JPMorgan Maintains Conviction on Ad Agencies

Analysts at JPMorgan are sticking with their conviction on the advertising stocks, in particular Omnicom (OMC) and InterPublic Group (IPG), stating that their diversified revenues and variable cost structure will help them navigate the challenging environment better than other media companies.

However, they have taken down revenue and margin expectations for the stocks for 2009 but note that further reductions could be possible because of the huge uncertainty around the advertiser and agency budgeting process. That uncertainty could also create volatility in the stocks.

Omnicom is down 50% and IPG is down 60% from 52-week highs. The firm has a price target of $40 for Omnicom and $10 for IPG. Both stocks are trading at 6x ’09 EBITDA at OMC’s current stock price of $25 and IPG’s current stock price of $3.69.

From JPMorgan Analyst Alexia Quadrani:
Following channel checks within agencies and further analysis surrounding anticipated layoffs, we are increasing our cost assumptions at both OMC and IPG.

Layoffs at OMC should depress 4Q margins. We are modestly reducing our revenue assumptions, which assume 80% of project based business in Q4 does not materialize and a general pullback in ad spending among the core customer base continues. However, we believe lower incentive comp will not be able to buffer the impact of substantial layoffs, largely at BBDO Detroit and other agencies within the US, which we believe will lead to a significant contraction in OMC's 4Q, 08 operating margin of 150 bps, bringing our EPS estimate down to $0.84 from $0.94 previously. Our 2009 estimate is now $2.73, down from $2.90, largely reflective of a lower base in 2008 and some further margin contraction in 2009.

Despite continued progress in the turnaround, we expect IPG's 09 margins to decline 70bps. Our revenue assumption at IPG is unchanged, at down a reported 7.1% from 2008. We now expect IPG’s 2009 operating margins to approximate 7.5%, a 70 bp decline from 2008. As a result, our revised EPS estimate is $0.42, down from $0.45. We note that we still remain slightly below management's profit target in 2008 of 8.5%, which was once again reiterated last week.

While we are very comfortable with new estimates, we note revisions have been frequent and will most likely be ongoing. We have spoken to many advertisers and agency executives who remind us how fluid the budgeting process is, especially in today's marketplace. With several advertisers still uncertain about their own budgets so late in the year, we note that there cannot be much conviction in estimates at these ad-based businesses. We believe this higher than average level of uncertainty in the budget process, combined with dramatic moves in currencies, will likely lead to other downward estimate revisions going forward, adding to some volatility in the stocks. That said, we still believe the diversified revenues and somewhat variable cost structure will lead to better overall results than most other media. We therefore continue to recommend the group as a great place to hide near term in this choppy market, understanding that significant absolute upside may have to wait for more stability in the overall economy.