Trading the Exchanges: CME Group

CME Group (CME) has lost more than half of its market value over the past three months and the stock price has cratered by nearly three-quarters in the past year. As illustrated in the accompanying three-month chart and table of valuation parameters (click to enlarge) for the major U.S.-listed exchanges, CME is extremely oversold and trades at less than two-thirds of book value (0.66) despite its position as the world's largest futures exchange with a major new source of revenue in the form of central counterparty clearing for credit default swaps (CDS) – which represents an estimated $45-$60 trillion market.



I have initiated a long position in CME, around 183 bucks, although there is no way to predict the exact bottom as shares are down more than 40 bucks in the past five days alone. Nasdaq OMX Group (NDAQ) is omitted from the accompanying three-month chart, but posted similar performance to the S&P 500 Index with a loss of 28% in the past quarter while Intercontinental Exchange (ICE) has outperformed both its peer group and the overall market with a 3% loss.

NYSE Euronext (NYX) trades at the deepest value parameters of the group for every category except price/book ratio and has lost over two-thirds of its market value in the past year, resulting in a fat dividend yield of 4.9%. ICE has taken over the top spot in terms of trading at a premium to the group and posted the strongest stock price performance in the past quarter.

With earnings power of $16-$17 per share for 2008 despite an expected decline of 10%-12% in trading volumes (with current valuations discounting a 20%-25% decline in trading volumes), CME has gone from trading at a premium to its peer group to posting the largest stock price decline in the past quarter and year. While NYX has gotten the early jump with SEC approval this past week as a central clearinghouse for CDS trading, the market is large enough for the entire group to benefit.

The Wall Street Journal reported last week that CME is in talks with six dealers to take equity stakes in the company's new CDS platform while it awaits SEC approval to begin trading. Meanwhile, ICE is also awaiting regulatory approvals and has decided to create a separate CDS clearinghouse to avoid the systemic risk of combining CDS with futures trading and to reflect the different collateral and liquidation requirements for each.

For 3Q08, CME posted a 25% decline in interest rate trading volumes, which was offset by an 18% increase in equity products – reflecting credit market turmoil and tremendous volatility in the equity market for the quarter. CME posted average daily volume of 13.2M contracts during 3Q08, generating $665M in clearing and transaction revenue – which represented a 4% increase from the year-ago period despite challenging credit and equity market conditions.

CME posted record quarterly trading volumes for E-mini (stock index futures in smaller sizes for greater liquidity and affordability, allowing individual investors to participate) and FX (foreign exchange currency trading) products and the company's NYMEX acquisition (energy + metals futures products and the ClearPort electronic OTC trading + clearing system) further strengthens its role as the leading innovator for new products and technologies on a global basis despite challenges such as global de-leveraging.

Comments

[Paul Price:]

CME is one of the best values right now in my equity universe database.

I see a 40% - 50% upside just on a change in mood with much more than that posssible over a 12 - 24 month horizon.

2008 Dec 28 08:58 AM

[327038:]

CME has gotten crushed along with all the financials, through no fault of its own.

While all the investment banks have had to write down bad debt, CME has none.

So while CME has, unfortunately, been placed along with the financials like Goldman, Citi, Morgan Stanley, Merrill, B of A, etc - the most important thing to remember is that they have all had to write down lotsa bad debts and loans, but CME has continued to do its job - providing trading and clearing and just continuing to be a cash cow.

With the addition of the clearing of the CDS market, the potential for CME to double or triple is quite obvious.

2008 Dec 28 04:28 PM

[Mosh:]

Sorry to ruin the euphoria of the article but there is a good chance that CME can go down further from here. If we’re entering a deep recession period then markets will be DEAD in 2009 and even further. The big and cheap money is gone for now. Many hedge funds are gone and of course all the investment banks. Who’s exactly going to generate the revenues for CME and other exchanges? Do you remember the anemic volume of 2002 recession? The recession now is far more severe. If things get worse, CME can see $100 and lower. I really don’t see a recession to buy it besides trying to guess where the bottom is. Usually that method doesn’t work that good.

2008 Dec 28 10:43 PM

[Moishe:]

Why didn't I sell at 700 and instead ride it down to where it is now.
The telling tale was when insiders were selling like a bra sale at Feilenes Basement. If I sold now, within hours it would go up $40 a share.
I was way overweight in my portfolio and smacking my forhead everytime I look at where the stock is. Stupid, Stupid, Stupid!!!!!!!!!

2008 Dec 29 10:57 AM

[Marc Michel:]

Just look at the company's web site where they report average daily volume. It is down and continuing down. In a very high margin business which this is, it has a pronounced effect on net margins. So while trailing PE looks cheap, it is a headfake. Also, CME is behind on the CDS clearing house with both NYX and ICE in the lead. Long term, I like CME for its very strong franchise, but would wait to see what base volumes will be. The last few years of hyper commodity trading artificially bloated CME's volumes. That is winding down.

2008 Dec 29 12:07 PM

[327038:]

Moishe said:

>If I sold now, within hours it would go up $40 a share.

How about doing all of the rest of us a favor and SELL!

Please!!!

2008 Dec 29 11:00 PM

[327038:]

Moishe:

How about selling your CME shares now?

That would put us around $240-250 for the year end.

That would at least be some consolation for a miserable year.....

2008 Dec 30 08:55 PM

[chickenlady:]

I believe in the strong leadership of the CME-and would not sell my stock.
Would I have sold my shares at $700.00 had I known what I know now? YES!
CME has been and continues to be an innovator in the financial arena. Stick it out.

Apr 23 06:22 PM