The Long and Short
Interpublic raises full year guidance yet again
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The Interpublic Group of Companies’ (IPG) third quarter results exceeded expectations, prompting management to raise full year guidance once again. Organic sales growth of 15% beat street estimates and proved to be 350 bp higher than the company’s closest peer, Omnicom (OMC – Baa1/BBB+), boosted by its higher percentage of revenue from the healthcare sector, which stands at approximately 28% versus 16% at OMC. This has enabled IPG to rebound much quicker from the lows witnessed at the start of the pandemic. The strong growth and solid margins, coupled with continued decreasing leverage are catalysts for potential upgrades of IPG by the rating agencies over the intermediate term. Since OMC has no debt maturities beyond a 10-year, there is continued support for IPG’s bonds in the long end of the curve, particularly the 20-year, given its lower coupon.
For the nine months ended 9/30/21, IPG’s organic growth rate was 12%, with double-digit organic growth in all geographic markets. While IPG’s credit metrics are slightly weaker than those of OMC, as evidenced in Exhibit 1, we note that IPG repaid $500 million of debt after quarter end with cash on hand. That said, IPG’s total lease adjusted leverage is now 2.6x and just slightly lower than that of OMC.
Exhibit 1: IPG vs. OMC Financial Metrics
Source: Company Reports; APS
Margins Continue to Grow
Despite the havoc that the pandemic caused for the ad agencies, IPG has witnessed a very impressive rebound to the top line and was also able to maintain margins. The quarterly EBITDA margin stood at 16.3%, which was a 10 bp increase from the year-ago period and a 160 bp expansion from the third quarter of 2019. Management’s ability to grow in an environment when the top line is declining was a true testament to their focus on cost cutting and its credit profile. IPG noted that they continue to see efficiencies in both structural and variable expense categories. Management executed several structural changes starting in 2Q20, which continued throughout the remainder of 2020. On the variable side, travel expenses, which have increased from last year’s levels, are still below levels witnessed in 2019. That said, IPG was able to deliver further margin growth this quarter despite seeing a 180bps rise in salary expenses (as headcount grew by nearly 4,500) as well as an increase in performance-based compensation. We expect IPG to further prioritize expense management going forward.
Debt Maturity Profile Extended and Very Manageable
As noted earlier, IPG repaid $500 million of debt subsequent to quarter end with cash on hand. We note that IPG’s debt issuance back in February of this year was used to redeem $250 million of 4% notes due in 2022, $500 million of 3.75% notes due in 2023 and to partially pay down the company’s 4.2% notes due 2024. That said, IPG’s next debt maturity is the remaining $250 million balance of the 4.2% 2024 notes. IPG was able to extend its debt maturity profile with the deal while reducing overall interest costs. IPG’s weighted average debt maturity now stands at 12 years, while OMC’s weighted average maturity is roughly half at 6.7 years. Furthermore, IPG’s largest debt maturity year is 2030 when $650 million comes due, while OMC has 3 years where over $1.0 billion matures (2026, 2030 and 2031).
Exhibit 2. IPG Debt Maturity Profile
Source: Company Reports; APS
Financial Strength Important for Value Creation
Management noted on the earnings call that the strength of their balance sheet and liquidity remains important for value creation. While the cash balance was reduced to just under $2.0 billion with the debt payment, liquidity stands at nearly $3.5 billion as the company maintains an untapped $1.5 billion revolver. With no debt now maturing until 2024, IPG remains in a very strong position to execute on tuck-in acquisitions while returning cash to shareholders via the dividend, which stands at roughly $400 million annually. With free cash flow expected to be at least $1.0 billion on an annual basis, IPG could continue to grow via strategic acquisitions without any further increase to debt levels. Again, lease adjusted leverage now stands at 2.6x and we expect leverage to tick down further as EBITDA continues to grow. Core debt (not adjusted for leases), stood at approximately $3.0 billion post the recent debt paydown, while non-adjusted EBITDA was roughly $1.54 billion, translating to “core” leverage of just under 2.0x.
Agencies Revise Outlooks to Stable
Both Moody’s and S&P revised the outlooks on IPG from negative to stable earlier this year, reflecting the faster pace of recovery and return to positive organic growth. We believe IPG’s rebound in organic growth has exceeded the agencies expectations as IPG is close to or at the metrics needed for an upgrade to high-BBB. Moody’s had made mention in their release that they were concerned over potential “economic scarring” from the pandemic which could potentially make advertisers less willing to increase ad budgets going forward. Global advertising spend is expected to rise 11.2% in 2021 (according to Zenith) and currently IPG is exceeding that rate as its organic revenues are up 12% for the first nine months of 2021. That said, we believe the concern over the potential for economic scarring, according to Moody’s, may be overdone.
S&P noted that IPG has demonstrated and remained committed to its conservative financial policy by suspending share repurchases when it acquired Axciom in 2018 and maintaining that policy during the pandemic to improve liquidity. As we expect IPG to return to tuck in acquisitions and shareholder rewards, we think IPG will do so while maintaining core leverage at or below 2.0x. Should that metric move closer to 1.75x, we think S&P will look to upgrade, or at the very least, revise the outlook to positive. However, at the time of the outlook revision (March 2021) S&P was not expecting IPG to be close to its metrics needed for an upgrade for another two years.
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