View from City Road: Ad agencies scent recovery

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ALMOST four years after falling out of favour the advertising agency sector may be at a turning point in the investment cycle. Although few investors expect agency groups such as Saatchi & Saatchi and WPP to return to the heady ratings of the 1980s, the smell of recovery is in the air.

It is far too early to point to firm signs of an upturn, but the sector is moving off the bottom - at least in US. While Britain is in an economic slump, across the Atlantic a slow but steady climb out of recession has been apparent in the past few months.

As a result, advertisers are beginning to lift spending on their media campaigns, and press advertising volumes as well as television rates in US have hardened during the autumn period. Doubtless, some of this improvement has been due to the election blitz. But if the trend continues after polling day, Britain's beleaguered agency shares look undervalued.

The biggest beneficiaries are likely to be Gold Greenlees Trott, Saatchi & Saatchi and WPP. All three derive at least half their operating profits from the US.

While the impact of a strengthening dollar is likely to be neutral on WPP - thanks to its high dollar debts - the shares also offer the strongest upside potential. In J Walter Thompson and Ogilvy & Mather, it has two of the world's most powerful global advertising networks. Whereas its shares are trading on a lowly multiple of five times next year's earnings, Saatchi, albeit with a much stronger balance sheet, is trading on 16 times.

WPP's discount reflects its controversial management team, and high debt (even after its second refinancing). But given the expected upturn, the rewards outweigh the risk.

(Photograph omitted)