- In September 2016, we recommended going long the misunderstood advertising company Omnicom Group Inc. if certain events took place.
- The historical high correlation between OMC and the S&P500 Index made OMC a sub-optimal, high beta proxy for the SPY despite its above average ROIC & EVA.
- Strategies for improving OMC's relative stock price performance included optimizing its balance sheet (principally via a material stock buyback) and implementation of a number of additional corporate governance reforms.
- The good news is that since the Brexit vote in June of 2016, the OMC stock price performance has decoupled from the S&P500 Index.
- The bad news is that OMC has materially underperformed the S&P500 Index during this ongoing equity bull market. We would continue to avoid OMC until internal or external reforms are implemented.
Background & Recap
For over 15 years, Omnicom Group Inc. (OMC) has been unable to outperform the S&P500 Index (NYSEARCA:SPY), despite having industry-leading ROIC and EVA outcomes. Our Seeking Alpha article recommended a number of steps that OMC's senior management and its Board of Directors could implement to improve the odds of outperforming the market: https://seekingalpha.com/article/4007017-omnicom-group-investors-activists-radar-screens.
Not entirely surprisingly, OMC has not yet implemented these reforms. Which has resulted in an undesirable state of affairs where the OMC stock price performance has finally decoupled from the returns achieved by passively investing in the SPY. Prior to the Brexit vote in June 2016, OMC tended to outperform the SPY during bull markets and underperform during bear markets. Over the course of the entire equity market cycle OMC tended to perform in-line with the SPY. Due to its higher volatility during the equity market cycle, OMC was effectively a high beta version of the SPY.
Since the Brexit vote, OMC has broken its prior historical pattern of outperforming during equity bull markets and has consistently underperformed the SPY.
Figure 1: Relative Nominal Stock Prices: Weekly: July 2016 to November 2017: SPY & OMC
When we advocated for an end to the high correlation between OMC and SPY, this is clearly not what we had in mind.
Figure 2: Change in Log of Stock Prices: Weekly: July 2016 to November 2017: SPY & OMC
While there might appear to a somewhat positive linear correlation between changes in the OMC stock price and changes in the SPY, OMC tended to modestly underperform during up weeks in the SPY and materially underperform during down weeks. The net result of which is that there is a statistically significant relationship between changes in the SPY and the changes in OMC (p-value < 0.01), yet the overall correlation between the two data series is very weak. The adjusted R-squared of the weekly changes in the log of OMC and SPY is less than 10%.
Figure 3: Linear Regression: Weekly: July 2016 to November 2017: SPY & OMC
(Note: we also adjusted our historical, post-Brexit analysis for changes in the GBP/USD exchange rate. This adjustment had no statistically significant nor economically significant impact on the results of the post-Brexit SPY/OMC correlation analysis. The p-value for changes in the GBP/USD exchange rate was 0.5715 and the adjusted R-squared including all three variables was marginally lower at 7.2% versus 8.1% without the Pound. Macroeconomic conditions in the UK may place upward pressure on the British Pound yet, even if that was to transpire, the post-Brexit data suggests that any Pound appreciation against the US dollar will not provide the OMC stock price with a bullish tailwind)
It is too early to tell how OMC will perform during the next SPY bear market but the post-Brexit performance is rather ominous. Without the implementation of either (1) balance sheet optimization, (2) a change of control transaction, and/or (3) significant corporate governance reform, there is currently no reason to expect OMC to outperform during an equity bear market.
We would reiterate our original suggestion to avoid OMC until meaningful reform is implemented by OMC and/or an outside activist.