The FTSE100 ended March at near 18-month highs, thanks to bullish optimism about a sustained upturn. However, I’m convinced that in the latter part of this year, corporate profits will begin to compress as taxes rise, household budgets tighten and inflation bites. If I’m right, one area to avoid is advertising.
So what does this mean for WPP, the world’s largest advertising agency, employing around 138,000 staff and generating turnover of £8.7bn? Its operations span traditional marketing, media-buying, research, public relations and branding. It serves many premium clients, including a who’s who of the megacap world (think Allianz, Johnson & Johnson, Procter & Gamble and Shell).
But, despite being a high-quality organisation (led by industry veteran Sir Martin Sorrell) with strong positions in its target markets, WPP will still be dragged down with the rest of its peers. For instance, last year like-for-like revenues sank a hefty 8.1%. The main reason for the drop was double-digit declines in its cyclically challenged areas of automobiles, financial services and travel. Another problem is WPP’s high exposure to North America, where it makes around a third of its money. True, the greenback might strengthen temporarily in the event of another flight to quality. However, the US has a chronic debt burden similar to Britain’s. So longer term the dollar is likely to drift lower in real terms against most commodity-backed currencies and physical assets.
WPP (LSE:WPP), tipped as a BUY by ING
The City is forecasting 2010 sales and underlying earnings per share (EPS) of £8.9bn and 50.9p respectively, rising to £9.2bn and 56.9p in 2011. These put the shares on stretched 2011 price-earnings multiples of 13.5 and 12.0. They also offer a skinny 2.5% dividend yield. I would rate the group on a through-cycle operating profit before an amortisation multiple of ten. Adjust for £2.6bn of net debt and a £251m pension deficit and the result is an intrinsic worth of 550p per share (20% lower than today’s price). And that is after factoring in one-off boosts from the General Election, World Expo in Shanghai, the US mid-term elections and the Football World Cup.
I’m not the only one predicting tough times ahead. Even Sir Martin Sorrell is saying that 2010’s organic sales will remain flat, with global advertising spending set to rise by less than 1% this year.
Recommendation: TAKE PROFITS at 696p
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments