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Some investors rely exclusively on stock screeners to make investment decisions. CME Group, with its unique dividend policy, is a good example of the risk of relying on stock screeners to make investment decisions.
Looking at several different stock screeners in preparation for this post, I see not one that accurately reflects CME's dividend yield! They all reflect a ~2% dividend yield which uses the $1.00 quarterly dividend and the current ~$196 share price.
CME's dividend policy, however, includes a special annual variable dividend. The declaration of this special dividend is in early December for distribution in mid-January. This special dividend fluctuates annually and is set by the Board depending on CME's fiscal year performance.
Every stock screener I have looked at excludes this special dividend. However, don't take my word for it. Use the stock screener of your choice to see the dividend yield. In all likelihood, it is likely ~2% ($4/$196).
Looking at CME's dividend history, a $3.25 special dividend was distributed in mid-January 2022. The total 2022 dividend distribution, therefore, is $7.25; I have no reason to think CME will not distribute its $1 quarterly dividend in September and December. This means the dividend yield is ~3.7% ($7.25/$196).
I am not encouraging you to rush out and invest in CME because of its dividend yield. I raise this matter to draw your attention to the risk of relying on stock screeners. If you use a stock screener to aid in identifying investment opportunities, it should merely be an arrow in your quiver.
I last reviewed CME in my May 10, 2022 post shortly following the release of Q1 2022 results. With the release of Q2 and YTD2022 results on July 27, 2022, I take this opportunity to revisit CME.
Overview
A high-level overview of CME is provided in previous posts that are accessible in the FFJ Archives.
I encourage you, however, to read Part 1 in CME's 2021 Form 10-K if you wish to gain a good understanding of the business.
Financials
Q2 and YTD2022 Results
CME's Q2 2022 results are reflected in the July 27, 2022 Earnings Release, earnings presentation, and income statement trends.
There has been little to no revenue growth in recent years ($4.868B, $4.884B, and $4.69B in FY2019 - FY2021).
The most significant headwind has been the impact of low short-term interest rates on CME's interest rate-related offerings; these are typically its largest source of revenue. When interest rates are expected to stay low there is less need for interest rate hedging and less incentive for speculation. This creates a drag on CME's trading volume. Now that interest rates are rising, this drag should lift thus leading to an improvement in results.
In Q2 CME generated ~$1.24B, up more than 5% versus Q2 2021. This was driven by a 25% increase in futures trading activity.
YTD2022 revenue is just shy of $2.6B putting it on pace for FY2022 revenue above $5B.
CME reported adjusted EPS of $4.08 in the first half of FY2022, making it the best six-month results in CME history.
These strong results were fueled by:
- A 25% YoY increase in trading activity to an average daily volume (ADV) of 23 million contracts per day;
- A 24% YoY increase in interest rates and FX daily volumes;
- Record E-mini NASDAQ 100 options with an ADV that grew 136% YoY;
- E-mini S&P 500 options ADV was the second highest quarterly ADV on record at 1.1 million contracts;
- Total options ADV increased 23% to 3.9 million contracts versus Q2 2021. This was driven in part by 92% growth in equity index options; and
- ADV options activity in metals outside the US that grew 60% YoY;
CME has also benefited from increased retail interest in equity markets post-March 2020. Equity derivative products have witnessed a larger and steady increase leading to impressive results in CME's equity index futures business. If retail interest fades, however, revenue from CME's equity derivatives business should partially normalize.
Tailwinds to CME's business include:
- the rise of $0 commission trades;
- changes in investor behaviour; and
- the availability of futures on retail brokerage platforms.
Furthermore, if global commodity markets remain volatile, we can expect CME's energy and agricultural futures to see continued interest. I expect CME will continue to benefit from secular growth in the need to hedge commodity, energy, and interest rate exposure.
Over the long term, CME should see steadier revenue and earnings growth. It has a dominant position in many of the contracts that trade in its exchange and it is well diversified across multiple product lines.
CME also has a history of generating incremental growth through the introduction of new futures contracts such as the micro E-mini S&P 500 contract and bitcoin futures. The CME Group Product Slate provides access to most of CME's products. This is a searchable and sortable slate that links to product contract specifications and also provides the previous day’s volume and open interest data.
Google Partnership
In my February 9, 2022 post, I touch upon CME's 10-year strategic partnership deal with Google Cloud. This strategic partnership 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.
The issuance of Class G non-voting shares in November in conjunction with CME's partnership with Google impacts the calculation of EPS attributable to common shares. These Class G non-voting shares have similar rights to common stock except for voting rights. Management, however, expects the EPS for the Class G non-voting shares and common shareholders to be the same going forward.
In Q1 and Q2, CME incurred ~$6 million and ~$8 million of cash expenses toward its cloud migration to Google. CME continues to progress with its Google partnership and is tracking to its internal objectives to build the foundation for its move to the cloud.
Guidance
FY2022 guidance, for the most part, is unchanged from that provided when FY2021 results were released in early February 2022.
- Total adjusted operating expenses excluding license fees of ~$1.45B.
- FY2022 cash costs associated with the Google Cloud partnership are expected to be $25M - $30M. A portion of these costs may be capitalized.
- CapEx, net of leasehold improvement allowances, is expected to be ~$0.15B.
- The adjusted effective tax rate projection is 22.5% - 23.5% versus ~22% in FY2021.
- The migration of EBS to CME Globex technology was completed in Q2 2022. Beginning in Q3 2022, CME anticipates a shift of ~$4 - $5 million of quarterly EBS revenues out of Clearing and
transaction fees revenue into ‘Other’ revenue. - In addition to fee waivers in support of the SOFR First for Options initiative, CME expects an additional $3 - $3.5 million/month of Licensing and other fee agreements expense, for the duration of the SOFR First for Options initiative, which has been extended through August 2022.
Credit Ratings
Details of CME's Debt are found in Note 6 (page 16 of 37) in Q1 2022 Form 10-Q; the Q2 2022 Form 10-Q is not yet available.
There are no changes to CME's senior unsecured long-term debt ratings from those at the time of my May 10, 2022 post.
- Moody's: Aa3 with a stable outlook
- S&P Global: AA- with a stable outlook
- Fitch: AA- with a stable outlook
All 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
In Q1 2022, CME disbursed ~$1.5B in dividends of which ~$1.2B was the special annual variable dividend. A further ~$0.4B was disbursed in Q2.
Since the implementation of the special annual variable dividend policy in early 2012, CME has returned ~$18.5B to shareholders in the form of dividends.
CME has not repurchased shares in recent years; 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. The weighted average number of issued and outstanding shares for the first 6 months of FY2022 is still ~359.
Increases in outstanding common shares are 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 77 of 107 in the FY2021 10-K.
Valuation
CME's diluted PE in FY2011 - FY2021 is 12.92, 18.77, 27.53, 29.45, 24.22, 26.89, 33.12, 14.20, 35.28, 30.34, and 33.70.
When I wrote my October 2021 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.
When I reviewed CME on February 9, 2022, it had recently reported $7.29 in FY2021 GAAP diluted EPS. With shares trading at ~$250, the diluted PE based on FY2021 results was ~34.3.
Using the current ~$250 share price and broker estimates, the forward adjusted diluted PE levels were:
- 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.
When I wrote my May 10, 2022 post, CME was trading at $201.60.Using the current broker estimates, the forward adjusted diluted PE levels are:
- FY2022 - 18 brokers - mean of $7.89 and low/high of $7.63 - $8.35. Using the mean estimate, the forward adjusted diluted PE is ~25.6.
- FY2023 - 18 brokers - mean of $8.44 and low/high of $7.84 - $9.33. Using the mean estimate, the forward adjusted diluted PE is ~24.
- FY2024 - 12 brokers - mean of $8.97 and low/high of $7.87 - $9.53. Using the mean estimate, the forward adjusted diluted PE is ~22.5.
On July 27, 2022, I acquired additional shares at $195.135. Using the current broker estimates, the forward adjusted diluted PE levels are:
- FY2022 - 17 brokers - mean of $7.91 and low/high of $7.33 - $8.23. Using the mean estimate, the forward adjusted diluted PE is ~24.7.
- FY2023 - 17 brokers - mean of $8.43 and low/high of $7.87 - $9.21. Using the mean estimate, the forward adjusted diluted PE is ~23.
- FY2024 - 12 brokers - mean of $8.88 and low/high of $8.14 - $9.94. Using the mean estimate, the forward adjusted diluted PE is ~22.
CME's valuation is attractive.
Final Thoughts
As noted earlier, CME's top-line growth has been muted in recent years because of the low-interest rate environment. In the first 2 quarters of FY2022, however, there has been an uptick in revenue.
CME is not a highly capital-intensive business so I anticipate a larger component of its growing revenue to flow to EPS and Free Cash Flow relative to recent years.
CME was my 20th largest holding at the time of my Mid-2022 Investment Holdings Review. In my January 2022 Investment Holdings Review, it 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.
Immediately following my August 5, 2018 post, I initiated a 300 share position on August 7 within a 'Side' account in the FFJ Portfolio. I subsequently acquired another 300 shares on June 29, 2020 within a 'Core' account in the FFJ Portfolio. Both purchases were at ~$162/share.
I like CME's current valuation and outlook and have acquired additional shares at ~$195.315 to increase my exposure in the 'Core' account in the FFJ Portfolio.
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.
