The threat of a recession is prompting companies to cut back on their promotions and investors are increasingly wary of buying shares in the advertising sector. This is understandable given the strong correlation between global economic growth and nominal spending on advertising.

Both the MSCI European Media and Entertainment index and the MSCI World Media and Entertainment index have fallen year-to-date by 19.4% and 31.1% respectively.

Digital-focused advertising agency S4 Capital (SFOR) has seen its share price fall by 75% so far in 2022, not helped by a savage profit warning in July.

Two of the more traditional advertising agencies have also seen share price weakness despite either confirming or upgrading their earnings forecasts for the year. These are WPP (WPP) which is down by 30% and Publicis (PUB:EPA) which has declined by 16%.

PAY CLOSE ATTENTION TO ONLINE ADVERTISING

The economics team at Berenberg forecast a mild recession across the developed world, which is likely to negatively affect spending on advertising and marketing. Although advertising agencies will be affected by this event, internet-only media companies may fare worse.

Over the course of the last decade, advertising agencies’ growth rate has decoupled from global advertising expenditure. This reflects their concentration on large corporates, while small and medium-sized enterprises have been the driving force behind advertising expansion during the last decade. This is in part because smaller companies tend to be more reliant on online advertisements to attract new customers.

Recently, lower levels of consumer demand coupled with privacy changes implemented by Apple (APPL:NASDAQ) have forced smaller companies to reduce their marketing spend to conserve cash.

Last year, Apple released an update for iPhones that let users decide if they wanted to allow apps on their device to target them for advertisements. Most users decided to opt-out which has essentially made mobile advertising less effective for companies.

Analytics platform Varos looked at data from 1,300 small businesses and found their revenue declines had accelerated each month in the second quarter of 2022, according to a report in the Financial Times. Varos’ study also highlighted the cost of acquiring new customers through online advertising was ‘significantly higher’ this year than last, and that overall advertising spend on Meta Platforms’ (META:NASDAQ) Facebook network in 2022 was materially lower versus 2021.

According to data group Lotame, difficulties facing small business have impacted the giants of the online advertising world including Snap (SNAP:NYSE), Alphabet (GOOG:NASDAQ)-owned YouTube and Twitter (TWTR:NYSE) to the tune of $18 billion in revenues this year.

WILL WPP AND PUBLICIS BE NEXT TO WARN?

The message from both Publicis and WPP management teams has been consistent. Currently they do not see any sign of the downturn that the market is now anticipating.

Following a major restructuring and repositioning of the business, growth appears to be returning for Publicis, particularly in the key US market.

It continues to generate substantial cash flow, which allowed it to invest nearly €3 billion in buying Sapient (a business focused on digital transformation) in 2015, de-lever by the end of 2018 and subsequently buy Epsilon for $4.4 billion in 2019. Epsilon provides marketers with proprietary data resources to supplement audience profiles and measure customer engagement across channels.

Publicis views its CORE ID solution, which has 250 million profiles in the US alone, as a key asset that differentiates it from peers, and is one of the drivers behind it winning accounts with McDonald’s (MCD:NYSE) and Walmart (WMT:NYSE).

This focus on identity comes alongside management’s comments that the forthcoming depreciation of third-party cookies is likely to have a bigger impact on marketers and publishers than investors currently understand.

Google is to stop using third-party cookies in its Chrome internet browser from 2024. Cookies enable advertisers to track users across multiple websites and serve more targeted advertisements.

According to Berenberg estimates, Publicis is trading on a 2022 price earnings multiple of 8.3. Earnings per share are forecast to fall by 2.9% from 2022 to 2023, before rebounding by 3.7% in 2024. The current 5.4% dividend yield is forecast to rise to 5.5% in 2023.

For UK advertising agency WPP results for the six months to 30 June reflected a ‘strong first half’ featuring ‘sustained demand from clients’, according to the company. An estimated total of $3.4 billion of net new business was secured during the period including Mars, Sky, Audi and Danone (BN:EURONEXT).

WPP’s forward guidance is for organic revenue growth of 6% to 7% for 2022 coupled with a 50-basis point uplift in the operating margin.

According to recently updated Shore Capital earnings and dividend forecasts WPP is currently trading on a price to earnings multiple of nine, which falls to eight times in 2023.

WPP’s current full year dividend forecast is 35.5p. This equates to a 4.3% yield, rising to 4.7% in 2023.

While some potential bad news has already been priced into Publicis and WPP’s shares, the key risk is that negative market sentiment towards the broader advertising market will continue to weigh on these stocks.

WHICH UK STOCKS ARE RELEVANT TO THE ADVERTISING THEME?

There is a wide variety of stocks on the UK market whose fortunes are linked to advertising activities.

Aside from the big advertising agencies WPP and S4 Capital, there is polling business YouGov (YOU:AIM), whose data is heavily used by companies when targeting consumers.

Publisher Future (FUTR) generates a good chunk of its earnings from carrying advertising on its websites and in its magazines. Bidstack (BIDS:AIM) helps video game developers to earn more money by arranging for advertising to appear in their games. Dianomi (DNM:AIM) is a specialist in contextual advertising and helps brands to place adverts alongside relevant news topics.

Next Fifteen Communications (NFC:AIM) is trying to acquire M&C Saatchi (SAA:AIM). Having initially recommended a bid in May, Saatchi withdrew its support after a big fall in Next Fifteen’s market valuation reduced the value of the part of the deal being satisfied by shares. A meeting slated for 19 August aimed at resolving the situation was delayed until early in the fourth quarter of 2022.

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