Earnings Disappointment Makes Interpublic's Price More Attractive
We think the company is positioned to benefit as advertising and marketing become more complex.
Interpublic Group’s (IPG) second-quarter results came in short of expectations. The disposition of smaller ad agencies, along with the impact of foreign exchange, worsened the blow of practically no organic revenue growth during the period.
The top-line decline created additional pressure on the bottom line as the company failed to record year-over-year second-quarter operating margin expansion for the first time since 2013. Management does see a turnaround in the second half, as it maintained its organic growth and operating margin expansion guidance for the full year.
While our top- and bottom-line assumptions for 2017 were below management’s guidance before the earnings release, we lowered them a bit further. However, those adjustments did not affect our fair value estimate. The shares’ sell-off after the earnings disappointment, which has also lifted the dividend yield to 3.3%, may have created a buying opportunity as this narrow-moat name is now trading in 4-star territory.
Interpublic’s $1.88 billion in second-quarter revenue represented a 1.7% year-over-year decline. The 0.4% worldwide organic growth was hit with what appears to be a slowdown in ad spending in the United States, probably due to political factors that also impeded growth in that region for peers Omnicom (OMC) and Publicis. In addition, declines in Continental Europe and the Asia-Pacific markets resulted in no organic growth for the entire international segment. Interpublic’s total organic revenue growth was partially offset by the negative impacts of the divestiture of some agencies and foreign exchange headwinds.
It appears that various geopolitical risks in the U.S. and Continental Europe have worsened, as we expected. While management still expects overall 3%-4% organic growth in 2017, we remain cautious regarding short- to medium-term growth potential in those developed markets. We do agree with management that the slowdown in overall ad spending, as indicated by some ad holding companies’ second-quarter results, is due more to political uncertainty than an expectation of an overall economic downturn.
Disappointing second-quarter revenue resulted in some margin compression as Interpublic’s operating margin dipped more than 70 basis points from the prior year to 11%. Some cost control, mainly in office and general expenses, helped maintain the operating margin above 10%. We believe there is still room for margin growth with more operational efficiency coming from various strategies such as the centralization of data and analytics and additional disposition of some smaller agencies. However, we continue to assume margin improvement that is lower than management’s guidance for a 50-basis-point year-over-year expansion in 2017, mainly because of our lower organic revenue growth assumption.
Interpublic shares are now trading more than 13% below our $25 fair value estimate. We believe that while it experiences what appears to be a temporary slowdown, the company will continue to reward its shareholders via dividends and share buybacks. At current levels, the possible appreciation in the stock (based on our fair value estimate) along with a 3.3% dividend yield, may make Interpublic shares attractive. Interpublic has been distributing dividends to its shareholders for six consecutive years with a payout ratio between 25% and 50%. In addition, the company’s annual share buybacks have ranged between $300 million and $500 million since 2011. Interpublic’s share repurchasing has continued this year; during the first half, the company bought back $115 million of its shares at an average price of $24.13 per share.
Ali Mogharabi does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.