This CME Group Inc. (CME) stock analysis is the fifth in my series of analyses of Financial Data & Stock Exchanges industry participants. Please access the archives to read previous posts.
I view the Financial Data & Stock Exchanges industry as an attractive industry in which to invest for the long term. I currently have exposure to the following in retirement accounts, for which I do not disclose details, and/or in the FFJ Portfolio:
- S&P Global (SPGI) - guest post at Dividend Power
- Moody's (MCO)
- CME Group (CME) - guest post at Dividend Power
- Intercontinental Exchange (ICE)
In addition to my CME guest post at Dividend Power, I have reviewed CME a few times on this site.
These industry participants will release earnings on the following dates. I intend to review each company shortly following their respective earnings release.
- FactSet Research Systems Inc. (FDS) - released September 28
- Nasdaq, Inc. (NDAQ) - released October 20
- S&P Global Inc. (SPGI) - released October 26
- MSCI Inc. (MSCI) - released October 26
- CME Group Inc. (CME) - released October 27
- Morningstar, Inc. (MORN) - released October 27
- Intercontinental Exchange, Inc. (ICE) - released October 28
- Moody's Corporation (MCO) - released October 28
- CBOE Global Markets, Inc. (CBOE) - October 29
- TMX Group Limited (X.to) - November 8
Value Line, Inc. (VALU) released its Q1 2022 results for the quarter ending July 31 on September 13, 2021. This is a small-cap company ($0.31B market cap). I do not invest in small-cap companies, and therefore, do not intend to review it.
CME Group - Stock Analysis - Industry Overview
Further commentary about the industry and how industry participants are expanding into adjacent lines of business is found in my recent FactSet Research post.
CME Group - Stock Analysis - Business Overview
I am dispensing with a Business Overview since I have covered this in previous posts. I, however, encourage you to read Part 1 of CME's FY2020 10-K in which there is a comprehensive overview of the company's history, business strategy, competitive landscape, risk factors, and more.
OSTTRA Joint Venture with IHS Markit
On September 1, 2021, CME announced the formation of OSTTRA, a 50-50 joint venture with IHS Markit (INFO); SPGI is expected to close the acquisition of INFO in Q1 2022.
OSTTRA is a leading provider of progressive post-trade solutions for the global over-the-counter (OTC) market across interest rates, equities FX and credit asset classes.
Post-trade processing occurs after a trade is complete. The process consists of the buyer and the seller:
- comparing trade details;
- approving the transaction;
- changing records of ownership; and
- arranging for the transfer of securities and cash.
Post-trade processing is especially important in markets that are not standardized, such as the over-the-counter (OTC) markets, where buyers/sellers are exposed to counterparty risk and settlement risk.
CME will no longer be recording revenue and expenses associated with its post-trade businesses but will be recording its share of the joint venture earnings in the equity and net earnings of unconsolidated subsidiaries line of the income statement. For September, CME would have recorded ~$22 million in revenue and ~$11 million in expenses but instead, recorded ~$8 million in its share of the adjusted earnings of the joint venture. Management indicated on the Q3 earnings call that when the tax implications and providing support services for the joint venture are taken into consideration, there was essentially no impact on overall earnings.
CME Group - Stock Analysis - Financials
Q3 and YTD2021 Results
On October 27, 2021, CME released a Form 8-K which reflects Q3 and YTD2021 results. The accompanying earnings commentary is accessible here.
In Q3, CME generated more than $1.1B in revenue with average daily volume up 14% compared to Q3 2020. Q3 operating expenses were ~$0.496B or ~$0.412B on an adjusted basis and $0.355B excluding license fees.
Q3 CAPEX was ~$33 million.
CME’s revenue base is mostly transactional. This can lead to some volatility in quarter-over-quarter results.
Its various interest rate hedging products are a large source of revenue so the low short-term interest rates create a headwind for CME; if interest rates are expected to stay low there is less need for interest rate hedging and less incentive for speculation.
CME benefited from the rise in long-term interest rates at the start of 2021 as this led to increased volatility. Until there is a sustained increase in interest rates that leads to higher volatility, however, it is possible CME's interest rate trading volume could remain below the 2019 level.
On the flip side, CME has benefited from increased retail interest in equity markets. Trading volumes surged in 2020 and elevated volumes persist in 2021 thus benefiting CME's equity index futures business. Although revenue from the equity derivatives business could normalize over time if retail interest in equity markets fades, I envision retail investor interest in equity trading will very likely persist. The advent of $0 commissions, changes in investor behaviour, and the availability of futures on retail brokerage platforms should provide a permanent tailwind to the equity business.
In addition, CME’s energy and agricultural futures trading business should experience steady growth as the global economy recovers from the impacts of COVID-19.
The following schedule reflects CME's long-term debt as of FYE2020.
The $0.75B fixed-rate note due September 2022 is now short-term debt. No other significant debt payments are due until March 2025.
CME expects FY2021 total adjusted operating expenses, excluding license fees, and the impact of the OSTTRA joint venture to come in at ~$1.5B. This is down about $30 million from guidance at the start of FY2021.
In November 2018, CME completed the $5.5B acquisition of acquired NEX Group plc (NEX). By combining with NEX, CME created a leading global markets company that:
- generates significant efficiencies across futures; and
- enables market participants to lower their cost of trading and better manage risk.
It also improved CME's offerings to customers through the complementary combination of CME's exchange-traded derivative products and NEX’s cash and OTC products. In addition, it expanded CME's international footprint and global client base.
When the acquisition was announced, expectations were for NEX to be immediately accretive to adjusted cash EPS; ~$0.2B annual run-rate cost synergies were expected to be achieved by the end of 2021. In Q3 2021, CME reached expected cumulative run-rate synergies of $$0.2B related to the NEX acquisition.
CME Group - Stock Analysis - Credit Ratings
CME's senior unsecured long-term debt is the highest-rated of the stock exchanges analyzed within this series of reviews. For comparison purposes, I provide ratings for CME, ICE, and NDAQ in my Nasdaq, Inc. - Stock Analysis.
- 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 history is accessible here.
In the first 2 quarters of 2021, CME distributed $1.54B of dividends and it distributed more than $0.3B in Q3.
CME's dividend policy is somewhat unique in that it includes the payment of a special dividend. Since the implementation of the variable dividend policy in early 2012, CME has returned ~$16.3B to shareholders in the form of dividends.
This special dividend is typically declared in early December and is distributed in mid-January. Many stock screeners exclude this annual special dividend thus understating CME's dividend yield.
With shares trading at ~$217 and a $0.90 quarterly dividend, most stock screeners likely reflect a ~1.66% dividend yield. On December 10, 2020, however, CME declared a $2.50 special dividend payable on January 13, 2021 to shareholders of record on December 28, 2020. If we aggregate the YTD dividend distributions and the anticipated $0.90 quarterly dividend to be paid at the end of December 2021, the total dividend distributed in 2021 is $6.10 thus giving us a ~2.8% dividend yield.
In the 3 prior fiscal years, CME's EPS, FCF, and special dividend were:
- FY2018 - EPS of $5.71, FCF of $2.324B and a $1.75 special dividend.
- FY2019 - EPS of $5.91, FCF of $2.427B and a $2.50 special dividend.
- FY2020 - EPS of $5.87, FCF of $2.518B and a $2.50 special dividend.
The Q3 Form 8-K does not reflect YTD FCF and the Q3 10-Q is not yet available from which to calculate FCF. In the first 3 quarters of the current fiscal year, however, CME has generated $5.60 of diluted EPS. This is somewhat comparable to full-year EPS results in each of the 3 prior fiscal years. I, therefore, anticipate CME will declare in early December a special dividend above $2.50. I also anticipate the quarterly dividend will be increased from $0.90 to $0.95 starting with the dividend payable in March 2022.
The weighted average number of issued and outstanding shares in FY2011 - FY2020 and the first 9 months of 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.
CME Group - Stock Analysis - Valuation
I wrote a brief May 29, 2021 CME post to determine whether I should write 3 covered call contracts at a $230 strike price and a July 16, 2021 expiry. These contracts expired meaning I retained the underlying shares and 100% of the $1.70/share option premium I collected. When I wrote that post, CME was trading at ~$218 and guidance from the brokers which cover CME was:
- FY2021 - 21 brokers - mean of $6.75 and low/high of $6.18 - $7.55. Using the mean estimate, the forward adjusted diluted PE was ~32.3 and ~28.9 using $7.55.
- FY2022 - 21 brokers - mean of $7.34 and low/high of $6.66 - $8.05. Using the mean estimate, the forward adjusted diluted PE was ~29.7 and ~27.08 using $7.55.
CME is now trading at ~$217 and broker guidance derived from the two online trading platforms I use is:
- 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 and ~31 if I use $7.07.
- 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 and ~27 if I use $8.05.
- 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 and ~23.7 if I use $9.14.
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. YTD2021 it has generated $5.60 in diluted EPS and I envision FY2021 EPS of $7.45 - $7.50. Using my estimates, the forward diluted PE is ~29.
CME Group - Stock Analysis - Final Thoughts
The broad base of CME's asset class exposure and its strong competitive position generally means relatively stable long-term results; the weaker trading volume, driven mostly by CME's interest rate offerings, is likely a temporary factor.
I believe CME should continue to see long-term steady growth in revenue and earnings. It has a dominant position in many of the contracts that trade in its exchange and it is well-diversified across multiple product lines.
Over the long term, CME should benefit from secular growth in the need to hedge commodity, energy, and interest rate exposure. It also has a history of generating incremental growth through the introduction of new futures contracts, like the micro E-mini S&P 500 contract and bitcoin futures, or adjusting the structure of existing products.
I hold CME shares in a 'Core' and a 'Side' account in the FFJ Portfolio. With shares currently richly valued, I do not intend to acquire additional shares at this time.
Stay safe. Stay focused.
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 SPGI, MCO, CME and ICE.
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.