Wednesday morning the company announced earnings and it has given the stock quite a boost [Ed: MCO dropped on Friday]. While the news out of the company wasn’t particularly spectacular, it appears investors were mostly relieved that the news wasn’t any worse. The company actually beat estimates coming in with earnings of $0.76 on revenue of $641m. The figures are up 31% and 26% respectively from last year and show that for the time being, the company has had plenty of business as it rates newly issued securities and continues to sell its research.
A red flag was raised when the company re-affirmed guidance for the entire year saying revenue and EPS would still be at the low end of the previously given range despite weakness in Residential Mortgage Backed Securities [RMBS]. If you look at this information critically, you will realize that beating numbers for the first half, and remaining flat on your full year guidance means you expect a slowdown in the second half. This isn’t exactly a news flash as it is widely known that financial ratings will be difficult, but it appears to be a little more serious than the company lets on in its public statements.
An analyst had a pertinent question about contagion during the conference call. Contagion is when markets become more correlated than previously thought and usually describes the idea of a worldwide recession where diversification in many markets becomes less effective as all markets are hit. Management noted that some contagion was possible but not to the extent many were speculating, and the company remains confident that diversification into many additional international markets will add stability.
A benefit to the stock is the fact that the company repurchased 7.7 million shares last quarter at a price of roughly $65. MCO has $800m still left in its stock re-purchase program and just authorized an additional program of $2 billion. John Neff from William Blair commented that it was interesting to see the company likely borrowing a good bit more to re-purchase stock when they are basically operating from a negative equity balance sheet. If rates continue to be firm or are bumped up to fight inflation, it will likely 1) cause a lower PE in many companies including MCO, 2) reduce the number of new issues thereby reducing MCO’s potential new ratings business, and 3) punish companies with a high debt load (maybe a company who borrowed too much to re-purchase shares?)
So I continue to look at the environment for MCO as challenging. I still have a short position that I hedged before the announcement but I am likely to roll out of the hedge as it has served its purpose. Volatility in this market and in this stock bring opportunity, but as always, make sure you are exercising discipline and risk control.