Omnicom's on Sale
The ad firm has some of the most acclaimed agencies in the business.
Omnicom Group’s (OMC) second-quarter numbers beat on the bottom line while coming in a bit short of expectations on revenue. While overall organic growth remained strong, we are now slightly more cautious about 2018 because of some weakness in North America during the quarter. Management continues to expect 2%-3% organic revenue growth this year. After slightly lowering our 2018 revenue estimate, we are maintaining our $85 fair value estimate. The stock fell in reaction to the results, and we think it is trading at an attractive level.
Omnicom reported total second-quarter revenue of $3.86 billion, up 1.8% year over year. The negative impact of the company’s continuing business dispositions was offset by a 2.1% foreign exchange tailwind and 2.0% year-over-year organic growth. As in the first quarter, the North America region experienced an organic decline because of weakness in Canada and continuing effects of client losses in the United States. In addition, further adoption of in-house programmatic advertising is putting some pressure on North American revenue, although management does expect this to lessen.
The company did win some new business during the quarter, which may improve second-half numbers. The new wins included HSBC going with Omnicom’s PHD for media planning and buying, replacing WPP’s (WPP) Mindshare. In addition, Omnicom’s GSD&M creative agency in Austin won the Pizza Hut account from independent agency Droga5. According to AdWeek, Pizza Hut spent over $225 million on the creative side of marketing and advertising last year. In the first quarter, GSD&M also won the $700 million-plus Air Force recruiting account.
Europe, Asia Pacific, and Latin America had organic growth of 5.9%, 8.5%, and 2.5%, respectively. In terms of services, revenue from CRM execution and support, which includes customized marketing and communications along with sales support, was down 4.4% year over year, while all other services grew and offset that decline. CRM consumer experience, which includes most of Omnicom’s digital marketing solutions, outperformed the company’s other offerings as it was up 7.1% organically from last year. In our view, the continuing growth in Omnicom’s CRM consumer experience is indicative of the company’s success in focusing on one-on-one and highly targeted advertising and marketing.
The operating margin came in at 15.1%, similar to last year as Omnicom continued to more fully utilize its resources. Salaries and services costs as a percentage of revenue dipped more than 20 basis points compared with last year. This was partially offset by an increase in general and administrative expenses as a percentage of revenue. We continue to expect higher investments in talent and additional resources in data and analytics during the second half, which may result in a full-year 13.1% operating margin, a bit lower than last year’s 13.5%.
Moat Built on Brand Equity
Omnicom is the second-largest player in advertising on the basis of annual revenue. It has attained that position less through acquisitions and more through organic growth, compared with peers. With its very well-recognized creative agencies and subholding companies such as BBDO and DDB, we expect Omnicom to maintain its market position as it generates competitive organic growth, continues to make acquisitions, and increases focus on the faster-growing emerging markets and the overall digital ad markets.
Through various acquisitions, the company has transitioned from traditional advertising toward becoming a complete solution provider with digital (including online video, social media, and mobile), along with other services such as public relations. Omnicom was relatively quiet on the acquisition front in 2016, two years after it ended merger talks with Publicis; however, it has been selected by large accounts such as AT&T and McDonald’s, along with many smaller accounts, which bodes well for the company’s revenue growth in the foreseeable future.
We look to Omnicom to pick up the pace of its acquisition growth strategy to gain further traction in other faster-growing international markets, as globalization of businesses in various verticals has increased demand not only for vertical-specific advertising expertise but also for experience, knowledge, and a clearer understanding of different cultures and regulations.
We also expect Omnicom to continue acquiring and investing in the growing digital advertising space. Clients of Omnicom and its peers are allocating more ad dollars toward below-the-line, or more targeted, digital campaigns, creating growth opportunities. Like its peers, Omnicom has made headway in providing different components of digital advertising such as programmatic media buying and ad placement, along with data analytics and performance-measurement services.
We believe Omnicom has a narrow economic moat. It holds valuable intangible assets, in our view, around the holding company’s brand equity and the strong reputations of its various advertising agencies around the world. We also think continuing investments in consumer data accumulation and analysis give the company a sustainable competitive advantage. To a lesser extent, we think Omnicom benefits from customer switching costs associated with further integration of its resources with its clients’ marketing departments. We believe the utilization of the company’s moat sources and overall execution will result in Omnicom earning excess returns on capital for at least 10 years.
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Ali Mogharabi does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.