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UK Value: WPP - A Guru-Backed Turnaround Story

Management's strategy to turn around the business is on track.

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The City Letter
Sep 19, 2021

Summary

  • The structural concerns for the advertising/media industries are overstated in my mind.
  • The role of the agency - to help clients optimize their marketing spend - is just as vital today as ever.
  • WPP is well placed given its scale, geographic reach and expertise across disciplines.
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When I noticed gurus

David Herro (Trades, Portfolio) and Charles Brandes (Trades, Portfolio) both own shares of WPP PLC (WPP, Financial) (LSE:WPP, Financial), I decided to take a deeper look into the company.

WPP is a value stock probably because traditional advertising agencies are seen by the market as old fashioned and not having the digital offerings the likes of Facebook (

FB, Financial) and Alphabet's Google (GOOG, Financial) (GOOGL, Financial) have. This view is similar to the one the market holds on ITV plc (LSE:ITV, Financial), which I wrote about recently.

This pessimism and fear that traditional advertising is dying a slow death comes from the fact that investors have an unshakable perception that Google and Facebook’s power is just untouchable. Why bother with advertising agencies when you can just work directly with big tech? Surely the likes of WPP, the world’s largest advertising agency (or more accurately, group of advertising agencies) is ex growth?

This view is actually very short sighted, in my opinion. Of course companies can organize their own advertising with whatever medium they choose. This has always been the case. The reason companies like WPP are useful is they offer the creative input and tactical and strategic advice to make marketing campaigns effective.

Big Tech also employs traditional advertising agencies themselves for their own campaigns. Indeed, Microsoft (

MSFT, Financial), Google, Apple (AAPL) and IBM (IBM, Financial) are all among WPP’s top 20 clients.

WPP’s history is quite an interesting one. Its energetic founder Sir Martin Sorrell grew the company by acquisition and allowed the businesses to operate independently. This missed the cross-selling synergies that were possible.

WPP 2.0

WPP is now lead by CEO Mark Read. It is trying to get those disparate parts to work more closely together. Read doesn’t want a client for one of his services to go to a rival for another service if WPP can offer it.

The other benefit from bringing the separate divisions together is cost savings. Some growth, especially the digital platforms, can come while costs remain mostly fixed, which offers margin upside. WPP has targeted margins of about 16% by 2023 compared with about 13% last year. I think this can be achieved along with revenue growth close to 10%. This combination would aid profits very nicely.

Where does my confidence come from?

First, WPP is in the process of sorting its balance sheet out. This means I think the Altman Z-score should improve from a distressed 0.6 to something much safer.

New management hosted an investor day titled “Accelerating Growth” on Dec. 7, 2020. The presentations by Read, Chief People Officer Jacqui Canney and chief financial officer

John Rogers (Trades, Portfolio) make interesting viewing. Back then, WPP was even more unloved, but the investor day presentations gave a clear strategy along with clear medium-term financial targets.

Since then, WPP has produced the goods at each subsequent earnings period, and has reiterated or raised guidance too. This gives me confidence that WPP is a structural turnaround story where management is on track.

WPP’s mid-term guidance is as follows:

1) 2.0-3.5% organic growth, with the traditional Communication services growing 1-2% and Technology / Experience / e-commerce growing about 10%

2) 0.5-1.0% contribution to revenues from mergers and acquisitions at a cost of 200-400 million British pounds ($274-549 million) annually

3) 15.5-16.0% Ebitda margin for financial year 2023 and a 20-30 basis point margin increase thereafter

4) 40% dividend payout

5) £300-400 million in share buybacks (what’s left of free cash flow post M&A and dividend, and net debt-to-Ebitda targeted at 1.50-1.75x)

All this offers a clear runway for rapid earnings per share growth. Analyst expectations EPS of 74 pence in 2022, which I think seems entirely reasonable. Slap a price-earnings ratio of 15 on this and we get a target price of £11.10. The current price-earnings ratio is 23.8 as WPP is still in recovery mode from the pandemic. Historically, WPP has traded with a price-earnings ratio in the high teens, so 15 is a conservative estimate, giving further upside potential if the market starts to buy into the WPP turnaround story.

WPP may be somewhat complex due to its holding company nature, but the key issue is that it is reshaping and repositioning itself, and it’s not an old economy stock even if it’s seen as one. That presents a buying opportunity.

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Disclosures

I am/we are Long LSE:WPP
Rating:
5 / 5 (1 votes)

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