Over the last couple of years we have had the famine; now we could be due for the feast. It is worth remembering that for much of the 1980s Saatchi & Saatchi strung together a sequence of years of fast earnings growth that put to shame even such supercharged performers as BTR and Sainsbury.
Profits are volatile because it takes the same resources to mount a pounds 1m advertising campaign as a pounds 10m campaign. And new business may not help in recession because winning the work carries up-front costs that may not be offset if cautious clients fail to deliver on promised spending plans.
Saatchi & Saatchi and WPP were forced into massive restructurings (exchanging debt for equity) - thus diluting the interests of the original shareholders. Nor are they out of the woods yet. Both are likely to report negative earnings per share under the new accounting rules in their latest financial years.
Nevertheless, it is a fair bet that the worst is past and this is always a time of opportunity in stock markets. Industry insiders say growth for the survivors in a drastically shrunken industry could be sensational as higher spending falls straight through to bottom-line profits. One note of caution is that 1992 has been a tough year and that has been reflected in analysts steadily downgrading their forecasts. At the beginning of the year there had been hopes that companies such as Abbott Mead Vickers and Gold Greenlees Trott, the two medium-size quoted agencies which have weathered recession best, would perhaps be around pounds 6m. Now expectations are more like pounds 4.5m with earnings per share around 18p. On share prices of 415p and 265p, respectively, that means the PEs are 23 for AMV and 15 for GGT - so some of the recovery potential is already in the price.
Abbott Mead Vickers is especially highly rated, partly because a 27 per cent stake is held by the US advertising giant Omnicom, which promised not to bid for two-and-a-half years after acquiring its initial stake in January 1991. It is expected to bid eventually though, and logically will strike sooner rather than later if profits are expected to recover. Other attractions of AVM are a strong balance sheet with net cash of pounds 6m, a sensational performance in 1992 with new business wins of pounds 42m and a much greater exposure to the UK economy than others.
The attraction of the more modestly rated Gold Greenlees Trott is partly UK recovery potential but also the size and quality of its US operations where evidence of economic recovery is much greater. Between 1988 and 1990 GGT spent dollars 50m acquiring regional agencies in three of the fastest growing US cities: Austin, Texas; Minneapolis in Minnesota; and Atlanta, Georgia. The result is that in the current year to end-April 1993 between two-thirds and three-quarters of group profits are expected to come from the US.
It is not as good a dollar play as that might suggest, because of dollars 30m of US borrowings, but prospects for continued growth look good. As recovery spreads to the UK, profits should recover to 1990's record pounds 7.7m and more, dropping the p/e to 10 on, say, a two-year view.
WPP and Saatchi & Saatchi are more speculative but their survival should no longer be in doubt. As recovery develops, investors are going to start doing sums assuming a restoration of profit margins to their pounds 1bn-plus turnovers. For WPP at 55p, for example, a 10 per cent margin would imply profits of pounds 120m against a pounds 288m market capitalisation.
(Photograph omitted)Reuse content