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Morningstar | Whether It’s Creativity, Media, or Technology, IPG Is Firing on All Cylinders; Raising FVE to $26. See Updated Analyst Note from 19 Oct 2018

Similar to peers Publicis and Omnicom, IPG reported better-than-expected third-quarter 2018 results as the firm continues to excel by combining its investments in technology and data analytics with its well-known media and creative agencies to retain clients and land some new ones. Continuing strong organic growth in the U.S., some of which was driven by higher spending by consumer package goods companies, remains encouraging in our view. In addition, with the acquisition of Acxiom completed in October, we believe IPG is now well positioned to become the one-stop shop for advertisers. While management maintained its 2018 full-year guidance, we are now raising our fair value estimate of IPG to $26 per share from $25 as we have modeled in slightly higher operating margin assumptions from 2020 through 2027. We think after integrating Acxiom into its offerings, IPG may increase its client retention rates, which may create further operating leverage. In reaction to third-quarter results, IPG shares are trading nearly 10% higher and are now up 14% since July 16 when the stock was given a 4-star rating. While we have increased our valuation of IPG, the stock is now approaching our fair value estimate and 3-star territory as it is now trading at a 0.94 price/fair value. For this reason, we recommend waiting for a wider margin of safety before investing in this narrow-moat name.

IPG third-quarter total net revenue increased 3.4% from last year to $1.9 billion, mainly due to its impressive 5.4% organic growth, which was partially offset by headwinds from foreign exchange and disposition of some of its agencies. The firm continued its momentum in the largest ad spending market in the world, the U.S., as it posted 5% year-over-year organic growth during the quarter. While this increase was driven mainly by more ad spending within the healthcare, technology, telco, and financial services sectors, the firm did state that higher spending by consumer package goods (CPG) firms also contributed to such growth. In our view, this may also be good news for some of IPG’s peers, including WPP, which generates around one third of its net revenue from CPG clients. During the quarter, IPG also landed new clients such as American Express and Quicken Loans, while retaining other ones including Charles Schwab.

Other regions such as Europe, Asia-Pacific, and Latin America also posted strong year-over-year organic growth. Management reiterated its full-year organic net revenue growth guidance of 4%-4.5%. We continue to estimate organic growth of around a 3% CAGR during the next 10 years.

While strong organic growth also helped increase headcount 2%, IPG’s adjusted operating margin (which does not include expenses associated with the completion of the Acxiom acquisition) ticked up 50 basis points from last year to 14.4%, mainly due to accelerated top-line growth. While we expect lower G&A expenses to widen operating margin by 70 basis points in 2018, at the high end of the firm’s 60-70-basis-point margin expansion guidance, we have also slightly increased our margin assumptions for 2020-27. In our view, after the completion of the Acxiom integration into its offerings, IPG may experience higher client retention rates, which will likely push margins a bit higher toward 14.

We note that we believe our margin expansion assumptions are conservative. In our view, IPG will gain access to valuable global consumer data that can help the firm diversify its revenue and possibly become a one-stop shop for advertisers. However, Acxiom will also require more capital expenditures for system maintenance and data management that will partially offset the benefits of faster top-line growth and margin expansion.