McDonald’s (MCD, Financial) decided on Monday to consolidate its creative agency business with Omnicom Group (OMC, Financial).
According to the Wall Street Journal, Omnicom will be McDonald’s new partner for all of its U.S. national marketing initiatives. In 2015, McDonald’s spent $820 million on U.S. advertising, possibly including media and creative agency spending. Omnicom shares were up 1.38% at market close.
(McDonald’s, Wall Street Journal)
Valuations
According to GuruFocus data, Omnicom shares were trading at a trailing 12-month price-earnings (P/E) ratio of 19 times (industry median of 19), price-book (P/B) value ratio of 9 times (industry median of 2 times) and price-sales (P/S) ratio of 1.4 times (industry median of 1). The advertising company also sponsors a trailing 12-month dividend yield of 2.39% with a payout ratio of 45%.
(Omnicom, Company website)
Omnicom Group
In its recent annual filing, Omnicom stated that it was founded in 1986. The company claimed to be both a holding company and a leading global provider of advertising, marketing and corporate communications services.
The company provides several client-specific advertising and marketing services as found in the screenshot below.
(Omnicom List of Services Provided, Annual Filing)
Omnicom’s clients come from a variety of industries around the world and are served by several Omnicom agencies. The company’s largest client contributed 2.7% ($408.6 million of $15 billion) of total sales and was served by more than 250 Omnicom agencies.
According to its website, Omnicom had more than 1,500 agencies worldwide and about 74,900 employees. Geographically, Omnicom earned most of its sales in 2015 from North America (60% of total sales) followed by Europe (26%) and Asia Pacific (10%).
(Omnicom, Company website)
Sales and profits
In mid-July, Omnicom reported its second quarter results. The advertising company reported 2.1% growth to $3.88 billion in sales and 4.55% growth to $324 million in profits year on year, representing a profit margin of 8.34%. For the past five years (2011 to 2015), Omnicom had sales and profit growth averages of 3.8% and 5.7%.
As can be observed, Omnicom spends most of its revenue on operating expenses. The company identified these expenses in two categories: salary and services costs and office and general expenses. Salary and service costs consisted of employee compensation, including freelance labor, and related costs and direct service costs. Meanwhile, office and general expenses consist of rent and occupancy costs, technology costs, depreciation and amortization and other overhead expenses. With $15 billion in total sales last year, Omnicom spent 75% or $11.4 billion in salary and services cost and 12% or $1.85 billion in office and general expenses.
Cash, debt and book value
As of June 30, Omnicom had $1.5 billion in cash and short-term investments. The company also had total debt of $4.95 billion with a debt-equity ratio of 2.17 times. According to GuruFocus data, Omnicom had 45.5% of its total assets identified as intangibles and goodwill. Lastly, the advertising company had a book value of $2.28 billion.
(Read Omnicom’s Q2 Investor Presentation.)
Cash flow
(Omnicom Cash Flow, Annual Filing)
In 2015, Omnicom grew its cash flow from operations by 47% to $2.17 billion from fiscal year 2014. There were no observable nor marked changes in the company’s cash flow as shown in the image above except for the termination of interest rate swaps.
Found in F-18 of its annual filing: "In October 2015, we (Omnicom) terminated the swap on the 2020 Notes" and realized a gain of $36.9 million, and Omnicom reduced the notional amount of the swap on the 2022 Notes to $1.0 billion and realized a gain of $13.5 million. The gains will be amortized to interest expense over the remaining terms of the notes.
(Read Omnicom’s 2015 Annual Report.)
With $2 billion in cash flow from operations, the advertising company spent $202.7 million in capital expenditures leaving it with $1.97 billion in free cash flow. Omnicom then returned 62% or $1.2 billion of its free cash flow to its shareholders as dividends and share buybacks. The company only reduced its debt by $1.1 million that year.
(Cash Returned to Shareholders, Omnicom Investor Presentation)
As highlighted by Omnicom in its recent presentation, the company has been consistent in providing more (110%) of its profits to its shareholders not just for the past year but for the past decade. With this consistent performance, the company can be regarded as a good steward of its shareholders.
In terms of cumulative return, Omnicom gave 15.13% in average annual total return to its shareholders since 2010 while the Standard & Poor's 500 gave 12.48%.
Conclusion
Omnicom won praise for being a good steward of its shareholders. The company also demonstrated good steady growth in its business operations in recent years. Its dividends and share repurchases can be relied upon going forward.
Nonetheless, the way the market has priced its shares recently offers a minimal margin of safety. Omnicom’s shares are trading at good premium, especially its P/B multiple, compared to its peers. Historically, it would have been nice to pick up some of its shares back in 2011 and 2012, when its average P/E ratios were just below 14 times. Also, one should also consider Omnicom’s balance sheet status prior to buying its shares in the future.
Disclosure: I do not have shares in any of the companies mentioned in this article.
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