Advertising stocks have fallen in line with the broader market so far this year, with the S&P 500 Advertising Sub-Industry Index losing 18%.
Trouble is coming for the industry, Wells Fargo analysts write in a commentary. “All of our channel checks suggest an ad recession is mounting,” they said.
That includes “softening TV scatter, a deceleration in agency growth, and a snap-down in shorter-cycle advertising like radio and digital,” the analysts said.
“Our view is that this recession will look more like 2001 than [2007-]2009 or 2020, meaning it won't have the dramatic world-ending psychology of the great financial crisis and pandemic. But, it should be characterized slower consumer spending and as a result less advertising dollars.”
As for specific stocks, “controversially, we like the agencies, as we think the business models are far more resilient than prior periods, have strong cash flows to support bigger buybacks, and have limited estimate risk.”
Bullish on Interpublic and Omnicom
That led the analysts to upgrade Interpublic Group (IPG) and Omnicom Group (OMC) to overweight.
“Less controversially, we're bearish on radio and see a tough period ahead, so we downgrade iHeart Media (IHRTB) [to equal weight] and Audacy (AUD) [to underweight],” the analysts said
As for out-of-home advertising, “we're neutral, but downgrade Clear Channel Outdoor (CCO) [to equal weight] due to leverage and less ability to transact in Europe,” the analysts said.
The upgrades of Interpublic and Omnicom “may not make much sense to investors, but underpinning our bullishness is the resilience of these business models,” the analysts said.
“We think agencies are structurally sounder than in prior eras, with perhaps 50%-plus of revenue less cyclical.” That’s “due to things like digital transformation, performance marketing, and media buying,” the analysts said.
“IPG and OMC also exhibit low operating leverage,” they said. They estimate 2023 organic growth for the companies at zero, which they see as “conservative.”
But they also think “EBITA (earnings before interest, taxes and appreciation) margins have limited year-on-year downside risk, while the companies can and likely will lean more into buybacks….
“We see these media stocks as solid places to be invested, as they outperform on earnings/cash deployment through the recessionary period.”
Radio and Out of Home
Turning to the radio sector, “as a percentage of local ad spending, radio has gone from a 41% share in 2000 to a 35% estimated share in 2022,” the analysts said. “Radio has grown nicely in digital and podcasting, but terrestrial is still the biggest piece of the pie.
“Our channel checks suggest broadcast radio is seeing a quick and severe pullback on recessionary fears, and we think broadcast radio revenue will be down about 10% in 2023.”
Looking at out-of-home advertising, “while we're broadly constructive on the category, it should see declining fortunes in a recession,” the analysts said. “As a levered equity (9 times net), that has a big impact on CCO's valuation, so we downgrade this stock.”
