On Monday this week (26 Oct) the world's largest advertising company WPP (WPP) disappointed the market with its third quarter update. The numbers themselves looked pretty good with total reported revenues up 5.9% to £2.9 billion but the outlook statement from chief executive Martin Sorrell had a downbeat tone. 'Worldwide, GDP is under pressure and forecasts have been slowing,' he said. 'The US continues to be strong but its recovery is patchy.' Sorrell's additional warning that corporate leaders are looking risk averse is a potentially worrying if not massively surprising observation.
Canary in the coal mine
Advertisers, and WPP in particular thanks to its breadth, scale and geographic reach, are generally seen as good bellwethers for the economy because brands tend to increase ad spending in good times and cut quickly in bad times.
There are plenty of other indicators which economists and analysts monitor to divine the state of the global economy from copper prices to the Baltic Dry Index on shipping but if WPP is feeling gloomy then perhaps we should all feel a little nervous about the future.
To gain some understanding of how reliable a 'canary in the coal mine' the company can be we looked back at its 2007 interim results. Published on 17 August 2007, the same day the US Federal Reserve warned that the 'credit crunch' could be a risk to economic growth, the majority of the commentary which accompanied the results was pretty bullish but it did include this ultimately revealing nugget.
'The consumer remains under pressure on both sides of the Atlantic from increasing levels of debt, low savings ratios and house prices. Any slack in consumer spending has not to date been taken up by significant increases in corporate capital spending, beyond replacement spending. Company boards remain cautious, perhaps cowed by regulatory measures and fear of failure. The average life of a chief executive officer, remains around four years and apparently under two years for a chief marketing officer in the United States.'
This analysis suggested that beneath an apparently rosy looking global economy cracks were starting to appear and so it proved.
WPP itself actually fared reasonably well through the credit crunch and the global downturn that followed it. As the chart below shows, headline pre-tax profit progressed steadily except in what the group itself described as a 'brutal' 2009.
(Click on chart to enlarge)
Media mashed
Putting the macro environment to one side, how is WPP placed at the moment? It certainly looks to be faring better than its French peer Publicis (PUB:EPA) which suffered the worst one-day sell-off in its shares on 22 October as it slashed its organic growth target for 2015. However all advertising agencies are facing a threat to their high margin media buying business.
As Liberum's well respected media analyst Ian Whittaker has observed, media buying - the purchase of advertising from a media company such as a TV station, newspaper or website - has been the 'rocket fuel' for the agencies in recent years. Although revealingly few agencies publish a breakdown Whittaker reckons media buying has generated margins of 25% to 30% against group average margins in the region of 16% plus.
Programmatic buying - an automated means of securing advertising space - is an increasing threat to this activity and the US Association of National Advertisers recently launched a wide-ranging investigation of the media-buying supply chain amid concern agencies may be making money on the back of their advertising spending in ways that are not transparent, such as taking undisclosed 'rebates' from media companies.
It remains to be seen if WPP can manage these challenges but even if you do not take a direct interest in the fortunes of the company it is always worth keeping close tabs on what it has to say about the economic backdrop.
