23.06.2016, 21:21

Fitch Affirms WPP at 'BBB+'; Outlook Stable

OREANDA-NEWS. Fitch Ratings has affirmed UK-based WPP Plc's Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB+'. The Outlook is Stable. A full list of ratings actions is below.

WPP's rating reflects its leading market position within the marketing communications services sector and its effective diversification across geographies, products and customer market sectors. The rating is supported by a strong cash generative capability, which enables WPP to invest both organically and through acquisitions. This allows the group to sustain its revenue growth profile, invest in new technology and content and acquire knowledge in a rapidly evolving industry sector. We believe these elements are key to reinforcing the group's competitive position.

Fitch expects that leverage will increase marginally in 2016 and 2017 but remain consistent with a 'BBB+' rating, albeit with limited headroom. Fitch expects leverage to remain broadly stable thereafter, with strong free cash flow (FCF) generation and discretionary spend on share buybacks and M&A providing sufficient flexibility to maintain average net debt to EBITDA within the group's target range of 1.5x to 2.0x.

KEY RATING DRIVERS

Diversified Portfolio Adjusting for Digital

WPP has a strong portfolio of advertising, measurement, market research, PR and brand management businesses, covering most elements of the marketing communications services sector. The portfolio is well diversified from a geographic and end-customer segment perspective. North America is WPP's largest single region, accounting for 39% of revenues in 1Q16, with UK and Western Europe accounting for 35% and other markets including BRIC countries accounting for 26%. Fitch views the diversification as credit supportive as it enables data and technology expertise to be leveraged from one market to another, targets global clients and reduces risks related to its cyclical exposure.

Reinforcing its Competitive Position

We believe WPP's ongoing focus on portfolio integration, providing integrated products and services and making investments in data, technology and content are important drivers sustaining the group's competitive position. These elements take time to come together and have a sustainable positive effect on financial performance. However, they are key to managing pricing pressure in the sector and providing greater value to the customers in a competitive sector. WPP's focus on these aspects enabled the group to profitably grow its market share in North America in 2015.

Strong Cash Generation

WPP has a strong cash generative capability that is primarily driven by the strength of its operating subsidiaries, EBITDA margins of 16% to 17% and relatively low capital intensity requirements. Fitch estimates that WPP is likely to generate between GBP1.1bn to GBP1.3bn of pre-dividend FCF annually over the next three years, assuming no significant macro-economic downturns. This in turn, leads to a net debt to CFO minus capex ratio of 3.5x (based on average net debt), one of the best amongst the Fitch rated European TMT companies. The combination of robust FCF generation, some cost flexibility and a consistent financial policy is core to the group's ratings.

Exposure to Macro-Cyclicality

WPP's revenues are driven by the marketing spend of corporates, which can fluctuate depending on business cycles and economic growth or contraction. This exposure constrains ratings in the sector. The group's geographic, product and end customer diversification helps to reduce these risks. In addition, 8% of costs in relation to net sales are variable staff costs, which can be reduced if needed. In periods of sustained economic downturns, WPP is able to gradually downsize some of its operating leases, which are primarily linked to property rental.

FX Exposure

We expect WPP's results to be positively impacted by FX in 2016. FX movements affect the company's revenues, but also its margin as WPP's emerging markets operations earn a higher margin than operations in more developed countries. WPP funds itself in USD, GBP and euro-denominated debt. While dollar, euro and sterling debt are largely matched by revenue generation in the US, Europe and the UK, the company is exposed to a modest currency mismatch in emerging markets. Around 29% of 2015 revenue was generated in APAC, LATAM, CEE and MEA regions. These regions are effectively funded by euro-denominated debt.

Limited Rating Headroom

We expect funds from operations (FFO) adjusted net leverage (based on average net debt) to marginally increase over the next two years to 3.7x from 3.5x in 2015. Average net debt to headline EBITDA is likely to remain towards the upper end of the group's target leverage range of 1.5x to 2.0x. . The increase in leverage is a result of ongoing M&A, increasing cash tax payments, higher capex levels and growth in shareholder distributions. Fitch expects the increase is likely to be sustained, resulting in limited ratings headroom at the 'BBB+' level. However, WPP retains sufficient financial flexibility as this assumes ongoing annual M&A spend of GBP400m and share buybacks of GBP400m to GBP450m (equivalent to 2%-3% of outstanding shares). We believe both elements can easily be flexed if needed to keep leverage under control.

Sector Opportunities and Threats

The marketing communications sector continues to rapidly evolve and change. There are a number of trends that create uncertainties in the future. These include the growing dominance of the likes of Facebook, Google and Amazon, disintermediation in media buying, the entry of consultancies and technology companies in to the sector, the growing importance of data analysis and growth in new digital and new media and changes in consumer consumption habits.

We believe these trends present both opportunities and threats for WPP. The company's business model is not affected or dependent on the type of media advertising e. g. TV, online or print. In our opinion, WPP's ultimate success will be driven by its ability make sense of the changes in the industry, acquire the right assets and skills that help improve reach and reduce costs for its clients. WPP's scale and FCF generation are important elements in its ability to keep up with the changes. A relatively early focus on portfolio integration, cost reduction and investments in content and new fields such as programmatic advertising demonstrates strong historical performance in aligning itself with future opportunities.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer are:

- Revenue growth of 6.5% in 2016, partially driven by currency effects. Revenue growth of 3% to 4% per year thereafter, driven by organic growth and ongoing M&A.

- Operating margins to expand by 20-30bp per year over the next three years.

- Capital expenditure to increase from 2.0% of revenues in 2015 to around 2.5% per year.

- Share buybacks of 2%-3% of share capital per year.

- A dividend pay-out ratio of 50%.

- Acquisitions of GBP400m per year.

- Leverage managed within the company's target of 1.5x to 2x average net debt to EBITDA.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

- Notwithstanding a strong industry position, diversification and a flexible cost base, the company's financial policy - balancing the need to invest in acquisitions, a progressive distribution policy and a measured leverage profile - are likely to constrain the ratings;

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- Events leading to average net debt/EBITDA trending consistently and materially above 2x.

- FFO adjusted net leverage (calculated using average net debt) remaining sustainably above 3.7x and pre-dividend free cash flow margin remaining consistently below 7% would also put pressure on the rating.

- A weakened operating profile or a change in financial policy, more so than M&A or cyclically driven trends, would put pressure on the ratings

FULL LIST OF RATING ACTIONS

WPP Plc

Long-term IDR: affirmed at 'BBB+', Outlook Stable

WPP Plc