Omnicom: The Thesis Is Close To Shifting To Options
Summary
- Omnicom has been on an incredible journey since the COVID-19 pandemic came, and made investors think advertising companies are dead.
- Since my original Corona Discount article, OMC has delivered returns that by far outperform the overall market.
- While the company has appreciated massively, potential growth ensures a continued, 9-10% potential future annual rate of return. I wouldn't necessarily invest here, but I see potential, nonetheless.
- Omnicom remains a "BUY", albeit a careful one. Another 4-5% increase in share price is enough to make it a "HOLD" from this point onward.
Omnicom (NYSE:OMC) is an investment I can look back upon with pleasure, given the RoR that's been delivered in around 12 months.
(Source: Omnicom Article)
I've consistently stayed positive throughout this company's recovery, for two simple reasons - valuation and fundamentals. While share price bounces up and down like a JoJo, this company's earnings and forecasts only took a moderate dent during one of the worst pandemics in history. In fact, the hit was lower than during the financial crisis, despite the company reaching a lower overall multiple during this crisis. It goes to show you that in the short term, the market really is a "voting machine", with people being happy to vote advertising giants like Omnicom out the door.
Well, they were wrong. Omnicom is growing and recovering, and the company has come out stronger for it all.
Let's look at recent results.
Omnicom Group - How has the company been doing/what to expect?
The focus for OMC has been on recovery, and this has been impressive. The latest results we have are the 1Q21 results which came in at numbers above 1Q20. Remember, 1Q20 was too early to see any real significant COVID-19 impacts for the full quarter. Net income was up, EPS was up, and the company boosted the dividend by $0.05/share compared YoY, coming to $0.2/share dividend bump for the full year.
The company continues on its path, cutting salary and related CapEx by around 10 bps for the quarter, as well as cutting office/occupancy costs by 60 bps YoY. Overall, operating expenses as a percentage of company quarterly revenues declined by 1.3% - too much to be a mere rounding error, but enough to show that the company is making progress in its transformative journey to become a leaner and more efficient company, with operating profit benefiting significantly as a result.
The company's operations remain heavily advertising-focused...
(Source: Omnicom)
... and heavily focused on the US, with nearly 55% of revenues coming from the US. In particular, Middle East and Africa saw significant declines YoY, but this was from very low numbers, to begin with. Asia Pacific saw organic growth of 2.5% YoY and European markets are only marginally changed as of now.
Industry-wise, trends are slow to shift. What we can see is a move away from automotive, towards T&E, Tech, Pharma/Retail and Consumer Staple products. However, the predicted "exodus" from legacy advertising has so far not materialized in any way.
(Source: Omnicom)
The company also reported significant improvements in overall cash flow, increasing FCF by $20.6M YoY, most/all of it straight from net income, with primary uses of FCF being for dividends - the total number of which is lower due to share buybacks, CapEx (which is nearly half of what it was in 2020), and other things. No share buybacks have been done during 1Q21, which I applaud given the valuation of the company's common equity.
Fundamentals and credit-wise, the picture remains a positive one. While overall total debt/EBITDA is up, net debt/EBITDA is down to 0.5X, due to a doubling of cash and equivalent, ending the company with net debt of around $863M, compared to $2.4B YoY.
Debt maturities are well-laddered, and the company can handle the closest senior notes with available liquidity on hand.
(Source: Omnicom Group)
With that, we can see that in terms of troubles or issues for the company, there really are none worth mentioning here. Fundamentals are solid, dividend coverage is solid, and we can look at the company's valuation to see why we should be a bit more careful.
Omnicom Group - What is the valuation?
Omnicom has recovered from its pandemic lows in its entirety and currently trades at a slight premium of 15.5X to its historical discount of 14.4X. However, the company is expected to grow EPS and improve results in the double digits for the next 3 years, resulting in potential outperformance of nearly 10%, even when looking at the company's historical discount valuation.
(Source: F.A.S.T. Graphs)
What it means is that Omnicom remains an, in my view, relatively easy way to secure 10% annual CAGR or thereabouts for the next few years at a relatively low amount of risk. Even trading lower, Omnicom would have to return to pandemic sub-10X P/E valuations for your longer-term returns to fully turn negative, which I (and the market) view as very unlikely. Outperformance on part of the company to pre-pandemic premiums, on the other hand, would result in returns of 15-18% annually for the next 3 years, when looking at a historical premium of 16-17X, not unrealistic when looking at the company's historical valuation.
So, all in all, we're at a fork in the road. The company won't need to advance more than a few percentages for the returns to go under 9% here, at which point I would consider OMC to become a "HOLD", because the conservative upside is lower than I'm looking for. As a matter of fact, this might already be the case by the time this piece is published.
I, therefore, implore readers to carefully watch the valuation where OMC is currently trading, and what to expect.
As of this time, investment in Omnicom is still possible for conservative investors accepting 9-10% annually, but the time for this is quickly running out, if recent history is any guide.
Analyst targets for the company have been exceeded here, in part confirming the way I view this company, and the mean currently shows an overvaluation of 3.2% to a mean target of $79.67/share, given to us by 12 analysts with a range of$60-$98/share (Source: S&P Global). Unlike other companies, these analysts haven't massively shifted their targets for the past 12 months, and at most Omnicom was 22% undervalued to their target.
All in all, it is confirmation to me that my thesis on Omnicom was, and remains, a decent one. The current returns are further proof of this, and I expect the company to perform according to expectations - as it has for the past few years.
How to invest in Omnicom Group
Option 1 - Long-Term Investment
Omnicom is a great BBB+ rated company, and one I would invest in even at the current valuation. However, we need to clearly state that as of now, potential returns are no longer as great as they once were, and what you should expect going forward are returns of around 10% per year until 2023-2024, at most.
This is still good enough for investing, as I see it, and therefore I consider it a valid long-term investment through its common share.
Option 2 - Selling Cash-Secured Puts
Selling cash-covered put options is another good way to make money off a company while waiting for it to drop further and making money until then. Because of the company's position, and a lower price being even more appealing, this could make it perfect for a nice put.
As of writing this article, I was able to find the following put.
(Source: Author's Data, Google Sheets, Option data from IBKR/Yahoo Finance)
I view this is as a great put to write. Nearly 10% annualized from an undervalued strike-price option for OMC with less than 75 days to maturity. This is an option I might actually write myself, even if the capital outlay is above my target of $4000-$6000. However, I recently increased my cash position, which makes such an investment possible.
Option 3 - Selling Covered Calls
I wouldn't sell covered calls in Omnicom, as I don't want to put my position at risk at the sort of meager returns these contracts would generate. I, therefore, view selling calls here as a no-go for me.
Thesis
Omnicom Group is a company that should have been bought at undervaluation around a year ago. If you didn't, there's still an opportunity here, just don't expect 70-80% in 3 years - because I doubt you'll be getting it. However, for those of you looking at safe, 10% returns per annum inclusive of dividends, this company still delivers, until it increases 3-4% more in terms of share price.
My five points for investing are:
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has realistic upside based on earnings growth or multiple expansion/reversion.
I've said before I'm willing to welsh on one of these points, and in this case, I would say #4 is not entirely being fulfilled.
This is not ideal, but given the market situation, you might find yourself in a situation where you might want to invest here anyway.
So, OMC is still a "BUY" here at what I consider to be a "fair" value for the company's expected results for the next few years - but it won't take much for the company to rise up and become a "HOLD", at which point you'd better look at the put options available.
Thank you for reading.
This article was written by
Wolf Report is a senior analyst and private portfolio manager with over 10 years generating value ideas in European and North American markets.
He is a contributing author for the investing group iREIT on Alpha where in addition to the U.S. market, he covers the markets of Scandinavia, Germany, France, UK, Italy, Spain, Portugal and Eastern Europe in search of reasonably valued stock ideas. Learn more.Analyst’s Disclosure: I am/we are long OMC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved.
I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles.
Option Disclosure: May write a PUT for OMC within the next 72 hours.
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