Treat media stocks cautiously as advertising's recovery goes slow

Taylor Nelson Sofres fully valued; John Laing stakes its future on PFI

The advertising industry is just coming out of its worst downturn for decades. After the lavish promotional spend of 1999 and 2000, on the back of the technology boom, things came crashing down in 2001.

Last year saw global advertising shrink more than 6 per cent in real terms, twice as deep and double the speed of the ad recession 10 years ago.

Zenith Optimedia, one of the leading advertising forecasters, yesterday published a report that confirmed hopes of a strong 2002 recovery in ad spend are fading.

Six months ago, Zenith predicted that European ad revenues would grow 1.7 per cent this year. Yesterday this was downgraded to contraction of 0.7 per cent. Globally, shrinkage of 0.5 per cent is seen.

However, there are some grounds for optimism. The US turned out better than expected in the first quarter (WPP is most exposed here), with growth of 0.2 per cent, as did the UK, which registered less-than-expected shrinkage of 4 per cent.

What does all this mean for investing in UK media shares? After hitting a low last autumn, UK media stocks enjoyed a strong recovery, on the back of a predicted bounce back in ad spend in the second half of 2002. As the year has progressed and evidence of a recovery has been rather limited, the stocks have retreated quite steeply. According to Zenith, that growth will finally show through by the end of the year. So it upgraded its UK forecast from 1.9 per cent contraction to minus 1.3 per cent.

Within the UK media sector, there will be considerable variation, with cinema and outdoor doing the best. TV (Carlton and Granada) should show growth for the year as a whole, while national newspapers will be the worst performers, deep in negative territory.

The trouble with buying now is that confidence remains extremely fragile – witness last week's WPP sell-off. And valuations of many of these companies are still pretty demanding – the TV companies are trading on about 24 times 2003 earnings, making these a hold certainly, but not a buy. Those with heavy US exposure (WPP and Pearson primarily) are worth watching but investors would be well advised to treat the media sector with great caution.

Taylor Nelson Sofres fully valued

Taylor Nelson Sofres has the good fortune to be in a part of the media sector – market research – which over the past few years has shown itself to be relatively immune to the wider swings of the economy or the media cycle.

Throughout the 1990s, market research grew at some 9 per cent a year. The reason for this healthy expansion, according to the finance director, David Lowden, is that the twin forces of globalisation and deregulation meant that businesses needed to better understand the dynamic environments in which they were operating. They would commission a company like TNS to research the market – the competitors, trends etc.

Issuing a trading update yesterday, Mr Lowden argues that, in a downturn, businesses need to understand their markets even better – for instance, to assess the effectiveness of their advertising spend, one of TNS' major services.

Last year, the company notched up a solid 6 per cent underlying growth. This year will be flat in the first half but TNS said that forward contracts and pitch activity means it is looking at 3 to 5 per cent organic top line expansion for 2002 as a whole (it has lost two significant contracts). The stock closed down 7p yesterday at 184p, well off a recent 12-month high of 247.5p, reflecting the fairly lacklustre growth forecast. The shares trade on a forward multiple of 20, leaving TNS fully valued.

John Laing stakes its future on PFI

John Laing is a 150-year-old construction group which has transformed itself into a more focused business. The company, which issued a trading update yesterday, now has two divisions: housebuilding and an "infrastructure" arm that works on Private Finance Initiative-style projects.

Laing has disposed of the construction interests that made it famous – liabilities (still retained in the group) from two very large, troubled projects meant it decided to quit this activity altogether last year. It has also sold its property development business.

Given its relatively small size, Laing cannot successfully run two capital-intensive divisions such as house building and PFI. So it must choose between them and it's no secret that infrastructure has won out. PFI projects offer more upside and this sort of work commands much juicier stock market ratings.

Yesterday the company gave a presentation to analysts on the potential of the infrastructure business and its trading update said that it is "confident that the group will return to acceptable levels of profitability in the current year".

The stock closed up 6.5p at 176p, putting it on a forward multiple of 11. Considering the prospects of the infrastructure business and the proceeds to come from the sale of housing, the stock is attractively priced.