S4 Capital needs to turn more sales into cash

After two delays to the publication of S4 Capital’s (SFOR) annual results, there were concerns that there could be something nasty lurking in the explanatory notes. In the event, other than a slipping operating margin and increased receivables, there was nothing too concerning.

The digital advertising agency is highly acquisitive so it is best to look at like-for-like figures to get a picture for how the business is performing. On this basis, billings rose 66.8 per cent, but operational cash profit (Ebitda) only increased by 11.9 per cent which meant that the underlying margin was down 5.1 percentage points.

Management put this down to investment in new “whopper” clients. The company playfully, or regrettably (depending on your views on ad-speak) uses the hyperbolic term to describe clients with more than $20mn of billings. The new whoppers include Google, Meta (US:FB.), Mondelez (US:MDLZ) and BMW (DE:BMW). New business wins necessitated significant investment in new people. Once the new recruits had settled in, productivity increased, which helped margins recover to a degree in the second half. A statutory operating loss of £42.1mn was posted because of £137mn of adjustments associated with acquisition and amortisation expenses.

Cash flow from operations came in at £68.5mn, which was down from £72.4mn last year. The reason for this was a £132mn increase in trade and other receivables. The company said there was increased working capital to fund larger accounts – a possible explanation. However, rising receivables can be a red flag in cases where they indicate that clients are unable to pay their bills promptly.

Predicting the future for S4 Capital is tricky because advertising spend is closely tied to the macro environment which is highly unpredictable. Recently, Google announced underwhelming advertising revenue from YouTube and pointed the finger at the Ukraine war for this miss.

S4 Capital chief executive Martin Sorrell also acknowledged the challenges faced by the industry, saying “2023 may be a different kettle of fish as GDP growth weakens further and geopolitical tensions impact economics more significantly”. On the plus side, S4 Capital’s digital model is focused on first party data, so the company won’t be overly impacted by tightening privacy rules.

The FactSet 2024 EPS consensus forecast of 32.4p gives S4 a very affordable 2024 PE ratio of 10.5. But the likelihood exists that aggregate demand in the global economy will contract significantly as central banks tighten monetary policy, perhaps to the detriment of corporate marketing and advertising budgets. Although the delayed accounts didn’t hold any demons, we are wary of wider macro conditions. Hold.   

Last IC View: Buy, 569p, 5 May 2021