Nov 29 -
Summary analysis -- WPP PLC --------------------------------------- 29-Nov-2012
CREDIT RATING: BBB/Stable/A-2 Country: Jersey
Primary SIC: Advertising, nec
Mult. CUSIP6: 92933H
Credit Rating History:
Local currency Foreign currency
05-Apr-2011 BBB/A-2 BBB/A-2
07-Jul-2009 BBB/A-3 BBB/A-3
The ratings on U.K.-based communications services group WPP PLC reflect Standard & Poor's Ratings Services' opinion of its business risk profile, which we view as "satisfactory" (as defined by our criteria), and of its financial risk profile, which we view as "intermediate."
WPP's business risk profile assessment reflects the company's leading positions in advertising, market research, and public relations services, combined with broad geographic, business, and client diversity. The company's improving operating margin is a further positive factor. These factors are partly offset by our view of the highly competitive nature of advertising and marketing services, WPP's reliance on key management and creative personnel, and ongoing pressure on the group's clients to optimize spending on marketing.
We believe the group's financial risk profile is essentially constrained by a moderately high leverage at the "intermediate" level--albeit in line with the ratings. On the positive side, the company benefits from sound conversion levels of profits into discretionary cash flow.
Key business and profitability developments
We have slightly revised downward our previous organic growth forecasts for 2012, which anticipated growth exceeding 3.5% for the year. We now expect WPP's 2012 organic growth to be in line with the group's guidance of 2.5%-3%. The revision follows the group's publication of 3% organic growth in the first nine months of 2012, with 1.9% organic growth reported in the third quarter of 2012.
We believe, however, that advertising agencies such as WPP may struggle to post significant organic growth in 2013, given a lack of notable events such as 2012's Olympic Games and U.S. elections, and absent a marked improvement in the global economy. Our base forecasts reflect our opinion of a weakening economic outlook for Europe, which may translate into reduced corporate profits and a wait-and-see attitude from advertisers in the region. This is despite WPP's continuing sound growth in emerging markets and digital services; the latter grew by about 7% in the first nine months of 2012.
Advertising market forecaster ZenithOptimedia has slightly reduced its forecasts for worldwide advertising spending growth to 3.8% according to its latest study published in September 2012 (it forecast 4.8% in its March 2012 publication). However, it anticipates 4.6% growth in worldwide advertising spending in 2013, including a return to slow growth in the European Economic and Monetary Union (EMU or eurozone) after a projected decline in 2012. While ZenithOptimedia's forecasts are encouraging for ad agencies' revenue growth in 2013, such a growth forecast could contrast with our macroeconomic expectations for the eurozone. For example, Standard & Poor's currently anticipates that GDP growth in the eurozone will contract by -0.8% in 2012 and remain flat in 2013. We previously anticipated a modest 1% growth in 2013 for the region.
Under our revenue growth assumptions for 2012, we believe that WPP should succeed in reaching its aim of a 50 basis point increase in headline operating margin by year-end 2012. This is in line with the company's reported EBITDA margin of about 13.7% in the first half of 2012, which was up from 13.2% in the first half of 2011. We see margin stability in 2013 more at risk under our weaker revenue assumption for the year, which is more conservative than WPP's indication of a slight margin progression in 2013.
Key cash flow and capital-structure developments
As a result of higher profitability and improved working capital management over the past 12 months, WPP's adjusted average debt-to-EBITDA ratio slightly improved to about 2.8x in the year ended June 30, 2012, from about 2.9x at year-end 2011, in line with the current ratings. We believe adjusted leverage will be slightly under 3x at year end 2012 in our base-case scenario, taking into account the GBP348 million acquisition of digital advertising agency AKQA that closed in the third quarter of 2012. We view substantial improvement in adjusted leverage in 2013 as uncertain at this point, given our base-case scenario of weak economic prospects for Europe and the U.S. and our view that WPP could allocate the majority of free operating cash flow to dividends, acquisitions, and share buybacks during the period.
Adjusted free cash flow to average debt reached 13.6% in the year ended June 30, 2012, slightly below our expectations of 15% for the current ratings. However, we anticipate that this ratio could improve by year end 2012, in part thanks to continuous improvement in working capital changes, which significantly reduced operating cash flow in 2011.
The short-term rating is 'A-2'. We assess WPP's liquidity as "strong" under our criteria. We base our liquidity assessment on the following factors and assumptions:
-- We expect the group's liquidity sources to exceed its uses by more than 1.5x over the next 12 to 24 months.
-- Debt maturities for the next 12 months are manageable, in our view, and mainly consist--as of June 30, 2012--of about GBP378.9 million of overdrafts used as part of the group's cash pooling system, and about GBP86 million outstanding under a $1.6 billion revolving facility maturing in 2016. We also note that the group will have to face a EUR600 million bond maturity in December 2013.
-- Even if EBITDA declines by 30%, we believe cash sources would still exceed uses.
-- In calculating cash uses over the next 12 months, we included peak working capital assumptions--derived from our observations of working capital patterns over the past few years--of GBP400 million-GBP500 million, as well as projected dividend payments in line with the group's dividend payout objective of 40% over the next few years, acquisitions of new companies of about GBP500 million (mostly that of AKQA), and share buybacks of about GBP100 million.
-- In calculating cash sources over the next 12 months, we included the group's largely available cash balances --which reached about GBP1.3 billion as at June 30, 2011, of which about GBP1.2 billion was cash at bank or in hand, mostly relating to WPP's cash pooling system--and our assumption of free cash flow exceeding GBP1 billion in 2012.
-- Significant headroom under financial covenants--which do not step up--as of June 30, 2012, and which could, in our view, sustain a 30% drop in EBITDA. Debt is 30% below covenant limits. WPP's $1.6 billion revolving facility has financial covenants of net debt to EBITDA of below 3.5x and EBITDA coverage of net interest of more than 5x, which the group measures on a rolling semiannual basis.
-- Our view of WPP's good standing and access to bank funding and capital markets, as evidenced by its relatively regular bond issuance.
-- We believe that the group's liquidity is supported by sound conversion of EBITDA into free cash flow of about 40%.
-- WPP will have to face significant debt maturities in 2014, of about GBP1.1 billion, which we expect the group to pro-actively address over the next 12 months.
The stable outlook reflects our expectations that WPP's sound free cash flow generation, combined with a moderate financial policy, will allow it to post credit metrics commensurate with the current ratings over the next two years. In particular, we believe WPP is likely, in our base-case scenario of weak growth over the next 24 months, to achieve adjusted leverage of about 3x during the period.
We expect that WPP's financial policy will remain supportive of the current ratings. In particular, we anticipate that the group will balance its acquisition spending against share buyback activity. We view adjusted average debt to EBITDA of under 3.5x and adjusted operating free cash flow to average debt of over 15% as commensurate with the ratings.
We could, however, lower the ratings if WPP's credit metrics were to materially and lastingly weaken from current levels over the next few quarters, to levels no longer commensurate with the ratings. We could also lower the ratings if the group were to engage in material acquisitions and share buyback activity, resulting in durably and significantly weaker credit metrics.
We could raise the ratings if the group's revenue and EBITDA growth were to rise materially above our base-case scenario over the next 24 months, resulting in significantly stronger credit measures on a sustainable basis, such as average debt to EBITDA in the 2.5x-3x range and adjusted free cash flow to average debt of over 20%. We would also expect discretionary cash flow to rise in line with earnings. We view this scenario as relatively unlikely over the period, given our expectations of a persistent weak economic environment and continuing allocation of free cash flow to acquisitions and shareholder returns.
Related Criteria And Research
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Key Credit Factors: Methodology And Assumptions On Risks In The Advertising Industry, Aug. 18, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008