Shares in focus: Can WPP beat off Facebook?

The advertising agency faces stiff online competition, but trading is on the up, says Phil Oakley.

WPP is often referred to as the world's largest advertising agency. That's true but it is much more than that. WPP's activities cover the whole spectrum of company communications with its customers, including market research, public relations and brand-building. It is made up of 155 different companies based in 110 countries around the world.

The company is dominated by its chief executive, Sir Martin Sorrell. A former finance director of advertising legend Saatchi & Saatchi, Sorrell bought a stake in Wire and Plastic Products plc, a maker of wire shopping baskets, in 1985.

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He used the company as a shell to buyup advertising agencies and hooveredup big names such as J Walter Thompson and the Ogilvy Group in the late 1980s. WPP has made Sorrell a rich man as he has built it into a global advertising and communications giant.

He has undoubtedly done a very good job, although his hefty pay packet hasangered shareholders in recent years.

The company itself is seen as something of an economic bellwether. Companies only spend money on advertising when they are confident about the future and tend to cut back when times are tough.

That said, WPP's profits held up very well during the financial crisis and have grown strongly since then. Since 2009, dividends paid to shareholders have more than doubled and the share price has more than trebled.

However, the future of advertising is subject to much uncertainty. So can investors expect further big gains?Or are WPP's best days behind it?

The outlook

But regardless of how good Sorrell's expectations management is, the ultimate health of WPP depends on how confident his customers feel about spending money marketing their products.

Right now, there are a lot of worries that could cause them to keep their hands in their pockets. These range from the conflicts in Gaza, Ukraine and Syria, to the economic fragility of the eurozone and the question mark over whether companies and households can prosper when interest rates eventually go up.

Then there's the fact that advertising remains a tough business in which to make money. There's a lot of competition, your customers have lots of buying power, and they are always expecting you to do more work for less money.

The power of the internet has seen firms such as Google and Facebook come to dominate digital advertising. Companies now frequently go to these big players directly, cutting out middlemen such as the agencies.

Will its five-year plan deliver?

A big emphasis will be on doing more business in the emerging economies of Latin America and Asia, which have better growth prospects and a developing middle class who will want to buy lots more consumer goods.

Firms will, in turn, boost their advertising spending to reach them.Expect WPP to spend £300m-£400m a year over the next few years to beef up its presence in these markets. It wants them ultimately to account for around 45% of sales, compared to around 30% currently.

There will also be a big focus on digital advertising, as this will be accounting for more of companies' marketing budgets. WPP has a big lead over its nearest rivals in this area and will need to work hard to preserve and grow this.

It will also have to cut costs. It has done a good job of making its business more resilient to downturns by outsourcing more staff and IT functions, and using less office space. If sales can grow modestly as well, then WPP reckons it could increase its profit margins from 15% now to 18% by 2020.

With the company keeping a tight lid on investment spending, there's a good chance that its free (or surplus) cash flow will be a lot higher than the £1.2bn that was available last year.

That could be very good news for shareholders. Dividends have grown strongly as WPP has paid out a larger chunk of its rising profits and this trend may be able to continue.

Expect WPP also to use its cash to buy back around 2%-3% of its outstanding shares every year. With a profit kicker expected from buying new businesses, WPP is targeting earnings per share (EPS) growth of 10%-15% a year over the next few years.

Current trading is going well, with operating profit above the company's budget for the year, although profit margins are being held back slightly by the strong pound. However, the company's shares will always be something of a hostage to people's concerns about the world economy, which could make the shares volatile.

They are currently around 13% below the highs they hit in January due to people fretting about rising political tensions. On over 14 times expected earnings, the shares are no bargain but WPP has shown it has what it takes to thrive in hard times. So now could be a good time to buy.

Verdict: long-term buy

WPP (LSE: WPP)

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