Interpublic Group's Rough Quarter Offers Opportunity for Investors

Interpublic Group (IPG) had a rough 2nd quarter, and investors have had an even rougher time since earnings announcements on July 21.  However, the drop from almost $26 (a 15-yr high) to $21.70 offers a buying opportunity for investors with a longer-term horizon.

IPG is the 4th largest advertising agency in the Big 5 which includes NY-based IPG, London-based WPP, Paris-based Publicis, NY-based Omnicom (OCM), and Tokyo-based Dentsu.  In 2016, 60% of IPG’s revenues were derived from the U.S., 12% from Asia-Pacific, 18% from Europe and the UK, 5% from Latin America, and 5% from others. IPG's top 10 clients accounted for about 20% of revenues and its largest single client accounted for 4%.

The company consists of three major agency networks: McCann Worldgroup, Lowe and Partners, and FCB (Foote, Cone, Belding). Its media agencies are bundled under the IPG Mediabrands entity. It also owns specialty agencies, including public relations, sports marketing, and talent representation.  Founded in 1930s as McCann Erickson, IPG has offered investors a roller-coaster ride of stock value.   

In 1987, share prices were $4 (adjust for four stock splits), rose to $58 in 1999, only to fall back to the $4 range by the depths of the market selloff in Feb 2009. Not helping matters, IPG was embroiled in accounting problems from 2002 to 2007.  Overall, if investors are a bit gun shy of IPG’s history, it would be quite understandable.   

However, while the short-term seems challenging, longer-term opportunities should amply reward current shareholders. 

2nd quarter results came in light of expectations.  Consensus earnings estimates were $0.34 a share and the company announced $0.27, 20% below street outlook. Revenues were also lighter than expected at $1.88 billion vs anticipated $1.96 billion, and represented a 1.7% year-over-year sales decline. In addition, management failed to generate year-over-year margin expansion, the first time since 2013.  On the conference call, management projected a turnaround in the second half, as it maintained its organic growth and operating margin expansion guidance for the full year.   

The US is experiencing a slowdown in overall advertising and marketing spending that has affected IPG’s peers as well.  The weakest business sectors for IPG in the first half were financial services, telecom, and technology.  Declines in Europe and Asia-Pacific markets resulted in no quarterly organic growth for the entire international segment.

Management believes the political climate of uncertainty in the US and Europe is adversely affecting the marketing psyche of companies, and expects more clarity, coupled with stronger demand for marketing services, as the year progresses.

Operating margins dipped from 11.0% in 2nd qtr. 2016 to 10.3% during the most recent quarter.  While management believes the last half of 2017 will produce margin improvements, investors should expect a continuation of weak margins, mainly driven by weak revenue growth amid stiff competition. 

IPG shares now offer a 3.3% yield after raising the dividend 20% in Feb 2017.  Management has maintained a 25% to 50% payout ratio over the past 6 years. 

Over the longer term, IPG has a fee and commission structure that is both relatively strong and sustainable.  While it operates in a very competitive environment, the ability to excel in creative talent, to successfully execute an increasingly complex marketing strategy, and the firm’s substantial market share drives IPG’s customer loyalty and new client wins.

As business improves, margin expansion should get back on track, and at least equal Omnicom’s 12.5%.  Management has been growing its business via smaller, bolt-on agency acquisitions, adding to margin improvement over time.  IPG is trading at 2-yr lows relative to its peer, Omnicom.

Of interest to investors, Return on Invested Capital ROIC has been steadily expanding since hitting a low in 2009.  After bottoming in 2009 at 5.0%, ROIC has risen to a 2016 year-end level of 15.0%. 

Earnings per share consensus is for $1.43 this year vs $1.34 in 2016.  Business and earnings are expected to pick up over the next three years, with $1.60 per share expected in 2018, $1.77 in 2019 and $1.96 in 2020. 

Partially driving higher EPS will be an average $300 million annual share buyback, or about 3.0% of outstanding float a year (based on current market cap).  Share count peaked in 2010 at 550 million shares, and has fallen to under 400 million currently.  Supporting the share reduction has been annual free cash flow generation of between $400 and $700 million.    

While the advertising sub-sector of the Consumer Discretionary sector has underperformed the overall market, buying these firms during temporary additional weakness should increase potential gains. IPG’s current decline should be temporary, and if so, over the longer term will provide more than adequate total returns.  Investors looking to expand exposure to this sector should review IPG.     

Thanks for reading.  This article first appeared in the Aug 2017 issue of Guiding Mast Investments.  George Fisher