Moody's: Momentum In Analytics

Summary

• Moody's has seen a very strong 2021, with real operating momentum displayed.
• The strong growth is compelling, as targeted KYC and ESG acquisitions make perfect sense as well.
• Moody's trades at a huge valuation premium, for good reasons if you ask me.
• Believing shares warrant to trade at a premium to the market, I am patiently waiting for a pullback here, or some longer term stagnation.
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Moody's (NYSE:MCO) has been active on the deal front again in 2021 as strong operational action and share price action has given management more confidence and willingness to pursue more deals.

With shares currently trading at $390 per share, they trade within imminent reach of their highs in the low $400s. This comes as Moody's has delivered on some great operational performance in 2021, as it has pursued some interesting M&A activity, all while leverage is still very much under control.

Back To 2020 - Pre-Pandemic

My last take on Moody's dates back to January 2020 when the company announced a $700 million acquisition of Regulatory DataCorp, a provider of anti-money laundering services, due diligence and KYC procedures. While the company is of high quality, known from its GRID solutions, multiples were demanding as the company was only set to generate $55 million in revenues in 2020, resulting in a 13 times forward sales multiple. Needless to say, the deal was just a bolt-on deal for Moody's which at the time was valued around $50 billion.

Moody's has seen quite a transition in its history. This $10 stock in the year 2000 rose to $70 in 2006 as rating agencies were in great demand. On the backdrop of the economic crisis and housing crisis, shares fell to $20 on the fear of big fines, break-up of the business, or other penalties being levied on the firm.

From that point in time, shares have rallied and kept rallying and actually traded at an all-time high of $250 in January 2020. This came as revenues had already steadily grown to $4.4 billion in 2018, accompanied by sky-high adjusted operating margins around 50%, or even above that. At that point in time, the company was set to generate some $4.8 billion in revenues in 2019 on which it could post adjusted earnings at just over $8 per share, as this worked down to a 32 times multiple.

That was a high multiple, but given the comparable growth posted by this business, the low interest rate environment and search for stable investments, it somewhat made sense. Furthermore, leverage ratios of 2 times were reasonable for the business, with Moody's awarded a $53 billion valuation, equal to 11 times sales.

More Greatness

After an initial pullback on the back of the outbreak of the pandemic in spring 2020, shares have quickly recovered and mostly traded in at $275-$300 range for most of the year. Shares rallied from $300 to $400 between the spring of 2021 and the summer of last year.

In February 2021, the company posted its 2020 results as revenues rose 11% in the pandemic year to $5.4 billion. Note that ahead of the earnings report, the company already announced two bolt-on acquisitions. Adjusted earnings even rose 22% to $10.15 per share, as all of this was quite encouraging while the company guided for 2021 earnings at a midpoint of $10.50 per share. With EBITDA trending at $2.7 billion that year, and net debt standing at just $3.7 billion, leverage ratios are very modest again.

The company has been on fire this year, with first quarter sales up 24%. This triggered a big rally in the share price, as well as led to management hiking the full year guidance. Even as second quarter revenue growth slowed down to 8%, the company hiked the guidance again, now seen at a midpoint of $11.70 per share. With 187 million shares trading at $380 this summer, Moody's supported a $71 billion equity valuation, or close to $75 billion enterprise valuation. This worked down to nearly 14 times sales reported in 2020 and at 32 times earnings seen in 2021.

Over the summer, the company announced a large deal. In August, Moody's announced a deal to buy RMS, a global provider of climate and natural disaster risk modeling and analytics. This was a substantial deal which is valued at $2 billion, set to add $320 million in revenues and $55 million in operating earnings. At just over 6 times sales, the deal looked cheap, yet margins of RMS trail those of Moody's by a huge margin, something which Moody's likely wants to address.

In October, Moody's posted third quarter results, a quarter in which revenue growth accelerated to 13% again. Extrapolating these results to the fourth quarter, I peg pro forma revenues at $6.2 billion, even ahead of the RMS contribution. Moreover, the adjusted earnings per share guidance was hiked to $12.25 per share. Net debt has risen to $5.1 billion post the RMS deal, yet I peg the EBITDA run rate at $3.3 billion here, for just a 1.5 times leverage ratio.

Following the results, the company furthermore announced another bolt-on deal, with the purchase of PassFort Limited and 360kompany AG, two European KYC technology solution providers. This involved two smaller deals, again focusing on the area of compliance which is a key focus point for the business, together with focus on ESG.

Concluding Thoughts

Truth be told, a current share count of 187 million shares works down to a $73 billion valuation at $390 per share. As leverage is very low, at least on a relative basis, and the company has been active on the dealmaking front, I see a roadmap for earnings in 2022 to see modest growth from the $12.25 per share of current earnings power. At current levels, the company trades at 32 times adjusted earnings, while leverage is very much under control and forward multiples should likely fall below 30 times.

Truth is that Moody's undoubtedly deserves a premium valuation in this market, yet with these kinds of multiple, the duration risk is enormous, as the question is how high the premium should be. I furthermore note that the business has seen a few strong quarters already, and I only see appeal at a 25 times earnings multiple, given where interest rates are.

Based on the current earnings power, this translates into a targeted entry level around $310 per share. While this does not seem to be in the works very soon, I note that shares traded at $350 in October of last year, but in the long term, shares of Moody's has seen years of stagnation or even retreats at various times. Given that shares have performed very well in recent years, I am a patient investor waiting for better entry levels here.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.