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Wednesday 21 March 2018

Ad giant WPP can 'change conversation' at attractive share price

Mad Men showcased the days when the big ad agencies were untroubled by diversification
Mad Men showcased the days when the big ad agencies were untroubled by diversification

Aidan Donnelly

Who would have thought that a television series that chronicled the 'goings-on' at a fictional 1960s' New York advertising agency would grasp the attention of an audience. The producers at US cable giants HBO and Showtime certainly didn't, as they passed on the opportunity to buy the first script. However, another cable TV company, AMC, took the risk and seven seasons, 16 Emmy and five Golden Globes awards later, the appeal of Mad Men is evident to everyone.

It's more than 50 years on from the time the show depicted, and the advertising industry has undergone monumental changes since. That industry now bears little resemblance to the business of Don Draper et al at fictional agency Sterling Cooper.

Nowadays the industry is dominated by six global companies whose activities have expanded far beyond the original advert design and creation work that they were synonymous for. At the top of the pyramid lies the British-listed WPP, a holding company for over 160 communications companies across advertising, media investment management, information and consultancy, public relations and public affairs, healthcare and speciality communications, and branding and identity services.

The major advertising agency groups globally have been buffeted by a perfect storm of global economic growth pressures and structural debates about the longer-term role of the agency business model. Agencies' main clients are medium-and large-sized advertisers. The high level of diversification as well as concentration in the industry means that agencies' sales growth is closely tied to the revenue trends of their customer base, which have been slowing for the last few years. However, a number of changes are transforming - or will soon transform - the marketing landscape, with a corresponding impact (not necessarily negative) on the industry. Clients, for example, will increasingly require advice and help on how to conduct their digital transformation, thus creating new streams of revenue to replace legacy ones.

As a group, the large agencies have displayed a strong long-term track record of high single-digit or low-double-digit annual profit growth that has been driven in a broadly balanced fashion by general market growth, profit margin improvements and clever use of their cash. WPP has done better than others in the industry by focusing on the second two of these levers.

However, just because you are the biggest in the industry doesn't mean you are immune to its issues. WPP's track record shows a near-metronomic delivery of profit growth that came to a screeching halt after 28 quarters with the reporting of the company's year-end 2016 results. The guidance for 2017 was also lacklustre.

The main worry for investors is whether the 2pc organic sales growth that management forecast for this year is the new norm for the company and the industry - or whether it is caused by account losses.

There are reasons to believe that WPP can weather these storms. It boasts a strong business mix with the largest emerging market business as well as a good digital presence. The more challenged part of its offering, market research, is decreasing in overall importance for the company.

In the wake of the lacklustre forecasts for 2017 from WPP management, the share price has fallen. The pullback in the share price offers an attractive entry point for investors with patience to profit from the current poor sentiment.

As Don Draper would tell you: "If you don't like what's being said, change the conversation."

Aidan Donnelly is head of equities at Davy Private Clients. See disclosures at

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