Undervalued Dividend Growth Stock of the Week: Omnicom Group Inc. (OMC)

Becoming wealthy is a very straightforward process.

Now, that doesn’t mean it’s easy.

It’s simple, but it’s also difficult.

That simplicity extends to investing.

Successful long-term investing is actually an uncomplicated process.

I’ll show you how simple it can be.

Take the investment strategy I use, for instance.

This is the investment strategy I used to become wealthy at a young age.

It’s dividend growth investing.

This strategy basically involves buying shares in world-class businesses that are paying out rising cash dividends to shareholders.

There are more than 800 US-listed examples of these stocks on the Dividend Champions, Contenders, and Challengers list.

You buy these stocks at attractive valuations and hold for the long term.

Sounds simple? 

Yeah. That’s because it is!

So simple, in fact, that I used it to go from below broke at 27 years old to financially independent and retired at 33.

I even lay out exactly how I did that in my Early Retirement Blueprint.

By sticking to simplicity, I built my FIRE Fund.

That’s my real-money early retirement dividend growth stock portfolio.

And it generates the five-figure passive dividend income I live off of.

Better yet, that dividend income continues to grow year in and year out, like clockwork, all by itself.

Like I noted earlier, though, buying high-quality dividend growth stocks when they’re undervalued is part of the deal.

Jason Fieber's Dividend Growth PortfolioWhile price is what you pay for a stock, it’s value that you get.

An undervalued dividend growth stock should offer a higher yield, greater long-term total return potential, and reduced risk.

That’s relative to what the same stock might otherwise offer if it were fairly valued or overvalued.

All else equal, because price and yield are inversely correlated, a lower price results in a higher yield.

This higher yield leads to greater long-term total return potential.

Total return is, after all, the sum of investment income and capital gain.

Boosting yield gives you more potential investment income.

Capital gain gets a potential boost, too, via the “upside” between a lower price and higher intrinsic value.

These favorable dynamics also reduce risk.

Undervaluation introduces a margin of safety.

That’s a “buffer” that protects the investors downside against unforeseen issues.

An undervalued high-quality dividend growth stock can be a tremendous long-term investment.

The good news is, undervaluation is far from difficult to spot.

Making this even more straightforward is fellow contributor Dave Van Knapp’s Lesson 11: Valuation.

As part of an overarching series that’s designed to teach dividend growth investing, Lesson 11 provides some fantastic information on exactly how to value just about any dividend growth stock out there.

With all of this in mind, let’s take a look at a high-quality dividend growth stock that appears to be undervalued right now…

Omnicom Group Inc. (OMC)

Omnicom Group Inc. (OMC) is an advertising, marketing, and corporate communications company.

Now composed of over 1,500 subsidiaries, the company can trace its roots back to the late 1800s.

It’s since grown into one of the largest marketing and corporate communications companies in the world.

Not only is it a very large company, Omnicom Group has built up an impressive amount of diversification, scale, breadth, depth, and experience across their various businesses.

For further perspective on that, they provide services to over 5,000 clients in over 100 countries.

They have exposure to almost every industry in every country. They practically have their fingertips on the pulse of the entire global economy.

Thus, buying Omnicom Group stock is almost analogous to investing in the global economy all in one go.

The company operates across the following fundamental business disciplines: Advertising, 54% of FY 2018 revenue; CRM Consumer Experience, 17%; CRM Execution & Support, 12%; Public Relations, 9%; Healthcare, 7%.

United States accounts for approximately 52% of total revenue.

One might initially think of this as an advertising company.

But I believe the more accurate way to think about Omnicom Group is as a comprehensive corporate communications company.

They work closely with their clients in order to shape the message and image that’s communicated to their clients’ customers. Omnicom Group does this in a very holistic way, managing that communication from top to bottom.

This isn’t just advertising campaigns; Omnicom Group is a one-stop shop that offers a complete array of solutions.

The proper shaping, management, and distribution of a company’s message is arguably more important than ever.

The rise of the Internet has allowed for rapid and unfettered dissemination of information.

Communication consumption has been greatly changed by this. It’s become more difficult to control a message.

The experience and breadth that Omnicom Group provides should therefore become even more critical and valuable, assuming they can successfully overcome these changes.

Putting them in the driver’s seat is the very nature of the business model.

One of the most compelling reasons to invest in the likes of Omnicom Group is the sticky client base.

Once a company like Omnicom Group becomes attached to a client’s marketing department, it’s essentially nonsensical to switch to a competitor due to switching costs (both in time and money) and no guarantee things will improve.

Furthermore, since Omnicom Group controls the likes of acclaimed BBDO and DDB, the company can just move a client from one network to another. This would be a far easier solution for a client than switching providers wholesale.

This bodes well for the company’s ability to grow its profit and dividend for years to come.

As it sits, the company has increased its dividend for 10 consecutive years.

That time frame obviously includes all of the prolific changes I just noted. So I think this speaks volumes about the company’s wherewithal and willingness to pay an increasing dividend.

The 10-year dividend growth rate is sitting at a monstrous 14.9%.

However, there’s been some recent deceleration here.

For instance, the most recent dividend increase came in at 8.33%.

But that’s still very attractive dividend growth when you consider the stock yields 3.44%.

That yield, by the way, is more than 60 basis points higher than the stock’s own five-year average yield.

And with the payout ratio coming in at 43.8%, the company is financially positioned to continue handing out sizable dividend increases for the foreseeable future.

Of course, we invest in a business based on where it’s going, not where it’s been.

So I’ll build out a long-term trajectory for dividend growth, which will also aid us when it comes time to value the business and its stock.

I’ll first show you what Omnicom Group has done over the last decade in terms of top-line and bottom-line growth.

Then I’ll compare that to a near-term professional forecast for profit growth.

Blending the proven past with a future forecast like this should tell us a lot about where Omnicom’s business might be going.

The company grew its  revenue from $11.721 billion in FY 2009 to $15.290 billion in FY 2018.

That’s a compound annual growth rate of 3.0%.

I’d usually like to see mid-single-digit top-line growth from a fairly mature company like this.

Omnicom Group falls a bit short; however, I think it’s important to keep in mind that this period included one of the most challenging recessions the US has ever had (which is where most of Omnicom Group’s revenue comes from).

In addition, the aforementioned challenges in the broader industry have weighed on results.

Meanwhile, earnings per share increased from $2.53 to $5.83 over this period, which is a CAGR of 9.72%.

We can see plenty of excess bottom-line growth here.

That appears to be mostly fueled by significant share buybacks – the company has reduced its outstanding share count by almost 27% over the last decade.

Simultaneously, Omnicom Group has worked to expand margins, particularly over the last five years.

I think margin expansion should uplift investors, since that’s occurred during a period of unprecedented change in the industry.

Looking out over the next three years, CFRA is predicting that Omnicom Group will compound its EPS at an annual rate of 5%.

That’s a marked change from the 8% EPS CAGR that CFRA was predicting as recently as this spring, back when the target price on OMC was actually much lower. I honestly find it inexplicable to lower growth expectations and raise the target price.

CFRA sees broad-based revenue growth helped by digital transformation initiatives, a favorable mix of services, and investments in data and analytics.

But noted headwinds include currency, and there are concerns over macroeconomic factors (such as slowing international markets).

Looking at the dividend growth track record to date, the payout ratio, and the overall positioning of the finances, I don’t see any reason why Omnicom Group can’t deliver very solid dividend growth for years to come.

In my view, CFRA’s earlier 8% EPS CAGR forecast was more reasonable. But even a 5% growth rate would still allow for Omnicom Group to hand out mid-single-digit dividend raises – which comes on top of that market-beating yield. That’s because the dividend sucks up so little free cash flow.

Moving over to the balance sheet, Omnicom Group’s high quality shines through once more.

While a long-term debt/equity ratio of 1.72 would appear high at first glance, that’s only because a heavy amount of treasury stock is weighing down common equity.

That significant buyback activity shows up here, and it’s artificially skews the balance sheet.

But there are no real issues whatsoever here.

Total cash is ~83% of long-term debt.

Moreover, an interest coverage ratio of over 8 shows us that Omnicom Group can easily afford its ongoing interest expenses.

The company’s profitability is strong, particularly for the industry.

Over the last five years, the firm has averaged annual net margin of 7.48% and annual return on equity of 44.17%.

ROE is admittedly aided by the low common equity.

But the margin expansion story is something special.

FY 2018 net margin is almost a full 200 basis points higher than it was in FY 2009.

Sure, I’m comparing a strong year to the depths of the financial crisis. It’s not totally fair.

But there has been a clear trend of noticeable margin expansion over the last decade, with that trend accelerating over the last five years.

Overall, there’s a lot to like about this company here.

But there are risks to consider.

Competition, litigation, and regulation are omnipresent risks in every industry.

Competition in this particular field is interesting in the sense that there are only a few major players (creating an oligopoly). However, the limited competitors that do exist are fierce and competent.

Any global economic recession will likely translate to a slowdown in spending, which goes for both consumers and businesses alike. This would undoubtedly affect Omnicom Group.

Also, the digital marketing landscape continues to quickly evolve. Any missteps by Omnicom Group could have far-reaching and long-term consequences. The company must remain on top of this. I see this as their biggest risk of all, because it’s more existential in nature. It’s concurrently their biggest opportunity.

Even with the known risks, this looks like an appealing long-term investment.

What makes it particularly appealing right now is the valuation…

The stock is trading hands for a P/E ratio of 12.69.

That’s materially lower than the broader market.

It’s also well off of the stock’s own five-year average P/E ratio of 17.1.

The cash flow multiple of 9.7 is also appealing by numerous measures, although there’s a more slight divergence from the stock’s three-year average P/CF ratio of 9.9.

Meantime, the yield, as noted earlier, is substantially higher than its own recent historical average.

So the stock does look cheap. But how cheap might it be? What would a reasonable estimate of intrinsic value look like? 

I valued shares using a dividend discount model analysis.

I factored in a 10% discount rate.

And I assumed a long-term dividend growth rate of 7%.

I think this is a sensible, if conservative, DGR assumption.

It’s below the company’s proven long-term track record, as well as their long-term EPS growth rate.

The payout ratio is extremely comfortable, and could be easily expanded.

Even the most recent dividend increase was well above this mark.

But the more recent EPS growth forecast for Omnicom Group from CFRA has come down.

And macroeconomic factors, as well as broader industry questions, linger.

In the end, I think the company is in a good position to deliver long-term dividend growth at a higher rate than my assumption, but I’d rather err on the side of caution.

The DDM analysis gives me a fair value of $92.73.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide.

The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.

It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today.

I find it to be a fairly accurate way to value dividend growth stocks.

I don’t think my valuation model was aggressive, yet the stock still looks very cheap here.

But we’ll now compare that valuation with where two professional stock analysis firms have come out at.

This adds balance, depth, and perspective to our conclusion.

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system.

1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.

Morningstar rates OMC as a 4-star stock, with a fair value estimate of $85.00.

CFRA is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line.

They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

CFRA rates OMC as a 4-star “BUY”, with a 12-month target price of $85.00.

I came in slightly high, but we all agree that the stock looks to be worth more than its current price. Averaging out the three numbers gives us a final valuation of $87.58, which would indicate the stock is possibly 16% undervalued.

Bottom line: Omnicom Group Inc. (OMC) is a high-quality company. They have great fundamentals across the board. The company’s diversification, depth, and breadth in terms of their geographic exposure, business lines, industry mix, and client base is fantastic. With a ~3.5% yield, 10 consecutive years of dividend raises, a low payout ratio, and the potential for 16% upside, dividend growth investors would be wise to consider this stock for their next long-term investment.

-Jason Fieber

Note from DTA: How safe is OMC’s dividend? We ran the stock through Simply Safe Dividends, and as we go to press, its Dividend Safety Score is 86. Dividend Safety Scores range from 0 to 100. A score of 50 is average, 75 or higher is excellent, and 25 or lower is weak. With this in mind, OMC’s dividend appears Very Safe with an extremely unlikely risk of being cut. Learn more about Dividend Safety Scores here.

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