The Long and Short
A strong start for Interpublic should close the gap to peers
Meredith Contente | July 8, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Interpublic Group’s strong performance in the first quarter this year coupled with its better-than-expected results during the pandemic sets the stage for IPG to trade through peers, including Omnicom Group (OMC). IPG maintains a slightly stronger balance sheet than OMC, and a free cash flow performance that outpaces it by nearly 600 bp. Management recently upped its forecast for organic revenue growth for 2022, off a very strong fiscal 2021 comparison. IPG bonds trade 10 bp to 15 bp wide to OMC – a difference that should collapse as the year progresses The company could also be viewed as an upgrade candidate by both Moody’s and S&P, providing a catalyst for further spread tightening.
Exhibit 1. BBB Media 7-10 year Curve
A Strong Start to the Year
IPG posted strong fiscal 1Q22 results underscored by double-digit organic revenue growth in each of its three reportable segments, despite continued macro uncertainty and geopolitical risk. Organic net revenues were up 11.5% on a consolidated basis with the U.S. witnessing growth of 12.2% and the International segment posting organic growth of 10.2%. IPG reported the largest organic growth rate in Latin America, which saw organic growth up 21.5%. Management noted that its global growth was driven by consistent increases across all client sectors. Adjusted EBITA in the quarter was up slightly from the year ago period. Given the strong top line growth, the EBITA margin contracted 80 bp year-over-year to 12.3%. However, we note that costs went up significantly, as headcount grew by 11% year-over-year and business travel resumed as employees returned to offices. Despite the margin contraction in the quarter, we note that on a LTM basis the EBITA margin is closer to 16.5% and is forecasted to be 16.6% for the full year. This puts IPG on par with OMC with respect to margins. Additionally, IPG’s free cash flow performance has been a real strength, with FCF/sales of 14.2% on a LTM basis. This compares very favorably to OMC, whose FCF/sales metric is nearly 600 bp lower at 8.3% (Exhibit 2).
Exhibit 2. IPG vs. OMC LTM Financial Performance
Balance Sheet and Liquidity Supports Higher Ratings
IPG ended the quarter with total leverage of 2.73x, which we note is slightly better than OMC’s leverage of 2.8x. On a net basis, IPG’s leverage is over a turn less at 1.36x, supported by its strong cash position of $2.4bn. OMC maintains a larger cash position, which puts its net leverage a bit lower than IPG’s at 1.1x (Exhibit 2). However, we note that OMC’s debt maturity profile is more front-end loaded relative to IPG’s. OMC’s weighted average debt maturity is 6.35 years, which we note is roughly half of IPG’s, which currently stands at 12.19 years. That said, OMC has more refinancing risk in the rising rate environment that we are currently in. Both IPG and OMC’s next debt maturity is not until 2024, which provides them both with some runway. However, OMC has nothing maturing past 2033 while IPG has 20 year and 30 year debt outstanding (Exhibit 3). Additionally, OMC’s deals are much larger than IPG’s as it currently has three debt maturity walls over $1bn. IPG’s largest debt maturity year is 2030, when $650mm comes due.
Exhibit 3. IPG vs. OMC Debt Maturity Schedule
Leverage Within Target Range for Upgrade Based on S&P Adjustments
We note that S&P makes certain adjustments when calculating IPG’s leverage. S&P looks at IPG’s leverage from a net basis and expects adjusted leverage to be in the low 1.0x area over the next two years. Currently, S&P’s threshold for an upgrade is to maintain adjusted leverage below 2.0x, with it currently at 1.3x. In addition to the maintenance of adjusted leverage below the aforementioned threshold, the agency would like IPG to sustain positive organic growth and favorable EBITA margins. Based on IPG’s full year guidance of organic revenue growth of 6% and an EBITA margin of 16.6%, IPG’s metrics are within S&P’s framework required for an upgrade.
Moody’s has yet to revisit IPG’s rating, but previously noted that leverage needed to be maintained below 2.75x. While there were some constraints to the rating due to its revenue base, revenues are now above $10bn. That said, IPG is now of scale to be considered for an upgrade relative to global peers. Additionally, IPG has demonstrated its ability to weather economic challenges better than peers as well as its ability to grow revenues organically while expanding margins.