Getting tougher

We remain relatively cautious going into Q1’22 results season. We lower price targets for WPP and Publicis again, where we expect an advertising slowdown, and continue to focus on noncyclical secular growth stocks, with UMG our top pick. We also resume coverage on Pearson, at Equal-weight.

Cyclical headwinds to intensify: The conflict in Ukraine has upended the investment calculus for Media & Entertainment stocks in 2022. We argue that spikes in commodity prices

and the steep drop in Eurozone consumer confidence

, coupled with the ongoing tightening of monetary policy in the US and Europe, suggest a slowdown in Europe is likely in the second half of the year. We anticipate this will negatively impact advertisingfunded stocks (WPP, Publicis, ITV, ProSiebenSat.1), where we remain relatively cautious, and favour non-cyclical, defensive with secular growth characteristics (UMG, Wolters Kluwer and RELX). Going into Q1 earnings, we again lower price targets for WPP and Publicis to street-low levels (lower long-term growth and margins), nudge up price targets for UMG, Wolters Kluwer and RELX (higher topline growth, FX), and resume coverage of Pearson with an Equal-weight rating and 750p price target. The key risk to our stock calls is valuation – non-cyclical secular growth stocks are expensive

, so if bond yields continue to rise, this could create a headwind to stock price performance if multiples compress. As we said at the start of the year , 2022 will be a tough year to make money in Media & Entertainment.

Advertising slowdown on the way: We lowered our forecasts for WPP and Publicis last month on the basis that advertising spending would be negatively impacted by higher commodity prices, via (i) a squeeze in gross margins for advertisers for whom fuel and commodity prices are significant input costs; and ( i) a squeeze in consumer spending as higher fuel, food and commodity prices combine with already elevated inflation to reduce household disposable income, which we argued could reduce the incentive to advertise, particularly ‘call to action’ marketing most likely to be affected. Over the past month, commodity prices have remained elevated, suggesting these pressures have not abated. In our base case – which assumes the current conflict lasts into Q2 – we see these factors reducing WPP and Publicis’ organic revenue growth to 2% in 2022, vs current guidance of 4-5%. In the event of a prolonged (12-month) crisis, we believe European advertising could decline by -5% y/y.

Latest feedback from media buyers points to some near-term weakness: Our latest channel checks with some of the biggest TV media buyers in the UK, Germany and Italy suggest advertising growth expectations for 2022 have eased over the past two months, which is supportive of our view that consensus forecasts for European advertising in 2022 have to come down. A summary of our conversations is as follows: (i) in the UK, buyers estimate FY’22 TV advertising budgets will grow by ~100bp less than their estimates prior to the start of the Ukraine conflict (+3% vs +4% previously), driven by FMCG and autos advertisers reducing spend, partially offset by increases in retail and financial services; (i) in Italy, buyers estimate FY’22 total advertising budgets will grow by 300-400bp less than their pre-conflict estimates (+2% from +5-6% previously), with FMCG and autos again cited as the main drivers of lower forecasts; and ( i) in Germany, FY’22 forecasts have not yet changed (+4%) – with some FMCG advertisers increasing spend in Q2 to support campaigns to compete with own-label products – but buyers highlight that March and April advertising are both down year on year, despite the benefit of Easter in April, and that TV networks have had to reduce prices to stimulate demand.

Implications for advertising: We would highlight that feedback from media buyers is not comprehensive, and could under- or over-estimate current trends. Furthermore, media buyers’ visibility on future spending is typically no more than 6-8 weeks, which means that forecasts for the year are based on assumptions that may change; may be narrowly focused on their own clients and media platforms; and may therefore not reflect the overall advertising market. But we note that the tone of our conversations is notably more cautious than in January/February, with buyers telling us “advertisers are planning downside cases for the year” … “sentiment is fragile, advertisers are much more focused on price than they have been”, and “visibility is extremely limited, even into Q2, let alone for the whole year”. This points to weakening advertising trends across Europe, in our view.

Stocks to focus on in Media & Entertainment: Our top pick in the sector remains UMG, which has non-cyclical, defensive characteristics, driven by revenues generated from music streaming platforms, which we believe will remain resilient during a consumer slowdown, given that ~85% of streaming revenues are derived from subscriptions with a highly attractive consumer value proposition. We also highlight the defensive characteristics of Wolters Kluwer and RELX, where musthave content for professional and business customers is unlikely to be materially impacted by higher commodity prices or a squeeze on household domestic spending. The only risk we would highlight for these stocks is on valuation – as well as high absolute earnings multiples for both stocks, their relative 12m forward P/Es are now in line with US peers

, vs 2030% discounts over the past 10 years. We continue to recommend S4 Capital, which is trading ~60% below our price target following the disclosure of two delays in the completion of its 2021 audit. We believe the issue(s) causing the delay will not be material to our profit expectations and argue that, once 2021 results have been announced, the shares should start to recover lost ground. The extent of the recovery will depend on the reasons for the audit delay, which are still not known, and the action taken by the company to ensure the issues do not recur. Finally, we remain constructive on Informa, where a divestment process for its highly valued B2B information business is well under way, the post-COVID recovery in Events is still sluggish, and a return to 2019 levels of profitability is not yet priced into the stock .

Where are forecasts rising? We highlight a full list of revisions in consensus 12m forward EPS

The following stocks have benefited from positive revisions: RELX, Wolters Kluwer, Universal Music Group, Pearson, WPP, Publicis, NENT, Ascential, S4 Capital, JC Decaux (not covered), Stroeer (not covered) and Keywords Studios (not covered). The following stocks have seen negative revisions: ITV, ProSiebenSat.1, Informa, Ubisoft and CD Projekt.

What looks cheap / expensive? As we highlight in Exhibit 4 , the European Media & Entertainment sector is trading at an elevated median 12m forward P/E of 17.2x, with TV Networks the lowest rated (5-11x); Agencies on 10-11x; Outdoor on 15-25x; Publishers/Events on 19-27x; and Video Games on 16-47x. We argue that low multiples for TV networks and agencies reflect elevated levels of structural risk– and investor concerns about the durability of earnings/cash flow – and regard these names (largely) as value traps. From an industry perspective, we favour Music, Video Games and Professional Publishing.