Robert Stephens, CFA, explains why WPP could deliver a successful share price turnaround after a challenging period.
Buying a stock that has recently reported a 50%+ drop in net profit is a risky move. After all, a large drop in profitability suggests there are fundamental challenges facing the business which may continue over future periods.
However, advertising and public relations company WPP (LON:WPP) could offer turnaround potential following its recent half-year results. The company is on track to meet its full-year guidance, as well as its three-year strategic targets, despite reporting a drop in profit after tax of 50.5%.
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The business is making major changes to its growth strategy. A key part of this involves simplifying what had become an inefficient and unproductive range of businesses that were acquired over a sustained period of time.
Over the last 15 months, it has made 44 disposals. As part of its disposal strategy, it will sell 60% of research, data and insight consultancy Kantar. Around $1.9 billion from the sale will be used to reduce debt, while $1.2 billion will be returned to shareholders. It plans to reduce its average net debt to EBITDA ratio from 2.1x in June 2019 to less than 1.75x by 2021. This could provide the business with a solid foundation for future growth.
In addition, WPP is investing in creativity as it seeks to enhance its competitive advantage. It will invest an incremental £15 million per year in creative leadership over the next three years, with the capital being focused on its key US market.
Investment is also being made in the company’s data and technology functions, as it seeks to become increasingly relevant to a wider range of clients. A simplification of its management structure will involve 3,500 redundancies and over 100 office mergers. This is expected to improve efficiency and productivity.
Although WPP expects to record a decline in like-for-like revenue and operating margin in the current year, its prospects over the medium term are forecast to improve.
For example, it is set to deliver organic growth by the end of 2021 that is in line with its industry peers. Moreover, the company’s operating margin is due to be at least 15% by 2021, which would represent an improvement of 310 basis points on the 11.9% achieved in the first half of the current year.
Clearly, there are risks facing the world economy that could lead to challenging operating conditions for the business. Its revenue is spread across a variety of major economies, which means that the ongoing trade dispute between the US and China could act as a drag on its financial prospects.
However, since the company trades on a P/E ratio of 6.7 following a share price decline of 26% in the last year, it seems to offer a margin of safety. This suggests that investors have not priced in the potential for an improving financial outlook for the business as it delivers on its strategy.
Therefore, while it could be a risky and volatile stock in the short term, the long-run recovery potential of WPP appears to be attractive.