Global growth will need to accelerate faster than projected for Interpublic Group of Companies Inc. (IPG:US) and Omnicom Group Inc. (OMC:US) to outpace the market for a second consecutive year, even though advertising revenue will get a boost from this year’s Olympic Games and World Cup.
Ad spending worldwide is forecast to rise 6.5 percent in 2014 to about $521 billion, according to Magna Global, Interpublic’s strategic global-media unit. This follows a gain of 3.2 percent last year and reflects “solid” growth prospects, particularly after Magna Global raised its June estimate of 6.1 percent, according to Vincent Letang, director of global forecasting at the New York-based group.
“This will be a very decent level,” Letang said, noting the primary reason for the “modest upward revision” was evidence in the second half of 2013 that European economies were strengthening.
With gross domestic product projected to accelerate worldwide this year, advertising budgets also could see a bump, benefiting Interpublic and Omnicom, said Mark Lamkin, founder and chief executive officer at Lamkin Wealth Management in Louisville, Kentucky, who has been tracking these companies for 10 years. While the outlook is “good,” shares of these ad agencies already reflect “best-case scenarios,” he said. Both “are a good GDP play, but the easy money has been made.”
The New York-based businesses -- which represent a wide variety of clients including Visa Inc. (V:US), PepsiCo Inc. (PEP:US)’s Gatorade and Coca-Cola Co. (KO:US) -- have led the Standard & Poor’s 500 Index during the past year. Omnicom, the second-biggest agency by revenue, has risen 41 percent in the last 12 months, and fourth-largest Interpublic is up 51 percent. That compares with an almost 26 percent gain in the S&P index.
The increases show this year’s two major sporting events in Russia and Brazil are “already baked in the cake,” said David Bank, a media analyst in New York with RBC Capital Markets. That’s because there’s an element of predictability with the timing and amount of related ad spending, so investors “generally buy on anticipation and sell on the event.”
Even so, the match-ups in the eight groups of the FIFA World Cup, slated to begin June 12, could provide some uncertainty to this year’s games, said Rich Tullo, director of research with Albert Fried & Co. LLC in New York.
If teams from large countries with a big soccer following advance to later rounds, the competition could be “very interesting and suspenseful,” which would benefit the agencies, he said. Otherwise, an early upset may mean fewer people watching and diminish any incremental ad spending.
U.S. revenue for Omnicom and Interpublic historically has grown about 2 percent to 3 percent more than U.S. GDP, Tullo said. While this correlation narrowed in 2013, the relationship still is “very strong.” The world’s largest economy expanded 1.7 percent last year, according to the median estimate of economists surveyed by Bloomberg.
Following a “significant improvement” in global growth in 2013 -- when real GDP rose 2.9 percent in the fourth quarter from the same period in 2012, according to JPMorgan Chase & Co. -- further gains this year probably will be “modest,” said David Hensley, director of global economic coordination for JPMorgan in New York.
GDP worldwide could increase by 3 percent in the fourth quarter of this year compared with the same period last year, led by expansion in developed markets, particularly western European economies, he said. The World Bank raised its global growth forecast this week to 3.2 percent compared with a June projection of 3 percent.
“Risk seems to be skewed to the upside,” Hensley said, adding that “fiscal drag” is abating in the U.S., which constrained expansion last year.
Global growth needs to exceed about 3.6 percent in 2014 -- which would be a “great scenario” -- for Interpublic and Omnicom stocks to see large gains, Lamkin said.
A political cloud over the Olympics -- set to open Feb. 7 in Sochi, Russia -- could hurt ad spending. Gay-rights activists plan to challenge Russian President Vladimir Putin and pressure Olympic sponsors, including Coca-Cola, by protesting a Russian ban on homosexual “propaganda” during the two-week event.
Atlanta-based Coca-Cola is one of 10 Olympic partners this year, along with Dow Chemical Co. (DOW:US), McDonald’s Corp. (MCD:US) and General Electric Co. (GE:US) There also are sponsors for specific sports, such as Visa, which backs the U.S. ski team, and automaker Bayerische Motoren Werke AG (BMW), which supports bobsledders. Some may be “squeamish” about being perceived as supporting Putin, Tullo said.
For investors who are bullish about expansion, advertising stocks offer increased cyclical exposure to an improving global economy, Bank said. As a result, he favors Interpublic over Omnicom because it has “margin upside” -- the ability to generate greater operating leverage -- from similar economic conditions.
Interpublic’s earnings will grow 30 percent (IPG:US) this calendar year, compared with 10 percent (OMC:US) for Omnicom, according to the consensus of analyst estimates collected by Bloomberg. Bank maintains an outperform recommendation on Interpublic and a sector perform on Omnicom.
Omnicom and Publicis Groupe SA (PUB) won European Union approval Jan. 9 to form the world’s largest advertising company. The merger still needs approval in China, as well as from shareholders, the companies said in a joint statement.
Investors appear optimistic about Interpublic, even after third-quarter sales and earnings missed analyst projections in the period ended Sept. 30. The company’s stock fell 5 percent (IPG:US) to $16.04 on Oct. 18 after it reported earnings of 17 cents a share, trailing the consensus estimate of about 18 cents.
Investors quickly “shrugged off” these weak results, according to Jim Stellakis, founder and director of research at Greenwich, Connecticut-based research company Technical Alpha Inc. The stock recouped its losses and has rallied (IPG:US) about 10 percent since then.
“That’s a bullish signal, especially since the stock had done so well already,” Stellakis said.
Interpublic cleared a “significant level” in April when it traded above $13.80 a share, where it previously formed a so-called triple top in 2005, 2007 and 2011, he added. Now, as it trades at prices last seen in 2004, the “long-term picture looks very positive.”
In addition, Tullo sees some “fundamental upside” to Magna Global’s forecast, as the rise in ad spending could exceed 7.5 percent. This would bolster advertising revenue, especially if U.S. and western European economies continue to expand. That’s in part why he maintains an overweight recommendation on Interpublic and a market perform on Omnicom.
Still, there are potential hiccups ahead. Omnicom’s stock (OMC:US) could experience disruptions this year related to the merger, while “tepid growth across the globe” would hinder these companies’ performance, Lamkin said.
“Both management teams will need to execute their strategies like Super Bowl champions to see championship gains in their stocks,” he said. “That’s not unrealistic, but will be very hard.”
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