Berenberg has cut its stance for WPP group PLC (LON:WPP) to ‘sell’ from ‘hold’ as it expects the advertising giant’s situation “to get worse before it gets better.”
The German broker also cut its price target for the FTSE 100-listed stock to 1,075p from 1,275p, with the shares currently trading at 1,207p, down almost 3.5% on Monday’s close.
READ: WPP up as it posts above-forecast first-quarter net sales, repeats full-year guidance
In a note to clients, Berenberg’s analysts said: “Regardless of the reasons for recent management change, WPP’s Q1 relative performance versus peers (particularly in North America) showed that all is not well from an operational perspective: we think that this will prove more difficult and costly to fix than consensus expects.”
They added: “The historical margin expansion trend has slowed to a crawl more recently, but margins could now start to step down. In FY 2018 our forecast of a 60bp (basis point) decline was already below guidance and consensus (flat) given the need to refill incentive pools and the mix effect of revenue weakness in the company’s most profitable region of North America.”
The analysts said they now assume that full-year 2019 margins will fall another 100bp, reflecting incremental fee pressure at a time of management change, and £50mln of net technology spend by a newly appointed CEO.
They added: “We assume margins remain flat from there in the longer term as potential restructuring cost benefits offset investment and fee pressure; so any cost savings announcements in future should not necessarily be considered additive to existing profit forecasts.”
Leverage still not to fall meaningfully
The analysts pointed out that, as guided, they assume that WPP sells £750mln of equity stakes and associate investments to reduce debt, but think that falling profitability, and the current guidance for acquisitions and buybacks to continue, indicates that its leverage will still not fall meaningfully.
They added; “At the same time, the earnings decline moves the dividend payout ratio above the current 50% level (at target); with a new CEO set to be appointed, there is clear scope for cash return expectations to be rebased and we now assume a flat dividend.”
The analysts said an internal appointment for the CEO position would confirm their view that a meaningful breakup is not likely, with only further smaller disposals possible, which would further exacerbate the earnings dilution and dividend payout issue.
They added that, after cutting their full-year 2019 EPS estimates for WPP by another 5%, the shares trade at around 9x EV/EBITDA, making it the most expensive ad agency on this metric.
The Berenberg analysts concluded: “In our view this leaves scope for de-rating as well as potential consensus EPS downgrades.”