Questor: WPP’s investors will need yet more patience but it has long-term recovery potential

Robert Stephens 22 December 2019 • 5:00am

WPP’s competitive advantage is enhanced by existing relationships with two thirds of FTSE 100 members Credit: REUTERS

Questor share tip: all-encompassing changes to its business model and the shares’ low valuation make the advertising firm a hold

Persevering with underperforming shares can test the patience of any investor. However, in the case of WPP, Questor thinks that taking a long-term view of its evolving business model could be a profitable decision.

The advertising company is making a painful yet necessary move towards new media channels that are quickly replacing traditional ones. Its clients now demand “data-driven” marketing via the likes of Google and Facebook, as well as creative strategies to capitalise on the growth of ecommerce.

This has prompted an increase in WPP’s “creative leadership” budget of £15m a year. It will be targeted on America, the firm’s largest market, and will enable its clients to adapt to structural change in their industries driven by new technology.

Structural change is also being delivered in WPP’s own business by its refreshed management team. It disposed of 30 non-core investments and associates last year and recently completed the sale of 60pc of Kantar, its research business.

These disposals have not only resulted in a simpler organisational structure that allows greater flexibility and adaptability to changing customer demands, they have also raised much-needed capital. Some has been used to reduce net debt, which has fallen by 10pc in the past year. This follows a three-year period in which it almost doubled to £4.5bn.

Asset disposals are being complemented by cost savings that are expected to amount to £275m a year by the end of 2021. This makes the £300m restructuring costs expected to be incurred by the business as part of its three-year turnaround plan seem highly worthwhile.

The company’s ability to adapt to an increasingly technology-led global economy will be aided by its existing presence within the marketing technology industry. It has 6,000 marketing technology employees, who managed more than £6bn of clients’ media spending with Google and Facebook in 2018.

WPP’s competitive advantage is further enhanced by existing relationships with 74pc of Fortune Global 500 companies and two thirds of FTSE 100 members.

Although there has been a trend towards a reduction in marketing spending among major corporations, its level as a proportion of their revenue is one percentage point higher than it was four years ago at 11.2pc.

A world economy forecast to grow by 3.4pc in 2020, according to the IMF, could support further rises in marketing spending, as could a forecast increase in emerging markets’ GDP of 4.6pc in 2020. WPP is increasing its exposure to fast-growing economies such as China; it already works with seven of the country’s 10 most valuable brands.

However, risks to the global economy such as political developments in America and Hong Kong pose a threat to WPP’s financial outlook. Likewise, its transformation plan is all-encompassing and could lead to a highly uncertain period for the business as it is implemented. This may have contributed to the share price falls of the past few years.

Following that decline, the stock now trades on a forecast price-to-earnings ratio of 10.4. This may undervalue WPP after its third-quarter update showed that progress was being made across its major markets and sectors, as evidenced by a 0.5pc rise in revenues (on a “constant currency” basis) following a decline in the first half.

This trend will almost inevitably falter at times as the company’s business model continues to evolve. Investors may therefore require continued patience with a stock that has yet to fulfil its potential following this column’s initial buy recommendation in March 2017.

But Questor sees persevering with WPP as a logical course for existing investors. Its new business model, low valuation and exposure to emerging economies suggest  long-term recovery potential.

Questor says: hold

Ticker: WPP

Share price at close: £10.65