Rising interest rates may be exposing advertising ineffectiveness
With the WPP share price down -11% on its Q2 earnings release, as FY17 revenue growth forecasts are trimmed along with market estimates for global advertising growth, I thought about writing a long winded post about markets propensity to increasingly aim below guidance towards the end of an economic cycle and in particular while the Fed threatens monetary tightening. It would also provide another great opportunity to show how the GrowthRater can help you gauge the potential forecasting error on organic revenue growth expectations and the apply this in the ‘sensitivity’ tools to measure the likely impact to valuations before you get run over by events. But then I realised that this would be just repeating what I wrote back in March and what was becoming increasingly clear following Q2 reports by rivals such as IPG which I also had flagged.
Another issue perhaps to be boiled over might be the more troubling issue of advertising effectiveness, or perhaps the lack thereof! When money is cheap and can raise the marginal returns from marketing budgets, to encourage more spending, the actual returns have been less flattering. What this of course means is that once we return to more normal rates and capital costs, then the camouflage is quickly stripped away and along with it a lot of marginal expenditure. Again this is not new and was featured in my blog post earlier in August, although you won’t find too many agency chiefs wanting to accept the uncomfortable possibility that some of their work is ineffective, assuming they could measure it. Far better to paint the current softness in client advertising expenditure and agency fees as a short-term cyclical event which will soon be stabilised by the usual expectations of improving GDP just beyond the immediate horizon and another sporting event stimulus to marketing spend. Otherwise, markets might start to notice an average organic top line performance on these stocks that is already significantly lagging the market average growth expectations priced into agency stock valuation and start to query whether a GrowthRating nearer the +3% CAGR organic net sales growth average, or perhaps lower, may be more fitting.
For the record, the -140bps cut in Global advertising forecasts by WPP’s Adam Smith (GroupM’s ‘future’ director), from +4.4% to +3.0% for 2017 is a little more dramatic when looked at on a ‘real’ basis (ie at constant prices). While I don’t have the inflation assumption implicit in the GroupM forecast, I imagine it shouldn’t be too far adrift from the OECD’s +2.3% forecast for 2017. This therefore would suggest a drop in GroupM’s real global advertising growth expectations for 2017 of two-thirds (-67%), which is quite some margin of error when around two-thirds of their cost base is represented by staff – ouch!