Madison Avenue Bulls? U.S. Ad Stocks Beat Market

Omnicom and Interpublic Have Been Outperforming the S&P 500

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Even as investors fret about the possibility of a recession, two stocks seen as especially sensitive to prospects for economic growth are signaling the concern is overblown.

Omnicom Group and Interpublic Group of Cos., the largest U.S. advertising firms by market value, have risen 4.1% and 13% respectively since June 30. That they've outperformed the Standard & Poor's 500 Index's 7.8% decline should provide a measure of assurance given how they fared the last time a recession was at hand.

Remember 2007? By the time the S&P 500 was topping out in October of that year, shares of Omnicom and Interpublic had already been falling for half a year -- and they hit bottom in 2008 four months before the benchmark gauge. Sure, things have changed in the period since. A merger unraveled for one company, an activist invested in the other, not to mention industry consolidation. But the relative strength of the stocks in recent months shows that some investors are unfazed by talk of another economic slowdown.

"These stocks are a GDP play. What I say to clients all the time is if you are bearish on global GDP, then you wouldn't want to be in agencies more than any other stock," said Tim Nollen, a New York-based analyst at Macquarie Capital USA, who maintains outperform recommendations on both. "That being said, they'll probably outperform other media stocks. They seem to be holding on pretty well."

Analysts forecast that revenue will climb at least 3% at the two companies in 2016, higher than the average estimate for the overall economy, which is anticipated to expand by 2.4%, according to economists surveyed by Bloomberg. Similarly, Magna Global, Interpublic's strategic global-media unit, said in December that ad spending worldwide will grow 4.6% this year to $526 billion.

A Standard & Poor's 500 index composed of the two companies has beaten its larger media counterpart by 18 percentage points since June 30, rising 7.5%. Compared with the benchmark gauge, the pair hit an 11-year high last week, capping a run that saw it outpace the market in nine of 10 consecutive weeks. This is a historically favorable month for the advertisers: the stocks have beaten the market in eight straight Februarys, by an average of 5.2 percentage points.

It's helped that the advertising market has been "stable" since mid-2015, while both Omnicom and Interpublic have delivered results that beat the median of analysts' estimates in at least the past two quarters, Mr. Nollen said. Meanwhile, the stocks are generally perceived to be more resilient than some of the more traditional ad-driven broadcast or cable networks, he said.

Omnicom's proposed merger with Publicis Groupe unraveled in May 2014, but the New York-based company through its divisions has made smaller acquisitions, including last month when BBDO Worldwide bought a majority stake in Wednesday Agency Group. Meanwhile, Interpublic has undergone changes -- including adding three independent directors to its board -- as activist investor Elliott Management Corp. has been pushing for it to consider a sale since taking a stake in the company starting in 2014.

"The activist role is a big part of the strength of the stocks, I think that's really supporting them," said Tim Ghriskey, who helps oversee $1.5 billion as managing director and chief investment officer at Solaris Asset Management in New York. Meanwhile, the consumer side of the U.S. economy continues to exhibit strength, which helps explain some of the optimism, he said.

"The cyclical exposure to the business is certainly there, but it takes a while for that to really filter through to the companies, so they aren't immediately penalized as an industrial company might be," Mr. Ghriskey said. Economists are forecasting modest growth in 2016, not a contraction.

Citadel, the $25 billion hedge fund, bought a 5.5 million-share stake in Interpublic in the third quarter, according to regulatory filings. But others aren't convinced yet.

Only 30% of analysts have a buy-equivalent recommendation for Omnicom, compared with Interpublic's 65%. While Interpublic has outpaced its rival, valuations also have risen. The stock, which closed at $21.91 on Thursday, is trading at a multiple of about 19.5 times earnings, about 8% above its 5-year average.

"It doesn't seem attractive to me just because it's gone up a lot," said Jim Stellakis, founder and director of research at Greenwich, Connecticut-based Technical Alpha Inc. "I've been telling people to wait until the stock's trading closer to $18 or $19."

Meanwhile, longer-term trends for Omnicom are discouraging, as the stock has performed roughly in line with the S&P 500 since 2003. "The near-term move for Omnicom doesn't do anything for it yet," Mr. Stellakis said.

So long as the U.S. isn't headed into another recession, the stocks are reasonably priced, according to Mr. Nollen. The fee-based business models for Omnicom and Interpublic will also buoy these companies, while this year's U.S. presidential election and Olympic Games will support additional advertising spending, he said.

"The overall ad market has certainly held stable. It went through a down phase a couple years ago, but it seems to have held on and been fairly strong," Mr. Nollen said.

--Bloomberg News

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