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I have positions in North America's two largest exchanges: CME Group (CME) and Intercontinental Exchange (ICE).
In my May 6, 2022 post, I disclose the purchase of additional Intercontinental Exchange (ICE) shares.
I last reviewed CME in my February 9, 2022 post. At the time, CME was trading at ~$250. Now, shares at trading at $201.60 and CME's valuation is far more attractive. In this post, I explain why I have acquired another 30 shares @ $204.665 in a 'Core' account within the FFJ Portfolio.
Overview
Although CME was founded in 1898, its origin dates back to 1848.
In a Global Derivatives Market Size, Status and Forecast report published in January 2022, the findings project a $39.17B global derivatives market size by 2027. In contrast, the market size in 2020 was $21.980B. This represents a CAGR of 8.6% during 2021 - 2027.
Even though derivatives might not be a component of your investment strategy, you can still participate in this projected growth. Investment exposure in CME means you are a part owner of the world's leading derivatives marketplace that enables clients to trade futures, options, cash and OTC markets, optimize portfolios and analyze data to efficiently manage risk and capture opportunities.
CME exchanges offer the widest range of global benchmark products across all major asset classes based on interest rates, equity indexes, foreign exchange, energy, agricultural products and metals. It also offers futures and options on futures trading through the CME Globex platform, fixed income trading via BrokerTec and foreign exchange trading on the EBS platform. In addition, it operates one of the world's leading central counterparty clearing providers, CME Clearing.
Financials
Q1 2022 Results
CME's Q1 2022 results are reflected in the Form 10-Q and the accompanying earnings presentation and income statement trends.
In Q1, CME generated an adjusted net income of $0.766B, up 19.5% from Q1 2021, and an adjusted EPS attributable to common shareholders of $2.11.
It generated ~$1.35B in revenue. Adjusting for the impact of the formation of OSTTRA, CME's joint venture (JV) with S&P Global, launched in September of 2021, revenue grew over 13% for the quarter.
In my October 28, 2021 post, I address the OSTTRA JV. When I wrote that post, the JV was with IHS Markit. In my May 5 S&P Global (SPGI) post, I state that SPGI completed the acquisition of IHS Markit at the end of February.
Adjusting for the impact of the formation of OSTTRA, revenue rose by ~$0.158B and adjusted expenses increased by ~$0.022B (Q1 2022 results versus Q1 2021).
CME continues to carefully manage expenses. On an adjusted basis, Q1 expenses were ~$0.425B and ~$0.344B excluding license fees. Capital expenditures were ~$22.5 million.
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, CME incurred ~$6 million of expenses toward its cloud migration to Google. Management now reports good progress in its partnership with Google. CME has completed the discovery phase of its analysis of its applications and has begun to build the technical foundation to move them to the Google Cloud platform; the initial focus will be on moving trading data to the cloud and leveraging Google’s data management capabilities. It will also be looking to move its corporate and clearing systems as part of the first phase of the migration.
Guidance
FY2022 guidance is unchanged from that provided when FY2021 results were released in early February 2022.
- 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, is expected to be ~$0.15B.
- The adjusted effective tax rate is projected at 22.5% - 23.5% versus ~22% in FY2021.
Credit Ratings
In March 2022, CME completed an offering of $0.75B of its 2.65% fixed rate notes due March 2032. The net proceeds together with cash on hand were used to redeem all $0.75B of its 3.00% fixed rate notes due September 2022.
Details of CME's Debt are found in Note 6 (page 16 of 37) in Form 10-Q.
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
- 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
CME's dividend history is accessible here.
CME's dividend policy includes a special annual variable dividend; its declaration is in early December for distribution in mid-January. Many stock screeners exclude this thus understating CME's dividend yield.
In Q1 2022, CME disbursed ~$1.5B in dividends of which ~$1.2B was the special annual variable dividend.
Since the implementation of the special annual variable dividend policy in early 2012, CME has returned ~$18B 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.
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.
CME is now trading at $201.60 and 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.
CME's current valuation is now more reasonable than a few months ago.
Final Thoughts
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 consider CME to be a high-quality company whose shares are currently reasonably valued. Therefore, CME is one of the companies in which I acquired additional shares on May 9.
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.
