-Shares slump on profit warning
-Escalating staff costs impact margins
-Suggests company needs to be better managed
Shares in Martin Sorrell’s S4 Capital (SFOR) lost nearly half of their value after the digital advertising group warned on profits, prompting analysts to slash their earnings forecasts.
Management lowered guidance to £120 million earnings before interest, tax and depreciation (EBITDA) for the full year. This compares with a consensus range of £154 million to £165 million before the announcement and implies a downgrade of 25% across the board.
The fact the shares fell by a greater amount (43%) would suggest the market has lost faith in the business, previously hyped as a major challenger to the digital advertising space.
STAFF COSTS RUNNING AHEAD OF REVENUE
There has been a marked divergence between the performance of the data, digital media and technology services offering which management expects to ‘deliver healthy EBITDA margins for the full year’ and S4’s content practice where staff costs have continued to increase ahead of revenue growth.
The group has imposed a hiring freeze and introduced new cost controls to ‘better balance’ the growth in revenue against costs.
MARGINS UNDER PRESSURE
S4’s growth in revenues and earnings has been driven by a series of acquisitions. Since its inception in May 2018, the firm has completed 26 deals, resulting in a marked increase in the number of employees.
Last September S4’s shares fell despite the group increasing its profit guidance for the third time during the year. The decline was attributed to surprise at the headcount and operating loss. The latter increased to £16.1 million compared to a profit of £1.3 million last year, largely due to acquisition payments.
Critically, headcount had increased from 2,644 in September 2020 to 5,751 a year later.
At the time the market was concerned that the higher headcount investment would impact gross profit. As a result, analysts did not materially lift their EBIDTA (earnings before interest tax depreciation and amortisation) forecasts.
Today’s profit warning demonstrates that the market was right to express concerns with respect to the increase in headcount and the associated rise in costs as they continue to act as brake on profitability.
EXPERT VIEW
Commenting on S4’s profit warning Peel Hunt analyst Jessica Pok said: ‘This is clearly a very disappointing statement given that margins have been under pressure since the back end of last year.’
Jefferies analyst Becky Lane said she expected consensus EBITDA expectations for 2023 would be cut by 20% to 30%.
