S&P Global Inc. (SPGI) is a high-quality company that has amply rewarded long-term shareholders. Acquiring grossly overvalued shares, however, can result in inferior investment returns even if the company happens to be high-quality. I think SPGI is a richly valued Dividend Aristocrat after reviewing Q1 2021 results and FY2021 guidance.
A Dividend Aristocrat is a member of the S&P 500 Index which has increased its dividend for at least 25 consecutive years; SPGI has distributed a dividend each year since 1937 and has increased its dividend 48 consecutive years.
These are links to my previous SPGI articles:
- March 2018 article - I conclude SPGI's valuation is too high and will wait for a better entry point.
- October 2018 article - SPGI's valuation is reasonable and I initiate a position within one of the 'Side' accounts within the FFJ Portfolio.
- February 2019 article - The valuation is once again too high.
- January 19, 2021 article - I revisit SPGI following the announcement of its intent to acquire IHS Markit (INFO). I disclose the purchase of additional shares through one of the "Core' accounts in the FFJ Portfolio.
This review is on the basis of the April 29, 2021 release of Q1 2021 results.
I encourage investors to learn about SPGI's business and risk factors through the review of Part 1 in the FY2020 10-K.
A high-level overview of the company's history is also available on its website.
IHS Markit (INFO) Acquisition
On November 30, 2020, S&P Global and INFO announce their intent to merge in an all-stock transaction. Terms of the merger agreement value INFO at $44B. The merger intends to bring together two world-class organizations, a unique portfolio of highly complementary assets in attractive markets, and cutting-edge innovation and technology capability to accelerate growth and enhance value creation.
- the merger to be accretive to earnings by the end of the 2nd year after closing with ~$0.48B of annual cost and ~$0.35B of revenue synergies;
- a target Capital Return of at least 85% of Free Cash Flow.
Page 10 of 20 in the Investor Presentation that accompanies the merger announcement indicates SPGI's recurring revenue is 69% while that of INFO is 88%. Following the merger, recurring revenue is forecast at 76%; this subscription or subscription-like recurring revenue services will:
- provide greater stability as SPGI heads into potentially high-growth markets over the next couple of years;
- even out any choppiness that may come from either fiscal policy or the exit from the very low-interest-rate environment.
Management expects $0.48B expense synergies and $0.35B revenue synergies from the merger (page 15 of 20 in the Investor Presentation).
Financial Review - Q1 2021 Results
SPGI now includes the following 3 new expense categories to provide insight into the type of expenses to be incurred related to the pending merger.
- transaction costs relate to completing the merge. This includes legal fees, investment banking fees and filing fees. In Q1 this amounts to $9 million.
- integration costs to operationalize the integration. They include consulting, infrastructure and retention costs. These costs are $40 million in Q1.
- cost to achieve are costs to enable expense and revenue synergies. Such costs include lease terminations, severance, contract exit fees and costs related to product development, marketing and distribution enhancements. There are no merger costs in Q1. These will begin to occur around the closing of the merger.
SPGI has a strong Balance Sheet with ~$4.5B of cash and cash equivalents, ~$4.1B of debt, a $1.5B undrawn revolver and no commercial paper outstanding.
On the Q1 earnings call, management reports momentum and interest in its rating services (new entity ratings and rating evaluation services) is picking up in China. It completed 18 ratings in Q1 versus 22 in FY2020
Non-transaction revenue increased 10% primarily due to growth at CRISIL, fees associated with surveillance as well as elevated new entity ratings and Ratings Evaluation Services activity; CRISIL (a SPGI company) announced the completion of a 100% stake in Greenwich Associates LLC in Q1 2020.
Revenue from Ratings Evaluation Services and new entity ratings each increased ~30% with 217 new entity ratings in Q1 being the highest quarterly total in over two years. Investors seeking yield and a greater appetite for risk is enabling weaker companies to raise debt.
On the Q1 call with analysts, SPGI's President and CEO noted that one of the biggest trends has to do with China. China savers are moving from just investing in real estate to putting money into financial assets, into pension, insurance and savings programs. As foreign investors move into China, the capital markets are becoming much more advanced.
SPGI is not providing FY2021 GAAP guidance because management cannot reliably predict all of the necessary components of GAAP measures around the INFO merger. However, SPGI provides adjusted guidance that excludes:
- anticipated merger expenses;
- the potential revenue and expense impact from consolidating INFO following the merger; and
- amortization of intangibles related to acquisitions.
2021 reported revenue is expected to increase mid-single-digits. Adjusted diluted EPS guidance is now increased by $0.30 to a new range of $12.55 - $12.75.
Free Cash Flow (FCF)
Q1 FCF excluding certain items is $0.718B. This is a ~$0.1B increase from Q1 in the prior fiscal year. Q1 FCF drops to $0.681B when $37 million in INFO merger costs are included; there are no INFO merger costs in Q1 2020.
Free Cash Flow guidance excluding certain items is increased by $0.1B to a new range of $3.4B - $3.5B.
The FY2023 FCF is expected to be more than $5B by 2023 and the target capital return is at least 85% of FCF.
The fact S&P Global Rating is one of four reportable segments of SPGI's operations gives me some comfort the company will do what it takes to have and maintain an investment credit rating. If SPGI were to be non-investment grade, I think many questions would arise as to why a company in the business of rating other entities can not even maintain an investment-grade rating.
SPGI has a leverage range target. Action is taken to restore leverage to within the range once leverage falls outside this range. SPGI's range is 1.75 - 2.25 as a stand-alone entity but after the merger, the range will be 2 - 2.5 times EBITA (Earnings before Interest, Taxes, and Amortization) because INFO has higher leverage than SPGI.
Management will review the combined debt base. If leverage is below the lower end of the new range, it will add additional leverage on the balance sheet to ensure an optimal overall corporate financing structure. If there is excess cash and excess capital going forward, this will present an opportunity to increase returns to shareholders.
On August 8, 2018, Moody's upgraded SPGI's domestic senior unsecured debt from Baa1 to A3 which is the lowest tier within the upper-medium investment-grade group of ratings.
This rating means SPGI has a STRONG capacity to meet its financial commitments. It is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
SPGI's credit risk is acceptable from my perspective.
Dividend and Dividend Yield
SPGI's dividend history on its website only dates back to 1995 but its track record of consecutive years of dividend increases extends well beyond this.
The $0.77 quarterly dividend is a yield of ~0.8% using the current $392.70 share price. Many investors may eliminate SPGI as a potential investment because the dividend yield is so low. This is unfortunate.
Investors would be wise not to focus solely on the dividend return but rather the overall potential return. With most of SPGI's potential return likely to come from capital gains, it is all that much more important to acquire shares when attractively or fairly valued!
The actual shares outstanding at the end of Q1 is 240.9 million.
Diluted shares outstanding declined by 1.7 million shares from the repurchase of shares before SPGI paused the share repurchase programs due to the pending merger. There is no current plan to repurchase shares before the merger closes. Management anticipates the resumption of share repurchases after the merger is completed.
For comparison purposes, SPGI’s 2011 – 2020 diluted weighted average common shares outstanding are 304, 285, 280, 272, 275, 265, 259, 253, 247, and 242 (in millions).
At the time of my March 2018 article, SPGI reported FY2017 diluted EPS of $5.78 and adjusted diluted EPS of $6.89. On the basis of SPGI’s March 2 $189.02 closing stock price, the forward PE was ~22.8 – ~23.2 (projected FY2018 diluted EPS of $8.15 - $8.30). On the basis of projected adjusted diluted EPS of $8.45 - $8.60, the forward adjusted diluted PE was ~22 – ~22.4.
When I wrote my October 26, 2018 article, SPGI forecast full-year diluted EPS of $7.77 - $7.87 and full-year adjusted diluted EPS of $8.50 - $8.60. Using the October 25 $177.17 closing stock price of $177.17, SPGI’s forward diluted PE was ~22.5 - ~22.8 and the forward adjusted diluted PE was ~20.6 - ~20.84.
In my February 14, 2019 article, SPGI reported FY2018 diluted EPS of $7.73. With SPGI trading at ~$195, the diluted PE was ~25.23. SPGI provided FY2019 full-year diluted EPS guidance of $8.50 - $8.70 and full-year adjusted diluted EPS of $8.95 - $9.15. Using the mid-point of the projected ranges the forward diluted PE was ~22.67 and the forward adjusted diluted PE was ~21.55.
SPGI reports $3.12 diluted EPS and $3.39 adjusted diluted EPS in Q1. FY2021 adjusted diluted EPS guidance is now $12.55 - $12.75.
Current FY2021 adjusted diluted EPS guidance from 16 brokers is a mean of $12.60 and a low/high of $11.94 - $12.91. There is a $0.27 variance in Q1 GAAP and non-GAAP results. I expect further quarterly adjustments in the remaining 3 quarters of the current fiscal year. It is reasonable to expect a FY2021 GAAP EPS range of $11.55 - $11.75 ($11.65 mid-point).
SPGI's April 29, 2021 closing share price is $392.70. Using my FY2021 GAAP estimates, the forward diluted PE is ~33.4 - ~34. The forward adjusted diluted PE using management's guidance is ~30.78 - ~31.3.
FY2022 adjusted diluted EPS guidance from 16 brokers is a mean of $13.80 and a low/high of $13.45 - $14.20. With shares trading at $392.70, the FY2022 forward adjusted diluted PE is ~27.7 - ~29.2.
The INFO acquisition is to close in the 2nd half of FY2021. This merger will result in a much different SPGI from prior years but is not expected to be accretive to earnings until the 2nd full year after close. I, therefore, think it is somewhat premature to start valuing SPGI as a combined entity.
SPGI - A Richly Valued Dividend Aristocrat - Final Thoughts
I like SPGI as a long-term investment because I anticipate an expanding market and view the company and Moody's (MCO) as market leaders.
I have invested in SPGI at far superior valuation levels than the current level and my investment is made on the basis of long-term potential capital appreciation. My reluctance to acquire additional shares now is because I think SPGI is a richly valued Dividend Aristocrat. The elevated valuation will make it difficult to generate a decent return. I am, therefore, exercising patience and discipline in the hope that the forward-adjusted PE level retraces to the low 20s.
Stay safe. Stay focused.
I wish you much success on your journey to financial freedom.
Note: Please send any feedback, corrections, or questions to [email protected].
Disclosure: I am long SPGI and MCO.
Disclaimer: I do not know your individual circumstances and do not provide individualized advice or recommendations. I encourage you to make investment decisions by conducting your own research and due diligence. Consult your financial advisor about your specific situation.