The Intercontinental Exchange (ICE) reports Wednesday morning, May 1 before the opening bell while the Chicago Mercantile Exchange (CME) reports before the opening bell Thursday morning, May 2nd, 2013.
There is a real horse race going on (and has been) the last decade for the publicly-traded exchanges to amass a diversified product line up for volume growth, to position themselves for the next global bull market if and when it should happen.
The CME bought the New York Mercantile Exchange the middle part of the last decade, while ICE recently acquired the NYX, although equities are not expected to be a big driver of ICE volume.
Here is our preview on the two exchanges, prior to this week's earnings releases:
Street consensus is expecting $1.97 in earnings per share (EPS) on $338 million in revenue for expected year-over-year declines of -5% and -2% respectively.
Estimates have remained stable since the early February '13 report of q4 '12 results, with q1 '13 volume being a little better than expected.
From running the numbers from the 10-K, ICE's total contract volume has grown about 12% the last three years, with 2/3rd's of the contract volume being natural gas and Brent Crude products. Roughly 70% of ICE's total volume the last few years is energy related.
Year-over-year growth rates of ICE rev's op inc, EPS
op inc gro
|3/13 (est)||-5% (est)||-2% (est)|
Source: internal spreadsheet
As the reader can quickly see, ICE's trends are following the slowing growth in the futures markets stemming from a slower global economy, less volatility along with the increased regulation and oversight in the futures business.
For calendar '13, consensus ICE estimates are expecting $8.45 in EPS on $1.46 billion in revenues for expected year-over-year growth of 11% and 7% respectively.
Basically, through 2015, analyst estimate consensus is looking for 11% - 15% EPS growth on 7% - 10% revenue growth for ICE.
In terms of cash flow, at 15(x) price to cash flow ICE isn't cheap, with a 6% free cash flow yield, however, we did note that ICE is currently returning only 5% - 20% of its free cash flow to shareholders. Unless they recently declared one, it looks like ICE doesn't yet have a dividend, and all the capital being returned is done through share repurchases.
The point being that ICE could become more shareholder friendly in terms of capital returned to shareholders, which could be a future catalyst for the stock. However, ICE could continue on its acquisition binge, using that cash flow for acquisitions rather than equity repo's or debt buybacks.
Our internal model values ICE at $168, while Morningstar has an intrinsic value on the exchange of $132, which if you split the difference and compare to current market values, leaves ICE fairly valued in today's market.
Chicago Mercantile Exchange:
When CME reports Thursday morning, May 2nd before the bell, analyst consensus is expecting $0.73 in EPS and $715 million in revenues, for year-over-year declines of 8% and 9% respectively.
CME's largest contract is the Treasury complex (interest rates) and eurodollars, so the next big catalyst for CME is the "great rotation" to stocks from bonds, as has been awaited now for 5 years.
Similar to ICE, CME's current consensus estimates through 2015 reflect a belief by analysts that CME can grow mid teens in EPS on high single digits revenue growth, over the longer term.
CME's cash flow valuation is less attractive than even ICE's trading at 24(x) price to cash flow with a 3% cash flow yield. CME has a nice dividend at 3.3% current yield, and they pay a variable dividend at year-end based on excess free cash flow.
(Interesting that CME pays the dividend and doesn't repurchase stock, while ICE repurchases stock and doesn't pay a dividend.)
Our internal model values CME at $70 per share, while Morningstar puts a fair value on CME of $57, so - again - CME looks fairly valued, albeit at a slightly better discount to fair value than ICE.
We are long CME since we just started modeling ICE, and while ICE's CEO is very highly regarded and ICE is thought to be best-in-class, we remain partial to CME given the broader asset class mix (interest rates, energy, commodities, eurodollars, not to mention the emerging product of credit default swaps (CDS). Perusing ICE's 10-K from 2012, contract volume is heavily concentrated in energy and nat gas product lines. However both exchanges function when volume growth is growing smartly over their respective fixed cost bases, thus driving earnings delta for both exchanges.
The exchanges are still suffering from lackluster capital and commodity markets, as global growth remains subdued and volatility seems to be greatly diminished relative to the middle part of last decade.
In the last few quarters, both ICE and CME have had a keen eye on expenses and have been cost cutting and sustaining the operating margin as much from expense savings as revenue growth.
The investing class has been awaiting the huge asset allocation trade from Treasuries and interest rate sensitive bond asset classes to the equity markets, and we think that is the next major boost for CME, both from the Treasury market as well as the eurodollar market.
Because of regulation and oversight the development of the CDS contract and resultant volume has been slower than expected. That contract could start to bear fruit in terms of volume by the end of 2013.
We'd buy ICE if it cheapened up to a level where we could own at a discount to its intrinsic value.