PUBGY - Omnicom: Buy This Advertising Giant While It's Undervalued

2024-01-08 08:10:00 ET

Summary

• Omnicom is a global advertising giant with deep industry expertise and long-standing client relationships.
• OMC has adapted to the changing advertising landscape, growing organic revenue and expanding into digital advertising with a recent acquisition.
• The company generates healthy margins, has a strong balance sheet, and rewards shareholders with dividends and share buybacks.

It’s been a while since I last visited Omnicom Group ( OMC ) here with a ‘Buy’ rating back in September, noting its increasing leverage of AI and organic growth opportunities. This global advertising giant strikes me as the type of investment that one can put on the back burner and not worry too much about, considering its deep industry expertise and long-standing relationships with its client base.

The stock has given investors an impressive 11% total return since then, surpassing the 5% rise in the S&P 500 ( SPY ) over the same timeframe. In this article, I revisit the stock and discuss why OMC remains a good long-term bargain in this market, so let’s get started!

Why OMC?

Omnicom is a global marketing and corporate communications conglomerate, offering services that include advertising, strategic media planning, precision marketing, public relations, and customer relationship marketing. It has a worldwide presence in 70 countries and has over 5,000 clients, many of which are leaders in their respective industries.

Perhaps more than other industries, the advertising industry has undergone dramatic shifts over the past decade, as consumers have dramatically shifted how they consume media, from traditional set-top boxes channeling cable network channels to OTT (over-the-top) streaming services that have a different marketing landscape. Moreover, consumers have increasing shifted their time and eyeballs towards digital content on phones and tablets, further complicating how media is consumed.

These fundamental shifts are reflected in OMC’s revenue trend over the past 10 years. As shown below, while OMC’s revenue nearly doubled over the past 20 years, much of that growth was experienced in the years leading up to 2015, and growth has stalled since that time.

Nonetheless, OMC is proving its ability to adapt in the current landscape, as it was able to grow organic revenue by 3.3% YoY during the third quarter, driven by notable performances in Advertising & Media, Precision Marketing, and Healthcare segments which all saw 4-6% revenue growth. This was driven by OMC’s making of headway into digital advertising such as ad placement within apps and data analytics services that give its clients an understanding of user engagement with their brands.

At the same time, OMC generates healthy margins, helping it to score a ‘ B ’ grade for Profitability as it relates to the Communications Services segment. It’s worth noting that OMC generated a TTM Net Income Margin of 9.6%, sitting well above the 3.2% sector median

Importantly, OMC’s healthy profitability enabled it to generate $1.3 billion in free cash flow during the first nine months of 2023, an increase of 9.4% compared to the prior year period. True to its historical commitment to shareholders, OMC utilized $424 million of that cash flow to pay the cash dividend, and $530 million to repurchase shares at discounted valuations.

Speaking of dividends and buybacks, OMC’s 3.3% dividend yield is well-covered by a 38% payout ratio and has a 5-year dividend CAGR of 3.1%. As shown below, OMC has been a serial repurchaser of its shares over the past 10 years, reducing its share count by 22% over this time period.

Looking ahead, OMC also has opportunities to grow externally, as it carries plenty of free cash flow after paying the dividend and even after funding buybacks, as noted earlier. This is reflected by a number of acquisitions last year, not least of which includes the announcement during Q4 of 2023 to acquire Flywheel Digital for $835 million, with the transaction expected to close in the first quarter of this year.

Flywheel is a growing service that enables brands to sell goods more efficiently on the digital marketplaces of notable names like Walmart ( WMT ), Amazon ( AMZN ), and Alibaba ( BABA ). As noted by OMC’s CEO, this acquisition “significantly broadens our reach and influence in the rapidly expanding digital commerce and retail media sectors, two of the fastest-growing parts of the industry."

Moreover, OMC could see plenty of organic growth opportunities, as Morgan Stanley ( MS ) expects for U.S. advertising spend to grow by 10% during 2024. Even taking out the benefits from political and Olympic spending, that number is still expected to be strong at 7%.

This is expected to be largely driven by increased online ad spending on smaller platforms like Snap ( SNAP ) and Pinterest ( PINS ). In addition, Amazon’s introduction of ads for Prime Video is the latest example of streaming services opening up to advertising, and could be another strong avenue for OMC’s revenue growth going forward.

Meanwhile, OMC maintains a strong balance sheet with a BBB+ investment grade credit rating from S&P. This is reflected by a very reasonable net debt to EBITDA ratio of 1.5x. OMC also has a $2.5 billion revolving credit facility that’s undrawn and provides a backstop for its $2 billion U.S. commercial paper program. In addition, OMC has $2.8 billion cash and short-term equivalents and no debt maturities until November of this year.

Risks to the thesis include potential for economic uncertainty and a recession, which could cut into the marketing budgets of OMC’s clients. In addition, OMC could see increased competition in the digital space as its peers like WPP plc ( WPP ) and Interpublic Group ( IPG ) are also ramping up their digital ad services. Lastly, the significant Flywheel acquisition comes with merger integration risk, as OMC would need to ensure that cultures mesh and that there isn’t a post-merger exodus of talent.

Considering all the above, I continue to see value in OMC at the current price of $85.88 with a forward PE of 11.6, which sits well below its normal PE of 16.1. At the current valuation, OMC is priced for flat to no-growth, whereas analysts estimate 5% to 8% annual EPS growth over the next 3 years.

OMC also trades favorably compared to its peers IPG, Publicis ( OTCQX:PUBGY ) and WPP with an EV/EBITDA of 9.0, sitting below the 9.2 to 10.5 range of its peers, as shown below. This is despite OMC’s moat-worthy size as being the world’s second largest advertising agency with subsidiaries like BBDO and DDB, which are some of the most acclaimed in the business.

Investor Takeaway

Omnicom has plenty of opportunities to grow in the evolving advertising landscape, both organically and through acquisitions. Its strong profitability and healthy free cash flow generation also allow it to reward shareholders with dividends and share buybacks with plenty of retained capital to reinvest into business.

While there are risks to consider, OMC’s current low valuation makes it an attractive investment opportunity with the dividend, share buybacks at an 8.6% earning yield, and potential for a reversion to its mean valuation. As such, I continue to rate OMC as a 'Buy' for investors looking for potentially strong total returns and exposure to the communication services segment.

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