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Morningstar | Omnicom Reports Mixed 2Q Results; Maintaining $85 FVE; Shares Undervalued

Omnicom’s second-quarter numbers beat on the bottom line while coming in a bit short of expectations on revenue. While overall organic growth remained strong in our view, we are now slightly more cautious about 2018 because of some weakness in North America during the quarter. Management continues to expect 2%-3% organic revenue growth this year. After only slightly lowering our 2018 revenue estimate, we are maintaining our $85 per share fair value estimate for Omnicom. The stock is trading in 4-star territory as it is down nearly 8% in reaction to second-quarter results. In our view, at current levels, the entry point for this narrow-moat name is attractive.

Omnicom reported total second-quarter revenue of $3.86 billion, up 1.8% year over year. The negative impact of the company’s continuing business dispositions was offset by a foreign exchange tailwind of 2.1% and the 2.0% year-over-year organic growth in the quarter. Like the first quarter, the North America region experienced an organic decline due to weakness in Canada and continuing effects of client losses in the U.S. In addition, further adoption of in-house programmatic advertising is putting some pressure on North American revenue, although management does expect this to lessen. We note the firm did win some new business during the quarter which may improve the second-half 2018 numbers. The new wins included HSBC going with Omnicom’s PHD when it comes to media planning and buying, replacing WPP’s Mindshare. In addition, Omnicom’s GSD&M creative agency in Austin won the Pizza Hut account from the independent agency Droga5. According to AdWeek, Pizza Hut spent over $225 million on the creative side of marketing and advertising last year. We note that in the first quarter, GSD&M also won the over $700 million Air Force Recruiting account.

Europe, Asia Pacific, and Latin America had organic growth of 5.9%, 8.5%, and 2.5%, respectively. In terms of services, revenue from CRM Execution & Support, which includes customized marketing and communications, along with sales support, was down 4.4% year-over-year, while all other services grew and offset the decline in CRM Execution & Support. CRM Consumer Experience, which includes most of the firm’s digital marketing solutions, outperformed the firm’s other offerings as it was up 7.1% organically from last year. In our view, the continuing growth seen in Omnicom’s CRM Consumer Experience is indicative of the firm’s success in focusing on 1-on-1 and highly targeted advertising and marketing.

Operating margin came in at 15.1%, similar to last year as Omnicom continued to more fully utilize its resources. Salaries and services costs as a percentage of revenue dipped more than 20 basis points when compared to last year. This was partially offset by an increase in general and administrative expenses as a percentage of revenue. We continue to expect higher investments in talent and in additional resources in data and analytics during the second half, which may result in a full-year 13.1% operating margin, a bit lower than last year’s 13.5%.