Contents
CME Group (CME) is a high-quality company. The challenge an investor currently faces by investing in this high-quality company is that will be difficult to generate attractive long-term total investment returns because the valuation is unreasonable. I recommend you invest in CME Group when its valuation improves.
Immediately following my August 5, 2018 post, I initiated a 300 share position within a 'Side' account in the FFJ Portfolio. I subsequently acquired another 300 shares within a 'Core' account in the FFJ Portfolio. Both purchases were at ~$162/share.
In my January 2022 Investment Holdings Review, I disclose that CME was my 17th largest holding. In my mid-April 2021 review, it was also my 17th largest holding and in mid-August 2020 it was my 15th largest holding.
I have reviewed CME in various posts that are accessible through the Archives. The most recent post was on October 28, 2021. Shares were trading at ~$217 and I deemed CME to be overvalued.
CME has released Q4 and FY2021 results on February 9, 2022. I now revisit CME to determine if I should increase my exposure.
Business Overview
Please refer to my October 28, 2021 post.
New Products
CME continues to launch new innovative products, tools, and services to support customer needs.
In early December, CME launched Micro Ether futures and volume surpassed 100,000 contracts within the first two weeks.
Trading in E-minis Russel 2000 Monday and Wednesday weekly options contracts was also recently launched, as the demand for the more short-dated options continues to grow.
CME also recently announced plans to launch a new 20 year U.S. Treasury bond future in early March 2022. This is pending regulatory review.
In FY2021, new products launched since 2010 generated ~$0.5B in revenue. This is a 30% increase from 2020.
In November 2021, CME announced a 10-year strategic partnership deal with Google Cloud. This will allow CME to transform derivative markets to cloud adoption and co-innovation to deliver expanded access, new products and more efficiencies for more market participants. In conjunction with this new strategic partnership, Google has made a $1B equity investment in a new series of non-voting convertible preferred stock of CME.
To better serve its clients, CME is accelerating focus on environmental and sustainability concerns and the emerging risk management needs of its customers. It has created a new environmental products portfolio that aggregates the full range of CME's existing and planned environmental and sustainability-linked products.
Given CME's success in finding and onboarding new global clients, it has invested in new client-facing personnel in Asia to accelerate this growth; CME generated more than $1.1B of revenue from its non-U.S. business.
Financials
Q4 and FY2021 Results
CME's Q4 and FY2021 results are reflected in the Form 8-K and the accompanying earnings presentation.
The earnings presentation references ADV and OI in several areas.
- ADV is the average daily volume.
- OI is open interest. It is the total number of futures contracts held by market participants at the end of the trading day. It is used as an indicator to determine market sentiment and the strength behind price trends.
In terms of customer penetration, every financial asset class saw a record average annual number of large open interest holders in 2021.
In Q4, CME generated more than $1.1B in revenue with average daily volume up 26% compared to Q4 2020. Adjusting for the impact of the creation of OSTTRA, CME's joint venture with IHS Markit that I touched upon in my October 28, 2021 post, revenue would have been up ~11% for the quarter.
The issuance of Class G non-voting shares in November in conjunction with CME's partnership with Google impacted the calculation of EPS attributable to common shares. These Class G non-voting shares have similar rights to common stock except for voting rights. Had the Class G shares been converted to common shares at the date of the issuance, the Q4 adjusted EPS attributable to common shareholders would have been $1.68 instead of $1.66. Management expects the EPS for the Class G non-voting shares and common shareholders to be the same going forward.
At the end of FY2021, CME had $2.95B in cash and marketable securities. If we back out the ~$1.2B special dividend declared in early December for distribution in mid-January, CME still had over ~$1.7B in cash and marketable securities.
CME has a ~$0.75B fixed-rate note due September 2022. The following are the remaining outstanding long-term debt instruments:
- €15.0 million fixed-rate notes due May 2023
- $0.75B fixed-rate notes due March 2025
- $0.5B fixed-rate notes due June 2028
- $0.75B fixed-rate notes due September 2043
- $0.7B million fixed-rate notes due June 2048
I envision CME will have no problem servicing this debt.
The December 31, 2021 Balance Sheet reflects $169.381B in Total Liabilities of which ~$157.950B is a 'Performance Bonds and Guaranty Fund Contributions - Current Liability'. This exact amount is reflected as a Current Asset leaving ~$11.431B in actual liabilities of which ~$5.4B is Net Deferred Income Tax Liabilities.
CME's strong Balance Sheet partially explains why its debt is rated so highly by Moody's and S&P Global (see the Credit Ratings section below).
Guidance
Total adjusted operating expenses excluding license fees are expected to be ~$1.45B.
The investment that is related to the Google partnership and the move to their cloud platform is expected to be $25 - $35 million. A portion of these costs may be capitalized and guidance will be updated as the engineering and migration plans finalize.
CapEx, net of leasehold improvement allowances, are expected to be ~$0.15B.
The adjusted effective tax rate is projected at 22.5% - 23.5% versus ~22% in FY2021.
Credit Ratings
There are no changes to CME's senior unsecured long-term debt ratings from those at the time of my last review.
- Moody's: Aa3 with a stable outlook
- S&P Global: AA- with a stable outlook
Both ratings are the lowest tier of the high-grade category and are investment grade. These ratings define CME as having a VERY STRONG capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree.
CME's credit risk is acceptable for my purposes.
Dividend and Dividend Yield
CME's dividend policy includes a special dividend that is typically declared in early December for distribution in mid-January. Since the implementation of the variable dividend policy in early 2012, CME has returned over $17.5B to shareholders in the form of dividends (~$16.3B at the end of Q3 2021).
CME's dividend history is accessible here. In FY2021, CME declared ~$2.5B in dividends; this includes the annual variable dividend of $1.2B.
Many stock screeners exclude this annual special dividend thus understating CME's dividend yield.
When I wrote my October 28 post, most stock screeners likely reflected a ~1.66% dividend yield; shares were trading at ~$217 and the quarterly dividend was $0.90. This dividend yield was misleading because on December 10, 2020, CME declared a $2.50 special dividend payable on January 13, 2021 to shareholders of record on December 28, 2020. If we aggregate the $2.50 special dividend and 4 quarterly instalments of $0.90, the total dividend distributed in 2021 amounted to $6.10 thus giving us a ~2.8% dividend yield if we use the ~$217 share price.
In my October post, I tried to determine the magnitude of CME's upcoming special dividend and the next quarterly dividend increase. My guess was a special dividend above $2.50 and a $0.05 increase in the quarterly dividend to $0.95.
- On December 9, 2021, CME declared a $3.25 special dividend.
- On February 3, 2022, it declared a $0.10 increase in the quarterly dividend to $1.00. Most stock screeners now reflect a ~1.6% dividend yield based on the current ~$250 share price.
The weighted average number of issued and outstanding shares in FY2011 - FY2021 (in millions) is 334, 332, 334, 336, 338, 339, 340, 344, 358, 359, and 359.
CME has not repurchased shares in recent years. The increase in outstanding shares is related to shares issued under the following:
- CME Group Omnibus Stock Plan
- Director Stock Plan
- Employee Stock Purchase Plan
Details of CME's Capital Stock and Stock-Based Payments commence on page 78 of 110 in the FY2020 10-K.
Valuation
CME's diluted PE in FY2011 - FY2020 is 12.92, 18.77, 27.53, 29.45, 24.22, 26.89, 33.12, 14.20, 35.28, and 30.34.
It generated $7.29 in GAAP diluted EPS in FY2021. With shares trading at ~$250, the diluted PE based on FY2021 results is ~34.3.
When I wrote my October post, CME had generated $5.60 in diluted EPS in the first 3 quarters of FY2021 and I envisioned FY2021 EPS of $7.45 - $7.50. Using the $7.475 mid-point and a ~$217 share price, I estimated a forward diluted PE of ~29.
Using the broker guidance from the two online trading platforms I use, CME's forward adjusted diluted PE levels were:
- FY2021 - 17 brokers - mean of $6.63 and low/high of $6.20 - $7.07. Using the mean estimate, the forward adjusted diluted PE is ~32.7.
- FY2022 - 17 brokers - mean of $7.27 and low/high of $6.54 - $8.05. Using the mean estimate, the forward adjusted diluted PE is ~30.
- FY2023 - 15 brokers - mean of $7.89 and low/high of $6.80 - $9.14. Using the mean estimate, the forward adjusted diluted PE is ~27.5.
I expect revisions to the current broker estimates over the coming days since Q4 and FY2021 results have just been released. For now, however, the valuation levels using the current ~$250 share price and current broker estimates are:
- FY2022 - 19 brokers - mean of $7.34 and low/high of $6.83 - $7.89. Using the mean estimate, the forward adjusted diluted PE is ~34.
- FY2023 - 17 brokers - mean of $7.95 and low/high of $7.50 - $8.91. Using the mean estimate, the forward adjusted diluted PE is ~31.
- FY2024 - 3 brokers - mean of $8.34 and low/high of $7.86 - $8.85. Using the mean estimate, the forward adjusted diluted PE is ~30.
I place no reliance on the FY2024 estimates since only 3 brokers have provided input and so much can happen in 2 years to significantly change these estimates.
Final Thoughts
Over the past 10 years, CME's average annual total investment return is ~18% when dividends are not reinvested and ~21% when they are reinvested. In contrast, the S&P 500 average annual total investment return over the same timeframe is ~14% and ~15%.
I expect CME will generate similar returns over the next 10 years. Even if its average annual total investment return comes up short at 16%, however, the Rule of 72 suggests a CME investment should double in 4.5 years.
I think that holding out for a forward-adjusted diluted PE below 20 will lead to an investor never investing in CME. On the other hand, investors are unlikely to generate attractive returns by acquiring CME shares at the current valuation.
In October 2021, I thought CME was overvalued. Now I think shares are even more overvalued!
If we estimate CME will generate $7.40 in adjusted diluted EPS in FY2022 and use a forward adjusted diluted PE of 28, then a share price below ~$207 is a level at which to consider acquiring shares.
I wish you much success on your journey to financial freedom!
Note: Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long CME.
Disclaimer: I do not know your circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decisions without conducting your research and due diligence. You should also consult your financial advisor about your specific situation.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
