Analysts Buy Into Ad Sector

Within the past month, there has been a bullish uptick in interest among financial analysts following the ad industry. Prudential Financial and SoundView Technology Group have initiated coverage of the sector, betting that ad stocks will fare better than the broader market as the industry recovers from its three-year slump.

“We believe the advertising-agency group will outperform the S&P 500 during the next 12 to 18 months on accelerating earnings momentum from multiple growth currents,” wrote Joseph Stauff, an analyst at SoundView, in his initial research two weeks ago.

Stauff expects the ad industry will enjoy above-average growth during the next three to four years as marketers increase spending from recessionary levels, with the largest agencies benefiting from market-share gains that were accelerated during the recession. He also predicts demand for higher-margin services will increase as marketers see a greater need to combat a cluttered media landscape.

Given the prospects of a larger economic recovery, Stauff points out that agencies consistently outperform in buoyant markets: “Historical stock performance indicates the advertising agencies posted the largest number of outperformances [vs. the S&P 500] among [their] media peers [in 11 out of the last 16 years]. This relationship has been even more pronounced in years in which the S&P 500 posted growth.”

Prudential argues that industry stocks are already beginning to reflect a U.S. ad recovery. The firm said that since the market’s low on March 11, the S&P 500 has gained 26.3 percent, while shares of the three largest ad-industry holding companies have averaged a 69.9 percent increase.

Prudential analyst Steven Barlow expects that rising corporate profits will fuel expenditures, particularly as marketers respond to spending increases by competitors. “While this has always been true, we believe that as a result of limited pricing power for both consumer and business products, advertising is crucial to achieve market share gains and to build messages that build brand equity through product differentiation,” according to Barlow’s research.

Prudential assigned an “overweight” rating to Omnicom Group shares and set a $95 price target; WPP Group has a $49 target and a “neutral weight” rating; and Interpublic Group has a $15 target with an “underweight” rating. Stauff is more bullish on IPG, giving it an “outperform” rating and a $20 target. He rated Omnicom and WPP as “neutral,” with targets of $85 and $50, respectively.

Merrill Lynch’s Lauren Rich Fine recently lowered her 2003 and 2004 ad forecasts to reflect weaker local U.S. spending this year and her “more muted optimism” for 2004. Fine predicts U.S. growth of 2.8 percent and global growth of 1.9 percent in 2003, down from 3.1 percent and 2 percent, respectively. “While you don’t necessarily share in any upside to our forecast, you are protected on the downside by both attractive valuations and fee-based compensation,” she said.