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Morningstar | Omnicom Kicks Off 2019 With Strong Organic Growth in 1Q; Maintaining $85 FVE

Omnicom reported impressive organic revenue growth along with year-over-year operating margin expansion, which led to better-than-expected bottom-line results. Strengths in the U.S. and Europe during the quarter were encouraging. Management maintained its 2019 top- and bottom-line guidance. We made slight adjustments to our projections and are maintaining our fair value estimate of $85 per share. The stock of this narrow-moat name is up nearly 5% and is approaching our fair value estimate and 3-star territory. We continue to recommend investments in ad holding names, which also include Publicis, WPP, and IPG, as upside to our fair value estimates and the firms’ average 5% dividend yield remain attractive.

Total first-quarter revenue of $3.46 billion was down 4.4% year over year as headwinds, including foreign exchange and impact of divestitures, more than offset the firm’s strong 2.5% organic growth, which slightly accelerated from the 2018 rate. North America revenue had an organic growth of 2.2% due to strong media buying in the U.S., plus the 6.1% growth contributed from Canada. European and Asia-Pacific regions posted organic growth rates of 3% and 2.1%. U.K.’s 1.3% organic growth along with solid growths in the Netherlands, Spain, and Germany, all of which more than offset weakness in France, led to the overall organic growth in Europe. The firm performed well in Australia, India, and New Zealand, which led to the 2.1% organic growth in Asia-Pacific compared with last year. Omnicom noted some weakness in China as a few projects were delayed, but are still likely to be completed this year. Weakness in Brazil, which is likely to persist, pushed revenue generated in Latin America down 3% from last year.

Operating margin expanded 74 basis points from last year to 12.4%, mainly due to Omnicom’s focus on operating more efficiently and the disposition of money losing agencies. While we are impressed with the firm’s margin expansion in the first quarter, and although management guided for a 20-30 basis point margin expansion for 2019, we continue to expect higher investments in talent and additional resources in data and analytics for the remainder of the year, which we think likely will drive margins lower than guidance.

We remain impressed with the firm’s overall strategy, which we think will help gain a stronger foothold in digital advertising, increase and enhance Omnicom’s technology offerings, and allow the firm to more effectively combine creativity with technology-driven data analytics.

Regarding digital advertising, Omnicom’s Annalect appears to be the firm’s response to the increasing data analytics-driven digital target or personalized marketing. While the firm is not as aggressive as IPG or Publicis has been in acquiring and owning data, we think Annalect’s open platform will continue to induce Omnicom’s clients to allow access to first-party data for real-time analytics and performance measurement. We expect Annalect and Omnicom’s other agencies to play a big role in the firm’s new retail group as digital retail ads, which are more e-commerce-focused, require real-time analytics and adjustments to maximize conversions and/or transactions. Annalect’s analytics capabilities plus access to clients’ first-party data will also allow Omnicom to help clients create, launch, and adjust high-ROI campaigns or ads not just online but also off-line.

In terms of technology offerings, Omnicom has also already taken steps to increase those offerings, which include data analytics tools for clients, along with long-term strategic technological expertise provided by Credera, the consulting firm that Omnicom acquired last year.

Last, we think Omnicom has also remained focused on creativity. In fact, it continues to integrate creativity with data analytics as it is training and educating its talent on the creativity side with data analytics skills. As we mentioned in our December 2017 Select report on other companies within the ad space, creativity is what differentiates ad agencies from consulting and technology companies.