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Morningstar | Publicis Reports Disappointing 1H 2018 Results; Lowering FVE to EUR 63; Shares Undervalued. See Updated Analyst Note from 20 Jul 2018

While Publicis displayed margin expansion during first-half 2018, the firm failed to meet expectations with disappointing organic growth, mainly in North America. Management maintained its full-year organic growth improvement and operating margin expansion guidance. While we expect acceleration in organic growth during the second half of 2018, we remain conservative and estimate such improvement to be minimal. However, we do foresee the firm benefiting from the signings of new clients plus higher growth coming from more focus on data, creativity, and helping advertisers with their digital business transformation beyond 2018. After adjusting our projections slightly lower, we lowered our fair value estimate of Publicis to EUR 63, from EUR 65. Publicis shares took a hit and closed at EUR 53.18, down 9%. At this level, we now view this narrow-moat name as an attractive investment opportunity.

Publicis' total revenue of EUR 4.28 billion during the first half of 2018, was down 8.2% year over year as in addition to foreign exchange headwind and results of net dispositions, organic revenue was down 0.4% during the first six months. The weak organic number was driven by weakness in North America, Europe, and Asia Pacific, offset partially by growth in Latin America and Middle East Africa.

While the firm posted organic growth of 0.1% in North America during the first half, second quarter's 2.3% decline was a disappointment. However, management reiterated that such weakness was due mainly to one-time difficulties faced by Publicis Health Solutions, which simply provides some clients with a third-party salesforce. Demand for such a service is normally very volatile, which during the quarter came at the expense of a EUR 30 million decline in Publicis Health revenue. Such decline lowered overall organic growth by 90 basis points. The firm also has not yet significantly benefited from some account wins in late 2017 and early this year. Those will be recognized during the remainder of 2018. Some new account wins include Macy's, Dunkin' Donuts, and McDonalds in France.

The implementation of GDPR in Europe drove organic revenue in the region down 1.7%. According to Publicis, as GDPR may lower online traffic to various properties, possibly reducing ROIs, some advertisers have become hesitant in buying ad inventory from those property owners or publishers. We think such hesitation is temporary and expect organic growth to pick up again in second half of this year and in 2019 as GDPR becomes more widely and routinely implemented by publishers.

Although Publicis lacked organic growth through June of this year, management is standing by its 2018 guidance of organic growth accelerating from 2017’s 0.8% along with some margin expansion. We have modeled revenue increasing organically by approximately 1.2% in 2018, followed by 2.1% in 2019. We believe such growth will be driven by revenue generated from recent account wins along with Publicis' focus on further integration of Sapient's offerings with its creativity and data analytics services. We think this will accommodate increasing demand in digital creativity which itself likely requires a digital transformation by advertisers. We continue to believe the firm is slightly better positioned to offer the entire suite composed of assistance with digital business transformation which could help many of its clients attain and parse through more valuable consumer or customer data, which can be utilized to design and launch more effective marketing campaigns.

While some headwind has slowed organic growth for the firm, Publicis' efforts toward simplifying its structure continue to help the firm streamline its operations. Publicis reported operating margin of 14.3% during the first six months of this year, up 60 basis points from the prior year. For the year, we expect 15.7% operating margin, a 20-basis point expansion from last year.