PUBGY - Publicis Groupe: Strong Outperformance And Growth Resilience (Rating Upgrade)

2023-10-18 08:30:23 ET

Summary

• I upgraded Publicis Groupe stock to a buy, with expectations of continued outperformance and a likely rerating of its valuation to historical levels.
• The company reported a 5.3% organic growth rate in 3Q23, exceeding expectations, and management revised its organic growth guidance for 2023 to a range of 5.5% to 6%.
• PUBGY is well-positioned in high-growth verticals like connected TV and retail media, and its resilience and improving operating margins validate its execution capabilities.

Overview

My recommendation for Publicis Groupe ( OTCQX:PUBGY ) is a buy rating, as I expect PUBGY to continue outperforming peers and the market is likely to rerate valuation back to its historical average. Note that I previously rated a hold rating for PUBGY, as I believe the stock is upside, which was not attractive based on my conservative assumptions.

Recent results & updates

Outperformance in all regions and an acceleration at Epsilon drove Publicis' organic growth of 5.3% in 3Q23, while Sapient's growth slowed. In spite of a general slowdown in digital business transformation projects, both Epsilon and Sapient saw double-digit growth. Gains in media market share and an expanded data offering also contributed to expansion. North America saw growth of 3%, Europe grew by 10.7%, the UK grew by 10%, France grew by 6.5%, Asia Pacific grew by 3.8%, and China shrank by 2.5%. As of the third quarter of FY23, net debt was reduced to €714 million, indicating a healthy balance sheet.

This quarter proved to be highly motivating, leading to my increased optimism about the business. Remember, I predicted 3–4% expansion, but the PUBGY reported 5.3% expansion in 3Q23. In addition, management revised its organic growth guidance for the fiscal year 2023 to a range of 5.5% to 6%, representing a 75 basis point increase at the midpoint.

However, it is expected that organic growth in the fourth quarter will likely fall within the 3%–5% range. The lower end of this growth forecast is based on the assumption that ongoing social and economic tensions will continue to impact client spending, lead to further delays in digital business transformation, and result in negative year-end budget adjustments by advertisers. Conversely, the upper end of the guidance assumes fewer cuts to traditional advertising, a quicker uptick in new business, and some positive impact from increased client budgets in Q4. In my view, the new guidance is somewhat conservative, with both perspectives having valid justifications.

Also notable, which I think further validates PUBGY's execution abilities, is that its resilience growth profile is matched by improving operating margins. Management revised their full-year 2023 operating margin guidance to 18%, thereby mitigating any potential uncertainties regarding a margin lower than 18%. This adjustment comes in light of the previous guidance, which indicated a margin that was in close proximity to the 18% mark.

From what I can see, 2024 should be another successful year for PUBGY. One of the primary factors contributing to PUBGY's prominent position lies in its dominance within the connected TV and retail media sectors, which are currently experiencing rapid growth . This particular market positioning results in a growth profile that is heavily inclined towards high-growth verticals. In the foreseeable future, the integration of AI and its data capabilities has the potential to enable AI to gain a larger portion of the creative market. This is primarily due to its ability to deliver personalized creative content on a large scale.

The second reason why we are confident in the growth of Publicis Media is not only that we are gaining market share with new clients or with existing clients that we are extending is that, we are leading the two major areas of growth for Media in the future, that’s our retail media and connected TV. from: 3Q2023 earnings call

In summary, I believe that PUBGY's organic growth is bolstered by a diverse range of sources, reducing the risk of significant deviations from its guidance if one particular sector underperforms. PUBGY's organic expansion is primarily driven by four key areas: Creative, Media Buying, Epsilon, and Sapient. This diversification contributes to the company's stability and resilience, mitigating the impact of revenue fluctuations within the media and creative industries. The synergies between PUBGY's operations further facilitate its expansion. For instance, it can leverage existing relationships with business transformation clients to upsell them into media or creative services.

As such, I think PUBGY will continue to outperform competitors. The inherent nature of the advertising business is that when the economy shrinks, it gets hit badly because businesses pull back on ad spending, given that it is easy to cut budgets. This was pretty much what happened to peers like Omnicom (growth basically slowed to near 0%) and WPP Plc (growth slowed to 2.6%). I expect PUBGY to receive the spotlight in this environment given its organic driver mix is more resilient (remember that PUBGY growth is 5.6%, strongly outpacing peers).

Valuation and risk

According to my model, PUBGY is valued at $88.21 in FY24, representing a 17% increase. This target price is based on my improved growth forecast of 6% in FY23 and 4% for FY24 and FY25, which is an increase from 4% for FY23 and 3% for FY24/25 previously. The increase in expectation follows management’s guidance and also the strong results and execution so far (far better than peers).

PUBGY is now trading at 10.5x forward earnings, which I believe will rerate upwards as PUBGY continues to outperform. Relatively to peers, I think PUBGY will receive the spotlight in the current operating environment due to its growth mix profile. When compared across other metrics, PUB has the best debt-to-equity profile (67% vs. peers at 144%), EBITDA margin profile (19% vs. 17.7%), and growth resilience as shown in recent quarters. I expected PUBGY to trade back to ~12x PE, its historical average, as it continues to execute.

However, I am also cognizant of the risk that the market is likely to group PUBGY together with peers, and in that sense, PUBGY valuation multiples are going to trend somewhat in line with the peer group. Hence, a slowing macro could continue to weigh on multiples, delaying the PUBGY pace of rerating upwards to 12x.

Summary

I recommend a buy rating for PUBGY, anticipating its continued outperformance in the market and a likely rerating of its valuation to historical levels. The recent quarter's results and updates have been highly motivating, exceeding expectations with a 5.3% organic growth rate in 3Q23. Management's revised organic growth guidance for 2023, ranging from 5.5% to 6%, suggests continued strength. However, the lower end of this range factors in potential economic and social tensions affecting client spending and digital transformation delays. Notably, PUBGY's resilience and improving operating margins validate its execution capabilities. It is well-positioned within high-growth verticals like connected TV and retail media, poised for further growth, especially with the integration of AI capabilities for personalized creative content.

With a diverse driver mix, I expect PUBGY to outperform competitors in the advertising industry, given its relative resilience. In terms of valuation, PUBGY's historical average PE ratio of ~12x is a target to watch for as it continues to execute. Nonetheless, the risk lies in the market's tendency to group PUBGY with its peers, impacting valuation multiples. A slowing macroeconomic environment could potentially delay the upward rerating of PUBGY's multiples.

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