), to execute his strategy throughout his long tenure at Apple.

In conclusion, we believe the three ad agency holding companies are integral to the marketing and advertising activities of corporations, even more so as the advertising landscape becomes more convoluted with new platforms for reaching consumers. These stocks tend to trade on short-term sentiment, which allows investors with a long-term horizon to be patient and invest when the market sours on these stocks.

Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.

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