WPP 'unlikely' to hit numbers, Morgan Stanley downgrades

WPP is likely to fall short of full year guidance and may face difficulties hitting its medium-term earnings growth targets, warned Morgan Stanley as it downgraded the advertising agency behemoth to 'equal weight' from 'overweight'.

Morgan Stanley, which cut its WPP share price target to 1,600p from 1,930p, also cautioned that is likely that the market's structural fears over agencies will see any early resolution.

After organic net sales fell 1.7% in the second quarter to drag the first-half down 0.5%, with half-year margins flat in constant currency terms versus a full year target of +30bps, the company has targeted full year organic net sales growth at 0-1%, after boss Martin Sorrell tugged down guidance from 3% in December and 2% in February.

While Sorrell said the third quarter saw July fall 2.5% but August "a little bit more encouraging", Morgan Stanley analyst Patrick Wellington forecasts the quarter will see net sales drop 1.5% with all three months negative year on year.

For the fourth quarter he predicted growth of 0.9% thanks to easier comparative from last year and as a new Walgreens contract kicks in, which would bring the year to -0.4%, still behind guidance.

Although there are fears over whether WPP can maintain its medium-term 10-15% EPS growth target, Wellington's team are still confident about the ad industry's prospects however.

"We think the industry slowdown is mainly the function of low GDP growth and the FMCG (and some other sectors) pressure on marketing expense. This has led to the associated procurement pressure on suppliers, including agencies, and some consequent price indiscipline among competing agencies," the analyst wrote.

He also said there was a structural depression mixed in due to client distrust as industry reports have focused attention on how agencies make their money and particularly on media buying margins.

"We think though the role of the full service agency in the marketing value chain is robust, that digital (despite FB and Google) is a source of growth and that new competition from consultancies is limited," he said.

If Sorrell can deliver his guidance, WPP's 1,420p shares "are lowly rated" at 11.7 times full year earnings and with solid free cash flow and dividend yields, "but signs of a robust cyclical upturn are required to rebuild confidence".