The macro challenges cutting short advertising budgets among the world’s largest spenders are inescapable. The second profit warning from Sir Martin Sorrell’s S4 Capital in just three months has not, surprisingly, unnerved investors in his old shop, WPP.
However, there is reason to think that the latter might sustain less of a bruising than Sorrell’s latest venture has endured. Unlike S4, WPP has been unburdened by hype.
Since the outlook darkened at the start of last year, its shares have traded at between seven and 13 times forward earnings. At the top-end that is less than half the peak earnings multiple for S4 Capital over the same period.
WPP now sits close to the bottom of the valuation range, not just since the onset of the most recent deterioration in advertising spending but also in the 15 years since the last big macroeconomic downturn.
WPP’s shares already account for another potential heavy cut to guidance. Reduce the earnings forecast by analysts for this year by a chunky 20 per cent and its shares would trade at just under ten times forward earnings, still below the long-running average.
• Sorrell gives second profit warning
S4’s once astronomical lead over WPP has been entirely wiped out after the group lost a quarter of its market value on the latest disappointment. That compares with a drop of less than 4 per cent on the day WPP warned about sales growth last month.
While WPP cut its underlying revenue guidance for this year to between 1 and 3 per cent, from 3 to 5 per cent, it held adjusted margin expectations steady at about 15 per cent. Why? It thinks cost savings of about £450 million against pre-pandemic levels, including reducing its rent bill, will help offset inflationary pressures and tepid levels of new work.
A decision to keep a steadier handle on costs in recent years should also prove fortuitous. It is a strategy that has been by necessity rather than just design. Either way, it has made margins more defensible under his five-year tenure.
WPP has been more focused on tackling its once high debt and a bloated structure under its boss, Mark Read, goals against which it has made considerable progress.
S4 is partly a victim of its immaturity as a business. Emboldened by a post-pandemic rebound in consumer spending and demand, S4 ramped up investment in 2021, ahead of an expected wave of revenue including from some big client wins.
That was behind a drop in the adjusted margin in 2021, and then again last year, when costs rose further ahead of revenue than anticipated. Yesterday’s cut to margin guidance to between 12 and 13.5 per cent this year, on the back of an anticipated contraction in revenue, puts it even further out of reach of an ambition to return to margins of 20-plus per cent.
Yet uncertainty remains for WPP, reason enough for the weighty discount on its shares. The higher margin North American business has been the source of the weakness this year. A cut in spending among tech companies battling their own contracting top-line growth has been a big contributor.
Management is betting on an improvement here, helping drive a recovery in like-for-like sales during the second half of the year, compared with the second quarter, when it clocked up just 1.3 per cent growth, excluding fees paid to external suppliers.
But whether that materialises is far from assured, even if annual comps do get easier during the current six-month period.
ADVICE Hold
WHY WPP’s significant discount already accounts for more potential downgrades to earnings
Phoenix Group
Phoenix Group’s beefy dividend has long made it an income play for investors, but the chances of those returns growing sustainably into the future looks better rooted than ever.
The £885 million in cash generated from writing new workplace pensions, savings and bulk purchase annuity business during the first six months of the year alone was enough to offset the £800 million a year lost as its closed book life insurance business runs off. Those books throw off cash as policies mature and as capital held by the insurer against the policies unwinds.
New business is higher margin and is already generating a greater proportion than legacy business. But from next year, for the first time in the company’s history, capital flows into that side of operations are set to outweigh funds lost by the legacy books of business that it buys up.
It reinforces a pivotal change in the dividend policy a year ago to increase the dividend consistently, rather than being reliant solely on snapping up open or closed books of business. Analysts estimate that the annual dividend will amount to 52.71p, which would leave the shares offering a potential yield of 9.8 per cent at the current price.
How sustainable is that dividend? Phoenix has business generating £12.5 billion of free cash, after the repayment of debt and interest costs. That would cover the £520 million cost of the annual dividend as it stands for more than 20 years, without Phoenix writing any new business or mergers and acquisition deals.
The shares have struggled in line with the rest of the insurance sector over concerns about the investments held on their balance sheets, but 99 per cent of Phoenix’s bond portfolio is investment grade and there were no credit defaults within its bond portfolio in the first half. Cash generated through so-called management actions — squeezing more out of its legacy books — rose to £471 million — way ahead of the typical historic rate. Management now thinks that cash generation this year will come in at the top end of the £1.3 billion to £1.4 billion guidance range.
Hitting that target could also stir a better share price return.
ADVICE Buy
WHY Shares offer a generous dividend that looks sustainable
