|Some analysts expect a pickup in ad spending in 2006. Does that make the ad agency stocks a buy?|
| * based on estimates for 2006 and prices as of 12/14/05 |
| Source: Thomson/Baseline|
NEW YORK (CNNMoney.com) – Admit it. You actually like some commercials.
Sure, everyone talks about how they love to zoom past commercials with their TiVo or digital video recorder (DVR). But some ads stand out. We all have our favorites. (I like the ones for Guinness beer. "Brilliant!")
With that in mind, should investors be interested in the companies that get paid big bucks by advertisers to come up with their marketing campaigns? And we mean big bucks.
Earlier this month, McCann Erickson, a unit of Interpublic Group (Research), won a five-year advertising contract worth $1.35 billion from the U.S. Army. The Army had been using Leo Burnett, a unit of Publicis Groupe (Research), previously.
Still, the leading ad agency stocks have largely lagged behind the broader market this year due to concerns about sluggish growth in traditional ad-based mediums such as television, radio and print. Online advertising is obviously another story.
The S&P 500 is up nearly 5 percent year-to date. But WPP Group (Research), which owns the Ogilvy & Mather and Young & Rubicam ad agencies, is flat while Omnicom Group (Research), which owns BBDO Worldwide, has gained 4 percent.
Shares of Havas (Research), which owns Arnold Worldwide, and Interpublic have fallen about 20 percent and 30 percent, respectively.
The lone standout has been Publicis, which also owns Saatchi & Saatchi. Its stock is up about 9 percent this year.
Better days ahead in 06?
But some expect the global ad market to be a bit stronger in 2006 thanks to the Winter Olympics in Turin, the World Cup soccer tournament in Germany and next fall's mid-term elections in Congress.
"Initial thoughts on 2006 from advertisers and ad holding companies suggest ad budgets are shaping up nicely," wrote Alexia Quadrani, an analyst with Bear Stearns, in a recent report.
To that end, Publicis said Wednesday that the company expects organic revenue growth, that is, growth from existing operations, of 6 percent in 2006 and that operating margins would improve. The company cited the prospect for signing new accounts as well as expectations for a better ad environment in Europe.
This forecast is in line with what some other ad agencies have been projecting for next year, a global ad spending increase of about 6 percent.
As such, the three largest firms appear to be attractively valued given their growth rates.
Omnicom, WPP Group and Publicis trade at about 16 to 18 times 2006 earnings estimates. And profits for the three companies are expected to increase in the mid-teens in 2006 and by about 12 percent a year for the next few years.
Not all ad agency stocks are good bets though. Interpublic and Havas, for example, have struggled -- for a reason.
Interpublic has had some high-profile accounting problems and investors have been wondering about the future of Havas after French corporate raider Vincent Bollore took control of the company over the summer.
Troy Mastin, an analyst with William Blair & Co., wrote in a recent report that Omnicom could wind up benefiting from some of its rivals' turmoil.
"Omnicom's properties are among the best-positioned agencies to benefit from account churn resulting from the speculation surrounding the future direction of Havas, prolonged accounting and management issues at IPG, and overall strong prospects for increased marketing spending activity," Mastin wrote.
And even though Interpublic was able to snag a big win with the Army contract, Quadrani wrote that the company has still lost more accounts than it has won this year.
Online may still be the way to go
Still, not everyone is convinced that next year will be strong, even the better positioned advertising firms. Some are concerned there may be too much optimism about next year's ad outlook.
Merrill Lynch analyst Lauren Fine wrote in a recent report that she thinks global ad spending will rise about 4.8 percent next year and that ad spending in the U.S. will grow 4.5 percent.
Fine is particularly concerned about whether forecasts for how much troubled car and media firms might spend next year on ads are too high.
"The auto and entertainment sectors (two of the larger advertising categories) are expected to see flattish growth next year. Historically, these categories have been bigger contributors to advertising growth, but financial challenges within these sectors will likely limit their ability to advertise," Fine wrote.
But the boom in online advertising is expected could help offset weakness in other areas, even for the larger traditional firms.
"Online advertising will do well and everyone will benefit from that, including the large holding groups," said Stewart Barry, an analyst with ThinkEquity Partners.
For this reason though, Barry said that newer online ad agencies like ValueClick, aQuantive and Digitas might be better bets than the Madison Avenue firms.
Of course, the online ad firms trade at much higher valuations: Digitas (Research) trades at 21 times 2006 estimates, ValueClick (Research) sports a P/E ratio of 30 and aQuantive (Research) trades at 43 times next year's earnings projections.
But analysts expect profits for the three companies to increase at a clip above 20 percent annually for the next few years.
"If you look at the multiples and growth rates, they are attractively priced," said Barry. "The online area by far is where the most opportunities are in advertising so I'd want to look at the leaders in that area."
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Analysts quoted in this story do not own shares of the companies mentioned and their firms have no investment banking relationships with the companies.