- £250mn to be spent on proprietary tech
- Expensive restructuring project
Addressing investors last month, WPP (WPP) chief executive Mark Read cited the words of Arthur C Clarke: “the best technology is indistinguishable from magic”. The advertising agency certainly hopes that tech will conjure up new enthusiasm for its business model. Artificial intelligence (AI) dominated its January capital markets day, cropping up 134 times in under five hours and held up to be “as transformative... as the internet was 30 years ago”.
Marketeers are good at spinning a yarn, however, and it remains difficult to gauge whether the FTSE 100 group is on the cusp of genuine change or fighting a losing battle in an unstable sector.
Demand outlook
WPP shares have fallen by roughly a fifth in the past year and 17 per cent of analysts recommend an underweight exposure to the company or have it on a ‘sell’. This compares with 4.5 per cent in February 2022.
The shift in sentiment is closely related to demand. Organic growth was struggling in the lead up to the pandemic and sales tumbled in 2020. Optimism returned when the agency bounced back strongly in 2021 and 2022, but this soured last year when the company downgraded sales guidance twice. Management expects to report adjusted revenue growth of 0.9 per cent for 2023. It had originally predicted growth of 3-5 per cent.
US technology clients were blamed for last year’s performance, and WPP’s struggles were echoed by S4 Capital (SFOR) and Next 15 (NFG). Industry pressures seem to be easing, however. Analysts at Morningstar expect total advertising spending in the US to grow by 4.6 per cent a year between now and 2028, fuelled by digital marketing.
UBS is slightly less bullish, but still expects a positive impact from AI. This will result in top line growth in the sector of 3-4 per cent a year over the medium term, compared to 2.5 per cent over the past decade. Analysts at the bank said companies would be seeking more advice on how to navigate the changing media landscape, and that AI would increase returns on advertising, encouraging clients to spend more with their agency partners.
WPP is also forecasting improvements. The company wants to accelerate organic growth to “3 per cent plus” in the next three to five years, helped by £250mn annual AI investment.
Management has given some striking examples of AI in action, describing a tool that can “guarantee” a 25 per cent increase in the conversion rate achieved on a product detail page (this is the webpage you see when deciding whether to add an item to your online trolley). The company claimed that clients are actually achieving uplifts of 40-50 per cent, which independent analyst Steve Clapham described as “unbelievable”. "A 25 per cent uplift is amazing (let alone 40-50 per cent) but it must be a one-off," he added. "Future benefits will be much lower, even if WPP can retain any advantage."
WPP does not have a track record of achieving consistent growth and – for now, at least – customers aren’t queuing out the door. Indeed, net new business is well below the highs of a decade ago. The uncertainty is reflected by the disparate analyst forecasts that have started to emerge. While Barclays is expecting organic growth to jump to 4 per cent in 2025, UBS is far more cautious, forecasting growth of just 1 per cent.
The company’s ability to win and retain big accounts will be a key factor. “These last couple of years, Publicis (FR:PUB) and, to a certain extent, Omnicom (US:OMC) have been a little bit more successful than their counterparts,” said Morningstar analyst Ali Mogharabi, citing WPP's loss of business involving Uber (US:UBER), L’Oreal (FR:OR) and Kimberly-Clark (US:KMB).
“It's not that they lack any assets or resources. It just seems that they're having difficulties in presenting themselves as a one-stop-shop.”
All eyes will now be on Unilever – historically one of WPP’s top 20 clients – which is currently reviewing its global media account.
Profit pressures
It’s not all about sales of course; profitability has also been under pressure for several years. Adjusted operating margins neared 17 per cent in 2016, but have averaged 14.7 per cent since then.
Industry analyst Brian Wieser, who formerly headed business intelligence at GroupM, WPP’s media buying business, said the company’s complexity was holding back margins, and suggested there was still “too many silos, too many business units, which slows them down”. The restructure, he warned, “is not going far enough”.
Even if WPP can improve its sales and its margins, cash flow could remain an issue. Barclays notes that WPP is worse than its peers at turning profit into free cash flow. Since 2011, WPP has turned 81 per cent of its net income into free cash flow, compared with 107 per cent at IPG (US:IPG), 114 per cent at Omnicom and 110 per cent at Publicis.
WPP is aiming to improve this “significantly” and working capital outflows are due to ease this year. Restructuring doesn’t come cheap, however. Transformation and restructuring costs came in at £196mn in 2023 and WPP’s statutory operating profit tumbled by 60 per cent as a result of these charges, together with impairments and the accelerated amortisation of intangible assets. Cash restructuring costs are expected to rise to £285mn in 2024. Even in 2025, UBS expects free cash flow to be well below 2019 levels, and restructuring charges are expected to linger until at least 2027.
Barclays argues that there is “deep value” to be found in WPP, and it is certainly cheaper than its international peers on a price/earnings basis. For now, however, there is little evidence that its turnaround plan, including its trumpeted AI strategy, is translating into material gains. Only time will tell but, in an industry dedicated to gloss and spin, extra caution is required.
WPP will publish full-year results on Thursday 22 February.
WPP is aiming to improve this “significantly” and working capital outflows are due to ease this year. Restructuring doesn’t come cheap, however: cash costs reached an estimated £205mn in 2023 and are expected to rise to £285mn in 2024. Even in 2025, UBS expects free cash flow to be well below 2019 levels, and restructuring charges are expected to linger until at least 2027.
Barclays argues that there is “deep value” to be found in WPP, and it is certainly cheaper than its international peers on a price/earnings basis. For now, however, there is little evidence that its turnaround plan, including its trumpeted AI strategy, is translating into material gains. Only time will tell but, in an industry dedicated to gloss and spin, extra caution is required.
