Interactive Investor

Stockwatch: a FTSE 100 value play or fool’s gold?

27th May 2022 11:44

Edmond Jackson from interactive investor

A drop in the share price of this blue-chip stock has piqued the interest of companies analyst Edmond Jackson. Here, he explains whether he’d buy, sell or hold.

An interesting situation currently among perceived cyclical stocks is WPP (LSE:WPP), a £10 billion FTSE 100 global marketing services group.  

Last Tuesday, the share price slumped 8% to 880p having already de-rated from 1,225p last February to around 950p. It broke below an apparent 920p technical support level that has existed for year or so, which “efficient markets” advocates would say is a portent of worsening prospects. Traditionally, advertising is seen as a leading cyclical indicator.  

As the US market rallied, WPP recovered to 920p where it trades on 10x consensus estimates for 32% earnings growth, albeit easing below 12% growth for a 9x price/earnings (PE) ratio. The dividend yield would be 4%, rising to 4.4% covered 2.5x by earnings – assuming forecasts are fair. 

Meanwhile, recruiters such as PageGroup (LSE:PAGE) and Robert Walters (LSE:RWA) are quite flat at around one-year lows, on forward PE’s just below 10x compared with the high-teens to mid-twenties during recent years. Forward yields are priced around 4%, not as high as 6% to even 10%-plus for some housebuilders, but higher than recently.  

Does this drop at WPP start to represent value, or should it be treated warily? 

Just how cyclical might the modern WPP prove? 

After the 2018 drop in financial performance (see table below) the group underwent quite a restructuring to reduce exposure to advertising and develop new marketing services such as digital.  

Some might say, however, that all such “communications” services are a variable cost that client firms would cut in a downturn before shedding employees. Even digital is exposed if consumer spending drops.  

Last Tuesday’s plunge related to a shock warning from social media platform Snap Inc (NYSE:SNAP), which warned: “the macroeconomic environment has deteriorated further and faster than anticipated”. Second-quarter 2022 revenue and operating profit were guided lower, in a sharp change in tone from the first quarter. 

It confirmed investors’ worst fears at a time when many are already edgy. The likes of Snap are more likely a portent of what lies ahead than macroeconomic data. 

Adding to wariness was a story about how advertisers are facing privacy changes such as Apple’s tracking restrictions, currently slowing businesses that boomed during Covid. 

It all conspired to a sense that digital marketing platforms are maturing and becoming more competitive. Facebook (Meta (NASDAQ:FB)) has cut spending and Twitter (NYSE:TWTR) announced a hiring freeze plus other cost-cutting measures. If consumer reach is reducing, then this is liable to have a knock-on effect on digital marketing. 

Snap is, however, a loss-making company valued at over £18 billion equivalent, or 4 to 5x prospective sales, hence its stock is particularly vulnerable to any negative shift. WPP’s strength of earning power justified a bounce back.

It is such a dilemma to divine economic prospects. Have consumers squirrelled away enough cash amid government give-aways during Covid, to help avert a recession? Might we anyway face a few years’ stagflation as higher prices – and wages, for some – get embedded, and which modest interest rate rises fail to quell?

Shifting sentiment can however be a boon for trading WPP shares – up or down. After its stock halved below 500p in March 2020, there was a bull run to over 1,200p which has now broken down below the 200-day moving average trend-line just below 1,000p. 

If the chart is your near-term guide as to probability, it appears to say “wait” before buying, until there is better confirmation of an apparent downtrend having been broken. 

Fundamentals remained strong, at least up to end-April 

WPP derives around 35% of revenue from the US, 29% Asia-Pacific, 22% Western continental Europe, and just 15% UK. Its stock is thus quite a proxy for global prospects and offers diversification from UK-specific risks. 

The group sports a satisfactory operating margin, although it has declined from around 14% to 9% (see table) which is a bit disappointing relative to my sense that WPP should have derived financial benefits from a restructuring. 

Last March, WPP joined other agencies ceasing Russian operations, although they represented only 0.6% of group revenues, so this should not have contributed to its stock de-rating. 

A 27 April first-quarter 2022 update cited like-for-like revenue up 8% - led by India up 25% and China by 12%. Developing countries did not dominate the momentum though: Germany rose 16% and both the US at near 9% and the UK just over 8%, scored respectably.  

Guidance for 2022 as a whole was raised from around 5% to 5.5-6.5%, which you could regard as a 20% upgrade if minor overall.  

The CEO cited momentum continuing from 2021, hence strong growth across all businesses and regions. Demand was strong especially in digital media, e-commerce, data and marketing technology. 

An equivalent £1.4 billion net new business was won including Mars, JDE Peet’s – the world’s largest coffee and tea company - and Sky. 

There was nothing whatsoever in the update to hint at a slowdown, but that’s the same as at UK volume housebuilders whose equity has de-rated to 6%-plus dividend yields.  

Anxiety is thus all due to macro fears, enhanced by Snap’s sudden warning. 

Buy-back programme will provide some profit benefit 

A maximum 121.3 million shares or (I estimate) 11% of the issued share capital was approved for buy-back at the 2021 AGM. It would appear some 40 million were bought back in the first quarter.

How value-enhancing this proves depends on whether the global economy avoids a slump, and whether WPP is shown to not be over-paying compared to where market price heads next.  

Perhaps the price might have dropped further in recent weeks, without this aspect of demand. 

You know my scepticism of buy-backs: if prospects are truly great then management would instead be investing; and if surplus cash still remains, why not raise dividends or make a special payout? I sense that boards prefer buybacks as means to pep up earnings per share (EPS), partly to show they are doing a good job but also to justify executive remuneration awards. In company news generally, buy-backs are proliferating.  

WPP - financial summary
Year-end 31 Dec

  2016 2017 2018 2019 2020 2021
Turnover (£ million) 14,389 15,804 13,047 13,234 12,003 12,801
Operating margin (%) 14.2 12.1 9.2 9.4 -20.2 9.1
Operating profit (£m) 2,048            1,909 1,204 1,248 -2,424 1,167
Net profit (£m) 1,400 1,817 825 844 -2,967 638
EPS - reported (p) 108 126 55.0 67.3 -243 52.5
EPS - normalised (p) 103 140 95.2 81.3 -50.5 69.3
Operating cashflow/share (p) 137 110 134 147 168 167
Capital expenditure/share (p) 22.0 25.6 29.7 31.3 22.3 24.1
Free cashflow/share (p) 115 84.8 105 116 146 143
Dividends per share (p) 56.6 60.0 60.0 22.7 24.0 31.2
Covered by earnings (x) 1.9 2.1 0.9 3.0 -10.1 1.7
Return on total capital (%) 11.5 10.5 7.0 8.0 -18.7 10.2
Cash (£m) 2,437 2,391 11,066 11,306 12,899 3,883
Net debt (£m) 4,131 4,483 4,017 3,789 2,852 2,943
Net assets (£m) 9,325 9,487 9,360 7,926 4,732 3,616
Net assets per share (p) 728 747 742 630 386 313

Source: historic company REFS and company accounts

Marshall Wace expands its short position 

Despite being the sole disclosed short seller - exposed to over 0.5% of WPP’s issued share capital – I would note Marshall Wace’s action given this hedge fund has plenty of experience at shorting and has often proven shrewd. 

Its position has built steadily since passing the threshold for disclosure in October 2017 when WPP traded around 1,400p and was falling fast from a 1,870p high. 

Marshall Wace briefly dipped below then re-appeared over the 0.5% position last November and has grown this steadily to 0.9% as of 11 May – which has been astute trading. The percentage sounds small but is £90 million. 

A weak hold stance currently 

I would not panic into emulating Marshall Wace, which may be using a liquid cyclical stock (among others) to hedge a big equity portfolio. 

Shareholders still need alertness to macro developments. Snap could not caution like it did without evidence from its revenue prospects, and WPP directors are yet to use the drop in their company’s share price to add to their holdings. 

Put WPP on your list lest the market slumps or a worse-case economic scenario unfolds. It can become volatile and you could get lucky with timing. If engaging cyclicals, however, I would currently favour UK housebuilders before marketing services. Hold. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.

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