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Morningstar | WPP 1Q Results Indicate Progress Toward a Turnaround; Maintaining GBX 1,450 FVE; Shares Undervalued

WPP reported first-quarter net revenue in line with our internal estimate. While weakness remained in the U.S. market, there are indications of improvements including large account wins and no large account losses during the quarter. In addition, WPP reassured the Street that it is progressing toward selling a portion of Kantar, and reports surfacing April 26 support the firm’s statement. Management did not change its 2019 outlook, and we are maintaining our GBX 1,450 per share fair value estimate on this narrow-moat name. WPP shares have reacted well to the news and are up nearly 6%; this Best Idea stock remains at 5-stars. At current levels, WPP shares also represent a 6%-plus dividend yield.

Net revenue dipped 0.7% from last year as growth from acquisitions and the foreign exchange tailwind were more than offset by organic sales decline of 2.8%. In North America, organic net revenue was down 8.5% as impact of account losses, mainly Ford’s creative account, from last year persists. We expect improvement in this region throughout 2019 as revenue from new account wins come in. Plus, according to management account reviews are back to normal levels and much lower than last year.

WPP’s organic net revenue in the U.K. declined 0.9%, better than last quarter and full-year 2018. The firm expects business in that market to strengthen a bit throughout the rest of this year. There was slight weakness in Western Europe with organic net revenue declining 0.3% as growth in Germany, Belgium, Denmark, Finland, the Netherlands, and Turkey were offset by weakness in Austria, Italy, and Spain. Like-for-like net revenue growth in all other regions was 2.8%, which we view as positive as those regions bring in nearly one third of WPP’s total net revenue. Net revenue from China drove such growth as fears of trade wars are not impacting ad budgets as much as they did in fourth-quarter 2018.

The decline in WPP’s U.S. net revenue negatively impacted growth in nearly all the firm’s segments, especially media and advertising and health and wellness, where WPP lost some accounts last year. Like-for-like revenue from media and advertising declined 4.8% from last year. Brand consulting, health and wellness and specialist communications organic net revenue was down 2.1%. Net revenue from data investment management and public relations was up slightly compared with last year as the firm’s Kantar data business experienced growth mainly in Asia-Pacific and Latin America.

We were impressed with WPP’s account wins during the quarter. The firm won 10 $40 million-plus billings accounts during the quarter, while it did not lose any of at least that size. WPP may be again gaining traction in the U.S. as of the total billings that it grabbed in the first quarter, which, according to the firm, was approximately $2 billion with one third from U.S. accounts. Plus, the quarter’s wins represent about half of the wins the company had during the entire 2018, and one third of what it had in full-year 2017. While there remains uncertainty about whether WPP’s first quarter billings win rate will continue throughout the year, in our view, it is indicative of the early stage of a turnaround. Plus, the second quarter may have gotten off to a good start as the firm won the creative account of Duracell with global coverage representing around $100 million in billings. It appears that the firm’s efforts in getting its creative agencies back on their feet and winning U.S. accounts are bearing fruit.

Regarding the sale of Kantar, management believes it is further progressing in selling a portion of the business. And according to a Bloomberg report on April 26, the remaining bidders for that business are now Bain Capital and Apollo Global Management. The price that WPP is seeking is reported to be around GBP 3 billion. If we assume that Kantar represents most of WPP’s data investment management business, then such a transaction represents 1.2 times 2018 Kantar revenue, which is similar to the trailing 12 months revenue multiple that our GBX 1,450 fair value estimate of WPP represents. From an EBITDA standpoint the GBP 3 billion price for all of Kantar is 8.3 times that segment’s trailing EBITDA, while our valuation of the entire firm is 9.6 times as it includes the higher margin media business. WPP plans to use proceeds from the possible deal (which could be around GBP 2 billion as the firm plans to keep around 40% of Kantar) to further strengthen its balance sheet.