Flow Traders Is A Lifeboat On Sale
Summary
- Flow Traders profits heavily from current volatile markets.
- Investors should expect Flow's best quarterly EPS in 2 years.
- The stock's performance has been moderate YTD.
- Though there are fundamental issues with the stock, there is enough option value in it for me to see 35% upside.
The current market is the most volatile one we have seen in a long time. Last Monday was perhaps the most volatile day since 2008. Flow Traders (FLTDF) just happens to be a company that profits from market volatility. You can find my first article on the company here, which provides important details about its business model. Basically the company makes money from making (ETF) markets and ETF arbitrage strategies by its traders. The YTD stock chart below only lifts a corner of the veil as market volatility is the sole reason of existence of this company.
Flow Traders stock performance YTD. Source: WSJ.com
In my last article, my thesis was that market volatility was the big reason to own Flow Traders at all. If markets stay calm forever, the company would maybe make an EPS of EUR 1 per year every year. That one euro per share doesn’t make the stock an attractive buy in its recent trading range of EUR 20 to 25 per share. The fact is that the stock has not performed well at all over the past year. But it is not just last year: the stock has seen a poor three years. Both the end of 2017 and 2019 saw calm markets and both times it had a profound impact on the stock.
The chart below shows an upturn in February 2018 in which the company disclosed at its Q4 release that it already made more money than in the full year of 2017. The EPS of Q1 2018 was EUR 2.36, but is generally regarded as a one-off because VIX ETFs (VIXY) (SVXY) were a special action arena by themselves in which Flow made a tremendous amount of money. Evidence of this was that NTI or Net Trading Income in Europe was up by about 60% YoY, while US NTI was up by over 1,060%.
Flow Traders stock price chart 3Y. Source: WSJ.com
Meanwhile, the stock, as that chart above shows, is not near its 2019 highs. This shows a mixture of low confidence in the company by investors, and maybe inattention by the market.
The volatility argument is a fundamental part of Flow’s own narrative to the financial markets, by the way.
Source: Flow Traders 2018 Fact Sheet.
While we shouldn’t necessarily expect an EPS of EUR 2.36 for Q1 2020, we can’t rule it out either as earnings volatility is skewed to the upside at Flow Traders due to its peculiar business model and approach to risk management. But we can have a look at 2008, which was – by far – the best year Flow Traders has ever had. To my knowledge, the company never disclosed what it made in that year, but the one datapoint I heard from the company was that traders had a bonus of EUR 400 thousand in that year, on average. This compares to about EUR 200 thousand per FTE in 2018 (73% of EUR 277,900 total compensation per employee according to the 2018 annual report). Non-traders are also entitled to variable remuneration, so I think that the 2018 EPS of EUR 3.46 is (in relative terms) below the 2008 level still. A comparable EPS would be closer to five euros per share in my estimate.
Market volatility
For your convenience, I have gathered some headlines on Monday’s volatility:
- Stocks Fall More Than 7% in Dow’s Worst Day Since 2008 (WSJ)
- Stocks sink most since 2008 as Treasury yields pushed to fresh historic lows (SA)
- Here are the milestones and firsts from the markets’ historically bad day (CNBC)
- Oil prices wrap biggest one-day collapse since 1991 (SA)
- The Vix Hit Its Highest Level Since the Financial Crisis. That’s a Lot of Fear (Barron’s)
- Stocks savaged, Italy on lockdown, prisons in uproar as coronavirus spreads (Reuters)
These are all nice headlines but to get to a guesstimate of what it means to Flow Traders, we should put it into perspective. Let’s start with the VIX index of the last 20 years. What we have seen over the past week or two is a clear spike, but it is not yet at 2008 peak levels, neither on level or duration. The peak VIX close of 2008 was just 80 points, while we were at 54 on Monday’s close (down from 60 in the morning). Though we are not at all beating 2008 levels yet, it is still substantial.
VIX Index over 20 years up to 9 March market close. Source: WSJ.
I have also compiled the data on average index moves of the Euro STOXX 600 and the S&P 500 (SPY) compared to regional NTI of Flow Traders. There is clearly a correlation between the average move of an index in a quarter and the quarterly NTI. This is important information as realized volatility is what really matters as the VIX index is just expected volatility captured in prices of options.
NTI is in EUR million. Average index move is the average daily % mutation either up or down of the respective index. Source: author's own calculations, supported by data sourced from Yahoo Finance and WSJ.com, and Flow Traders IR website.
Look at the table below for some more evidence of the rare volatility bout we are in. The table below shows the NTI of Flow Traders alongside the number of index moves greater than 3% of the STOXX and S&P indices.
NTI is in EUR million. >3% moves is the count of the number of days the respective index closed up or down by at least 3% versus the last trading day. Source: author's own calculations, supported by data sourced from Yahoo Finance and WSJ.com, and Flow Traders IR website.
QTD, the S&P had the highest number of >3% moves since 2011 (that was even before Tuesday’s 5% gain) while the STOXX 600 is at the most volatile point since 2015 according to the same count. Additionally, the number of QTD 3%+ intraday moves is also large for the STOXX, the most since 2011.
I believe that the combination in Q1 of the sudden VIX spike, the high trading volumes, chaos in every market (oil, treasuries, credit spreads, stocks), the strong realized daily swings, and the potential for more over the next weeks mean a great opportunity for Flow Traders to beat market expectations.
A fundamental issue with Flow Traders
The one thing about Flow Traders that bugs me is that it tends to disappoint a bit too often as there is a downward trend in its profitability. The two most important inputs for Flow Traders’ NTI are the ETP volume it trades and the margin it makes on each trade. The underlying ‘margin’ Flow makes on its trading volume differs by region but was just 0.5bps in the Americas in its last quarter.
Source: author’s own calculations.
While the margin correlates with market volatility, the relationship could be stronger and we see the same downward trend over time. It wouldn’t be so bad if we forgot that Flow Traders has grown over time (both in FTE and operating expenses) so the 2019 dots in the figure below should be above the blue ones, not below. This is because NTI is more or less ‘revenue’ and this should increase with headcount and operating expenses. It is understandable if net income remains stable with rising expenses, but revenue has to increase.
The logical explanation behind the green dots is that Flow Traders is facing competition. The competitive environment is also the reason why Flow has been making so much more money in the European market and why it has a much larger market share there than in the US market.
Quarterly NTI margin is on the Y-axis, while the X-axis measures the average VIX level in a quarter. Source: author’s own calculations.
I must admit, however, that the VIX used in the chart above is the volatility measure on the S&P 500, so it isn’t the most accurate benchmark for market volatility in Europe.
The story about the slimming margin shows why the results of the current quarter are important. Periods with similar realized volatility are rare and it is crucial to see how the company performs in this environment and how competitive pressure really tightens margins and eliminate arbitrage opportunities with greater volatility.
My model, which uses margin and trading volume as NTI inputs, estimates earnings per share of about 1 euro in the first quarter of 2020. It is important for the company to prove its business model and the necessity of its high and expanding cost base by achieving a great EPS in Q1. Today, the sell-side consensus stands at EUR 0.61, but I believe this to be a dated estimate as the range is wide. The high-end is closer to 90 cents, which I think is realistic. Anything close to EUR 2 would be a very pleasant surprise in my view. I can’t stress enough that after Flow’s disappointing 2019, this is what they need. It would also boost the interim dividend, which is usually 50% of H1 earnings.
Though it is always welcome to see earnings approach 5% of market cap in a certain quarter, it feels a bit light compared to the long wait for this volatility surge. If the market then returns to its ‘2019 calm’ in Q2, the year will see an EPS of EUR 1.90 or perhaps ten cents more or less. The low volatility of the past couple of years is an issue and Flow Traders will only be a blockbuster if we break from that spiral of low volatility. At the moment, I don’t see that priced into the stock which is why I think that the stock has a lot of embedded option value left.
Final thoughts
Volatility has returned to the markets in a big way and Flow Traders is set to profit from it. The response from investors has been moderately positive but doesn’t reflect anything big. I think that this quarter marks a ‘moment of truth’ for Flow Traders in which it has to show that its strategy and growth initiatives bear fruit and that it can profit substantially from volatile markets.
As in my last article, I still happen to think that an annual EPS of EUR 2 and a P/E of 15 is the right valuation for Flow, making the fundamental value of the stock EUR 30, while it is currently for sale at EUR 22. The upside is moderately attractive at this point, but every day markets remain volatile adds to Flow’s EPS and underlying value. Above all, I see the stock as a relatively cheap lifeboat for the possible implosion of the global economy.
This article was written by
Analyst’s Disclosure: I am/we are long FLOW TRADERS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (18)
I will cover Flow traders next week by doing a regression analysis and trying to predict Q1 earnings with it. At the first look, NTI will probably be somewhere between 150 and 200mln.
2020 6
2019 5
2018 6
2017 1
2016 23
2015 31
2014 12
2013 5
2012 14
2011 31
2010 7If you also take into account 1% moves, 2017 and 2019 were clearly in the bottom 3 years of the decade in terms of volatility. I think that this has imprinted the idea on investors (perhaps not too dissimilar from yourself) that this is a normal environment and these investors are selling the stock based on your logic. If you look back at the early 2000s or '90s, you'll also see that more volatility is usual. I must say that 2015 was unusual and that's why the founders decided to list the company in that year after which is shot up to the EUR 40s. I found the stock overvalued back then, but the case for 22.50 only makes sense if the margin keeps eroding for many years to come. That is, I think, the real bear case.
