S4 takes a tumble as AI capex eats into marketing budgets

Down 17% at 44.5p (£298m) - Third Quarter Trading Update

The market reacted strongly to this update, focusing more on the negative revenue guidance rather than EPS guidance.

S4 is Sir Martin Sorrell's advertising business, founded in 2018 after he left WPP (LON:WPP). He remains the largest shareholder:

Today's Q3 update from S4 doesn't read so badly to me, given that the market was already expecting a hefty revenue decline this year. Key points:

• Q3 net revenue down 6.4% (down 7.3% like-for-like)

• Year-to-date net revenue down 6.2% (down 5.6% like-for-like)

Net debt is £76m, a big reduction year-on-year and "significantly better than anticipated". It is a higher debt load than the company reported for June (£66m).

The guidance is where the disappointment lies:

2026 full year like-for-like net revenue now estimated to be marginally below previous guidance down high-single digits, with operational EBITDA remaining at current analyst consensus level of £85 million and operational EBITDA margin now estimated to increase by at least 160 basis points to 13.7%

Adjusted basic earnings per share is expected to be in excess of current analyst consensus of 6.1p per share

Previous guidance, given in the interim results, was for like-for-like net revenue down "mid-single digits".

Thinking in numbers: we are probably now heading for a 7-9% LfL revenue decline.

This doesn't bode well for Q4 given that year-to-date LfL revenue is down by only 5.6%, up to and including Q3.

Comment from the Executive Chairman:

"Throughout the third quarter, our trading continued to reflect increasingly volatile global macroeconomic conditions, heightened by rising geopolitical risks. Clients remained cautious amid this uncertainty, with hyperscalers and other technology clients continuing to prioritise capital expenditure on expanding AI capacity over operating expenditure.

AI is touching everything - and its heavy capex requirements are even coming at the expense of marketing budgets.

But the news on profits and margins is not so bad. Sir Martin Sorrell also says that the company expects "operational EBITDA remaining at current analyst consensus level of £85 million and operational EBITDA margin now expected to increase by at least 160 basis points to 13.7%."

This is unchanged guidance from the interim results: even a little better than the interim results, when the EBITDA margin was seen increasing by only 140 basis points.

Graham's view

I'm always sympathetic to companies missing on revenues but hitting their earnings targets. The way I see it, companies sometimes have more control over their costs than they have over their revenues, especially in the short-term when macro conditions are unfavourable.

And given that EPS forecasts are technically intact, at least for 2026, I do not even categorise today's update as a profit warning.

But it's also true that the Q4 revenue numbers must be shaping up very poorly, given the new guidance, with the company potentially entering 2027 from a position of weakness.

As for our stance, we were neutral on this in August when Roland took a prudently cautious stance at a market cap of about £260m.

With a market cap of about £300m today, I'm inclined to leave us on neutral today.

Based on the latest share price, I believe the PE ratio is currently 7.3x. Looking ahead to 2027, I'll be curious to see if 2027 forecasts get cut on the back of today's update. The existing EPS forecast suggests that the 2027 PE multiple falls to 6.6x.

As Roland did, I view this as a fair multiple - maybe even a generous one - for a business that is still carrying some debt (£50-80m at year end targeted), is in a state of revenue decline, and has a poor track record of profitability.