Moody’s Valuation Is Now Reasonable

I initiated a Moody's Corporation (MCO) position in October 2018 at ~$142 and disclosed this purchase here. These shares were transferred between investment accounts for tax planning purposes in mid-March 2021 at ~$290. This transfer triggered a capital gain and a new adjusted cost base.

Most recently, I analyzed MCO in this October 30, 2021 post as part of my analysis of Financial Data & Stock Exchanges industry participants. Based on my analysis, I concluded that shares were too richly valued and I would not be adding to my exposure.

In early January 2022, I completed an Investment Holdings Review at which time MCO was my 24th largest holding; it was my 26th largest holding at the time of my mid-April 2021 review and my 25th largest holding in mid-August 2020.

Fast forward to February 11, 2022, however, and MCO valuation is now reasonable. I have, therefore, acquired another 300 shares at ~$336 through one of the 'Core' accounts within the FFJ Portfolio.

Business Overview

Please refer to my October 30, 2021 post.

Financials

MCO's Q4 and FY2021 results and FY2022 guidance were released on February 10, 2022 (Form 8-K and Earnings Presentation).

The following images provide a very high-level overview of MCO's performance in FY2021.

FY2021 is the first year in which MCO surpassed $6B in revenue. It reported a record total revenue of ~$6.2B with ~$3.8B from Moody's Investors Service (MIS) and ~$2.4B from Moody's Analytics (MA) and its adjusted diluted EPS grew 21% from 2020.

The following table reflects the breakdown of MCO's annual revenue.

In comparison to FY2020 and FY2021, MCO's transaction and recurring revenue in prior years are:

• FY2019: 44% and 56%
• FY2018: 44% and 56%
• FY2017: 50% and 50%
• FY2016: 49% and 51%

 

On the FY2021 earnings call with analysts, management indicated that MCO's product enhancements enable it to increase revenue per customer from cross-selling upgrades and pricing opportunities.

Free Cash Flow (FCF)

In FY2012 - FY2021, MCO generated annual FCF (in millions of $) of $0.778, $0.885, $0.944, $1.109, $1.144, $0.664, $1.370, $1.606, $2.043, and $2.619.

FY2022 Guidance

MCO is accelerating the pace at which it is developing a range of new products and solutions. This investment, however, is being balanced with capital returns to shareholders.

In FY2022, MCO intends to return ~$2B to shareholders in the form of dividends and share repurchases.

In response to investor feedback, MCO has replaced its existing long-term targets with new medium-term guidance. The new medium-term guidance calls for at least 10% revenue growth on an average annualized basis and adjusted operating margin in the low 50% range.

Management's guidance calls for MIS's full-year revenue to increase in the low single-digit percent range. The adjusted operating margin forecast is ~62% which is in line with FY2021 and more than a 400 bps improvement since FY2020. This improvement is due to operational efficiency and expense discipline.

Management anticipates MA's revenue will increase in the high teens percent range. This reflects MCO's ongoing focus on expanding its subscription-based products and contribution from recent acquisitions. MA's adjusted operating margin at ~29% includes a 150 - 200 bps headwind from recent acquisitions and foreign exchange movements.

Credit Ratings

There has been no change to MCO's ratings from the time of my last review. The senior unsecured domestic long-term debt ratings assigned by S&P Global and Fitch are:

• S&P Global - BBB+ long-term unsecured debt credit rating with a stable outlook; and
• Fitch - BBB+ long-term unsecured debt credit rating with a stable outlook;

Both ratings are the top tier of the lower medium-grade investment-grade tier. These ratings define MCO as having an ADEQUATE capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to MCO having a weakened capacity to meet its financial commitments.

The Summary of Outstanding Debt and Debt Maturity Profile as of December 31, 2021, reflects a well-balanced maturity schedule.

MCO's credit risk is acceptable from my perspective.

Dividends and Share Repurchases

Dividend and Dividend Yield

MCO's dividend history reflects annual dividend increases starting 2011 following a dividend freeze that was precipitated by challenging business conditions during The Financial Crisis.

In FY2021, MCO returned $0.463B to its stockholders via dividend payments.

On February 7, 2022, the Board declared a regular quarterly dividend of $0.70/share. This represents a ~13% increase from the prior $0.62/share quarterly dividend. The next dividend will be payable on March 18, 2022 to stockholders of record at the close of business on February 25, 2022.

When I reviewed MCO on September 9, 2021, MCO was trading at ~$382 and the $0.62 quarterly dividend yielded ~0.65%.

At the time of my October 30, 2021 post, MCO was trading at ~$404 so the dividend yield was ~0.61%.

Shares are now ~$332.50 and with the quarterly dividend now being $0.70, the dividend yield is ~0.84%.

This low dividend yield is likely to dissuade yield-hungry investors from investing in MCO. MCO, however, is the type of investment where capital gains will likely comprise the vast majority of the total investment return.

Share Repurchases

MCO's Diluted Weighted-Average Shares of Common Stock Outstanding during FY2011 - FY2021 (in millions of shares) is 229, 227, 224, 215, 203, 195, 194, 194, 192, 189, and 188. Outstanding shares as of December 31, 2021, however, totalled 185.6. This is a 1% reduction from December 31, 2020.

As of December 31, 2021, MCO had approximately $1.1B of share repurchase authority remaining.

On February 7, 2022, the Board approved an additional $0.75B of share repurchase authority for a total of ~$1.7B remaining as of February 10, 2022.

MCO has also just announced a $0.5B accelerated share repurchase program expected to be completed in the first half of 2022.

I much prefer share repurchases to dividend increases IF shares are repurchased at attractive valuations. The significant decline in MCO's share price over the past couple of months is ideal considering the magnitude of MCO's intended share repurchases!

Valuation

When I reviewed MCO on September 9, 2021, management's adjusted diluted EPS guidance was $11.55 - $11.85. Using a ~$382 share price and the $11.70 mid-point of guidance the forward adjusted diluted PE was ~32.7. In addition, the following were the FY2021 - FY2023 adjusted diluted EPS analyst estimates:

• FY2021 - 16 brokers - mean of $11.87 and low/high of $11.69 - $12.52. Using the mean estimate, the forward adjusted diluted PE is ~32.2.
• FY2022 - 17 brokers - mean of $12.40 and low/high of $11.54 - $13.50. Using the mean estimate, the forward adjusted diluted PE is ~30.8.
• FY2023 - 12 brokers - mean of $14.01 and low/high of $13.05 - $15.25. Using the mean estimate, the forward adjusted diluted PE is ~27.3.

At the time of my October 30th review, MCO was trading at ~$404 and management had raised FY2021 adjusted diluted EPS guidance to $12.15 - $12.35. Using the broker guidance available at the time, I arrived at the following:

• FY2021 - 17 brokers - mean of $12.04 and low/high of $11.70 - $12.67. Using the mean estimate, the forward adjusted diluted PE is ~33.6.
• FY2022 - 17 brokers - mean of $12.46 and low/high of $11.62 - $13.61. Using the mean estimate, the forward adjusted diluted PE is ~32.4.
• FY2023 - 14 brokers - mean of $14.03 and low/high of $13.04 - $15.72. Using the mean estimate, the forward adjusted diluted PE is ~29.

Shares are now trading at ~$332.50. These are the forward adjusted diluted PE levels using current broker guidance.

• FY2022 - 16 brokers - mean of $12.66 and low/high of $11.87 - $13.60. Using the mean estimate, the forward adjusted diluted PE is ~26.3.
• FY2023 - 14 brokers - mean of $14.11 and low/high of $13.42 - $15.45. Using the mean estimate, the forward adjusted diluted PE is ~23.6.
• FY2024 - 4 brokers - mean of $16.23 and low/high of $14.90 - $17.55. Using the mean estimate, the forward adjusted diluted PE is ~20.5.

Only 4 estimates are currently available for FY2024 so I place little reliance on these numbers.

Final Thoughts

In addition to analyzing MCO in my series of analyses of Financial Data & Stock Exchanges industry participants, I also analyzed S&P Global Inc. (SPGI), MCO's major competitor; these posts are accessible through the Archives.

I viewed the valuation of both companies to be unreasonable and concluded that I would wait for a better valuation. The valuation of both companies has improved since late October so I have added to both positions; I disclosed the purchase of SPGI shares in this February 8, 2022 post.

Looking at MCO's performance relative to SPGI over the past 10 years we see they have performed neck and neck and have generated average annual total returns of ~25%. While this impressive historical performance does not predict future performance, it does, however, demonstrate that attractive future returns are possible. These companies are not like those which have never generated a profit or FCF yet claim that they will 'revolutionize' the world in which we live!

The Rule of 72 is a quick, useful formula that is popularly used to estimate the number of years required to double the invested money at a given annual rate of return.

If we divided 72 by an average annual total return of 25%, then the value of the MCO and SPGI investments should double in under 3 years.

As a company grows, it becomes increasingly difficult to replicate rates of return from when the company was much smaller. Therefore, I think an average annual total return of 25% going forward might be difficult to achieve. If the average annual total returns are lowered to 15%, then investors can expect their investment to double in value within 5 years. I consider this to be acceptable given the moderate level of risk I am assuming by investing in MCO and SPGI.

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 MCO and SPGI.

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.