The decline of WPP's (WPP) stock due to disappointing 2018 results and the resignation of CEO Martin Sorrell has created an attractive entry point for this narrow-moat name. The shares are trading at a discount to our £15 fair value estimate.
At current levels, WPP's dividend yields close to 5%. To our surprise, while Sorrell initially disputed the improper use of funds and personal misconduct allegations brought forth by the firm, WPP stated on April 14 that Sorrell had resigned, although he continued to deny the allegations.
While Sorrell's departure may hurt WPP's relationship with clients in the short term, we think the impact will be minimal. We remain bullish on the stock for a few reasons.
First, we continue to rate WPP with a narrow moat as its brand equity and the strong reputations of its ad agencies are based on the quality of services and not necessarily Sorrell’s leadership. Second, while no additional detail was provided by the firm, Sorrell's resignation was probably a decision he thought was best for WPP shareholders, in our view. We note that he still has a 2% stake in the firm.
Third, while Sorrell's departure may hurt WPP's relationship with clients in the short term, we think such an impact will be minimal as he has not been as instrumental in winning new business as he was years ago. The firm has sought to show signs of stability to its clients by replacing Sorrell quickly. WPP’s board has appointed Mark Read as CEO, which we think indicates some steadiness for the firm given that he is a WPP veteran who worked closely with Sorrell in the past.
Under his leadership, we expect WPP’s restructuring efforts, which were a result of clients demanding more transparency and better prices, to continue. We think the restructuring will help the firm operate more efficiently, possibly resulting in some operating leverage.
Further, with new leadership, the firm may implement some strategies a bit more quickly. They include possible sales of some of its assets such as the custom research side of the data investment management business and more aggressive integration of creativity and media agencies.
Lastly, our initial prognosis of management's underestimation of organic growth for this fiscal year proved correct. The firm now expects to end 2018 with organic revenue growth, unlike its initial guidance of no growth. While the turnaround in top-line growth that we had projected may be delayed, we continue to view the 20%-plus upside in the shares and the near 5% dividend yield as attractive.
WPP: Economic Moat
We view WPP as a narrow-moat company, meaning we consider it do have a small competitive advantage over its peers. WPP holds valuable intangible assets, in our view, around the holding company’s brand equity and the strong reputations of its various advertising agencies around the world. We also think the firm's continuing investments in consumer data accumulation and analysis give WPP a sustainable competitive advantage.
Finally, to a lesser extent, we think WPP benefits from customer switching costs associated with further integration of the firm’s resources with its clients’ marketing departments. We believe the utilization of the firm’s moat sources and overall execution will result in WPP earning excess returns on capital for at least 10 years.
While significant consolidation has taken place, WPP will continue to operate as a holding company, allowing the acquired agencies to maintain their reputations under their own brands and strengthen their relationships with clients. This helps WPP increase the value of its own brand by enabling acquired agencies to win larger accounts. In addition, WPP’s reputation and brand allow it to compete mainly with the other Big Five; WPP, Omnicom, Interpublic Group, Publicis Groupe, and Dentsu, for the larger accounts.
WPP and the rest of the Big Five also benefit from intangible assets in the form of consumer data, which they accumulate by managing and tracking the performance of their various campaigns. We believe this data, along with data provided by third parties, helps the firm analyse the returns on investment, or ROIs, of campaigns very quickly, which ad agency clients tend to demand more as they launch more below-the-line campaigns.
Further, access to this data may help WPP adjust and improve campaigns, whether on the creativity or media-buying side, to increase ROIs for clients and further enhance the value of its brand.
Lastly, regarding switching costs, as more Fortune 500 accounts seek simplicity along with multichannel marketing strategies, we believe integration must take place not only internally within the ad agency, but also externally with the accounts. This integration, whether it is due to multichannel campaigns or to enable an account’s marketing department to work even more closely with the ad agency, may create switching costs for the clients.
