WPP - Publicis Groupe: Cautionary Comments And Looming Recession Make This A Hold For Now

2023-04-24 13:05:21 ET

Summary

• PUBGY had a strong 1Q23 with organic growth of 7.1%.
• PUBGY's growth is expected to be in the upper half of its previously guided range of 3-5% for FY23, driven by its revenue mix, go-to-market strategy, and platform infrastructure.
• Investors should continue to monitor the comments made by management and competitors in the current macro environment.

Investment thesis

Publicis Groupe ( PUBGY ) is an advertising firm. The company provides a wide variety of media services, such as television, magazines, and interactive mobile and online communication. The broad argument is that the fields of data science, IT, e-commerce, and digital transformation are expanding, and with them, the demand for agencies' counsel and implementation. Agencies have a wide variety of clients, operate in different regions, and specialize in various fields, all of which allow them to weather economic downturns by adjusting prices and preserving profit margins. The 1Q23 results have shown how strong PUBGY's business model is, and how it compares relatively well against peers due to its expertise in data and digital transformation. PUBGY strong track record (a 4-year organic growth stack of 18%), is the highest among competitors such as Omnicom ( OMC ) and WPP ( WPP ). That said, readers should be aware of the cautious comments made by PUB and OMC on their 1Q23 earnings call, though. Specifically, both management team acknowledged that some digital transformation projects could experience delays and that the decision-making process could be slower for smaller projects. Despite what appear to be solid fundamentals and results, I am recommending a hold rating due to the unattractive 11x NTM PE and the impending recession (which may be much worse than expected). If the latter occurs, PUBGY will suffer from both a business and a flow (capital relocating away from the stock) perspective.

1Q23 results

1Q23 organic growth of 7.1% was 260 bps above the consensus estimate of 4.5%. One-third of the company's revenue came from data and business transformation, which contributed to its steady growth. Both Epsilon and Sapient increased their growth rates; Sapient by 11% and Epsilon by 10%. Consequently, management is now anticipating organic growth of 3-5% for 2Q23 and FY23. I anticipate a beneficial effect on consensus estimates as a result of this resetting of expectations. The significance of this robust organic expansion is something else I want to emphasize. PUBGY's 1Q revenues have experienced a 45% increase since 2019, with 18% of that growth being organic. Its superior performance relative to its competitors can be attributed in large part to the fact that one-third of its revenues come from data, technology, and business transformation - a growth segment that is experiencing strong secular tailwinds. Business transformation and digital media contributed to strong organic growth across all regions in Q1, indicating that the company is not overly reliant on any one area. Moreover, the underlying business successes are noteworthy. Adobe or Walgreens Media, Sonepar Business Transformation, Mondelez Production, and Dunkin' US Creative are just some of PUBGY's new business wins in 1Q23.

Strong growth in Europe

Organic growth in Europe for 1Q23 was 12.3%, which was significantly higher than the consensus estimate of 4.9%. Sapient played a significant role in the United Kingdom's exceptional organic growth rate of 24% in the first quarter of 2023. Sapient's global media operations as well as its many successful forays into the retail and financial sectors, all contributed significantly to the company's financial success. To be clear, however, I expect UK will start seeing tougher comps which should intensify beginning in 2Q23. Management did their best to set expectations right by factoring in the risk of potential delays in digital transformation projects that could have a disproportionately negative impact on Sapient into Q2 and FY23 guidance.

Staying conservative from management comments

I found it interesting that management, while noting no major shift in trends to date, did highlight that some caution has been factored into the guidance for the coming months. Though it hasn't happened yet, they warned that some clients, especially smaller clients in the U.S., might experience a slower decision process and potential delays in certain digital transformation projects. OMC noted a similar trend after a successful 1Q23 and reaffirmed its guidance for FY23. OMC management note that customers are becoming more wary and attempting to avoid long-term commitments in order to increase their spending flexibility. I think it's important to keep an eye on and be wary of the comments made by two major players. Given the uncertainty of the macro environment, the coming quarter could be significantly weaker than anticipated. This is a major factor in why I suggested a hold rating for the time being.

Guidance

PUBGY now anticipates full-year growth to be in the upper half of its previously guided range of 3-5% for FY23. The Group's growth will be propelled by the superiority of its revenue mix, go-to-market strategy, and platform infrastructure. The platform nature of PUBGY should continue to support the company's strong operating leverage and cost flexibility, and management has restated its target operating margin range of 17.5% to 18%.

Conclusion

PUBGY's did very well in 1Q23. Despite setting an ambitious growth target for FY23 and continues to benefit from strong secular tailwinds in data and business transformation, I highlight the cautious comments made by management regarding potential delays in digital transformation projects and slower decision-making processes. In addition, given the valuation at 11x NTM PE, which I believe is not attractive (no margin of safety from a historical perspective) and the potential for an impending recession, I recommend a hold rating for the time being. Investors should monitor the comments made by PUBGY and its competitors closely and remain cautious in the current macro environment.

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