NEW YORK (StreetAuthority) -- The economic downturn was brutal for the advertising industry. Advertising is the first thing to get cut when companies grow cautious, and ad budgets are only now beginning to thaw out. Investors have spotted the turn, bidding up shares of key players. But if you have a three to four-year time horizon, you've only missed the first stage of the multi-year sector rebound.
I attended a recent UBS advertising/media conference and couldn't help notice the broad-based bullishness coming from the various industry executives at the podium. Revenue across the ad industry is rising at a 7% to 8% clip this year. That's a surprising figure when you consider that the broader economy remains in a deep funk. The bounce back is simply a function of really weak ad spending in 2009.
As a general rule of thumb, industry revenue grows or shrinks at twice the rate of broader economic growth. So if the economy grows 3%, the industry should grow 6%. In that context, industry sales may grow at a more modest 5% next year if the economy stays in a funk.
Yet looking out over the next few years, the ad industry may do even better. Many firms have beefed up their skills in the areas of social networking and mobile advertising, both of which are becoming a bigger focus among corporate marketers. And the biggest ad spenders are springing back to life:
Auto makers, which historically account for 15% of ad industry revenue, are boosting their budgets now that they are financially healthier and have many new models to peddle
The wireless phone services sector, which is the second biggest source of ad spending, according to market research firm Kantar, will be pushing hard to sell 4G phones and data service plans in 2011
Financial services firms are also starting to bounce back, and have also comprised upwards of 15% of total ad spending
Here are my Do ETNs Make Good Investments?
Here are my three favorite advertising plays.
I hate recommending a stock that has jumped from $7 to $11 in the past five months, but Interpublic(IPG) shares may still surge well higher from here. Interpublic is one of the world's largest ad agency holding companies after acquiring dozens of firms in the last decade. Interpublic now has a strong presence in emerging markets and is also considered one of the most innovative digital branding shops.
But that spending spree led to a high cost structure, minimal synergies and a debt-laden balance sheet. So in the past two years, management has taken a hatchet to costs, sharply reducing debt in the process. The company is now in much better position to generate improved results. As industry revenue continues to rebound, cash flow is expected to exceed $500 million this year and $750 million in 2011. That has led management to hint that a share buyback or a new dividend could be announced in coming months.
Despite all the positives and the recent share price rebound, shares still trade for less than five times projected 2011 earnings before interest, taxes, depreciation and amortization on an enterprise value basis. Most analysts deploy price targets that are a few dollars above current levels -- because they are looking at projected 2011 results. If you look out beyond 2011, you can make a case for 50% or even 75% upside for shares in the next few years.
Looking for a more unconventional ad industry play? MDC Partners (MDCA) has been focusing on the high-tech angle of advertising. More than 40% of sales are derived from interactive advertising. In addition, MDC derives almost all of its revenue in the United States, a key consideration when Europe is looking a bit shaky at the moment (Read If the Euro Crisis Deepens, Here's What it Means for You.
MDC's executives sure are bullish on the company's prospects. In the past year, a dozen of the firm's officers and directors have bought a collective 284,000 shares, and none has sold a single share. That buying took place even as shares were reaching 52-week highs.
But this is no longer a well-kept secret after doubling from the 52-week low. Indeed, most analysts think shares are now fully valued when compared with near-term results. So the appeal of MDC lies in the multi-year growth plan ahead of it, especially as a key play on the Twitter and Facebook generation. Shares look pretty pricey in relation to GAAP profits, but are more reasonably valued at about eight times projected 2010 Ebitda. That's a bit higher than rivals such as Omnicom(OMC), but MDC's growth prospects appear to be the strongest in the industry.
Lastly, I'm a big fan of DG FastChannel's (DGIT) business model, which helps TV broadcasters maximize ad revenue streams.
Shares have rebounded smartly since I profiled the company this summer, but they still trade at reasonable multiples -- profits are growing at a 30% clip, yet the 2011 price-to-earnings multiple is in the low teens. Business looks back on track after a mid-year scare, and the company has almost no competition. And rising TV ad spending plays right into DGIT's hands.
Action to Take
After an impressive rebound, these shares don't look like a great near-term trade, but rather solid long-term investments. I'm concerned that the market is overextended after a recent rally, yet if we see any pullback that would set these stocks up to be fresh short-term trades, in addition to the long-term value they possess.
This article originally appeared on StreetAuthority.
At the time of publication, Sterman owned no positions in the stocks mentioned.
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