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Morningstar | Omnicom Continued Displaying Organic Growth in 2Q; Maintaining $85 FVE; Shares Fairly Valued

Omnicom closed the first half of 2019 with in line second quarter revenue and beating the consensus on the bottom line. We were pleased with organic growth, which was driven primarily by strengths in North America and Europe. Omnicom also continued to expand its operating margin. Management maintained its 2%-3% organic growth guidance for the full year, and we see no reason to change expectations. We are maintaining our $85 per share fair value estimate on this narrow-moat name. After solid second-quarter results, the stock is down around 3% which could be due to profit-taking (the shares have handily outperformed the market over the past year). While Omnicom is trading at a slight discount to our fair value estimate, the stock is in 3-star territory, and we recommend investing in its fellow narrow-moat ad holding firms including WPP, IPG, and Publicis that are currently trading at lower P/FVs.

Total second-quarter revenue came in 3.6% below last year as the continuing strength in the dollar, along with agency dispositions, more than offset the firm’s impressive 2.8% year-over-year organic growth. Revenue from North America grew 3.7% year over year organically, with 3.2% growth in the U.S. and 11.8% in Canada. We find increases in advertising and media revenue in the U.S. encouraging. It also appears that the firm’s investments in its healthcare advertising and media offerings are generating returns as management cited them as additional drivers behind top-line growth in the U.S. Revenue from Omnicom’s CRM Execution & Support offerings, which include field marketing, sales support, and point-of-sale, remained weak.

Organic revenue in Europe was up 3%. While the U.K.’s 5.7% growth was impressive, Omnicom did suggest that uncertainty regarding the impact of Brexit on future ad spending in that market remains. Like the U.S., strength in the U.K. during the quarter was a result of mainly higher advertising and media spending. Growth in New Zealand and Japan, more than offset a decline in China, resulting in 1.9% organic growth for the Asia-Pacific region. Decline in revenue from Brazil, which was likely due to a weakening economy, drove overall Latin America revenue down 2.4% from last year. Due to what we believe are various geopolitical factors, Omnicom’s revenue from the Middle East and Africa declined 8.3% from last year.

Omnicom’s cost control focus continues to pay off as the operating margin went up around 30 basis points from last year to 15.4%. Continuing dispositions of underperforming agencies have also helped the firm operate more efficiently. As the firm is likely to increase the hiring of more creative talent to jump-start work on some newly won accounts, we think margin expansion for the year will be only around 20 basis points.

Last, as one of Omnicom’s peers, Publicis, purchased data provider Epsilon for $4.4 billion, there were questions as to why Omnicom is not making the same type of investment. It appears that like WPP, Omnicom views access to data as more important than ownership of data. Management stated that it did consider Epsilon and Acxiom (bought by IPG in late 2018 for $2.3 billion), but the firm was not willing to pay what it viewed as too-high prices. The company already has its own differentiated data sources while it also has access to first-party data (or client data). Plus, similar to its peers, Omnicom can utilize data from other sources or third-party data. In addition, the firm has been investing in technology, data analytics, and people as it now offers those capabilities via Credera, Annalect, and Omni. As we mentioned in our July 14 note regarding WPP’s partial sale of Kantar (which indicated a data strategy like Omnicom’s), firms taking this route likely benefit from the fewer investment requirements for data gathering, updating, and management, while they focus mainly on digital and creativity integration.