Moody's: There Are Better Options

Summary

• Moody's is a high-quality business that operates in the attractive credit rating industry.
• However, the company is very exposed to the macro environment and it looks less attractive than peers like S&P Global.
• Its latest earnings results are very weak due to strong impact from macro headwinds.
• The current valuation seems elevated with little potential upside.
• I rate the company as a hold.

FangXiaNuo

Investment Thesis

Moody’s (NYSE:MCO) has been a premium compounder in the past decade, with shares up over 540%. However, the company is currently down 25% from its all-time in 2021 high due to macro headwinds. Despite the drop, I still do not think now is the right time to buy as the volatile economy still presents a huge risk. The company also looks less attractive compared to peers like S&P Global (SPGI), which is more diversified and less exposed to the macro environment. As the share price rebounded in the past few months, the company’s valuation now looks stretched with multiples above peers. I think there is minimal upside potential at current levels therefore I rate Moody’s stock as a hold.

Data by YCharts

Background

Moody’s is one of the leading credit rating firms in the world alongside S&P Global and Fitch. The company operates in two segments, which include Moody’s Investor Services (MIS) and Moody's Analytics (MA). MIS provides ratings for credit while MA offers data, research, and insights for customers.

The credit rating industry is extremely profitable. It is an oligopolistic market with a high entry barrier therefore every company in the industry has a strong moat. The industry also has a long and durable growth runway as debt issuance generally increases with GDP and needs to be refinanced after a certain period. According to Moody’s, $4 trillion of loans and bonds will need to be refinanced between 2022 to 2025. The analytics segment is more generic but still has a TAM (total addressable market) of over $30 billion, according to the company. The market has been expanding as more companies are looking for data and insights that can help them make better decisions.

Why Is Moody's Less Attractive?

Both Moody’s and S&P Global are high-quality businesses within the credit rating industry but I think Moody’s is less attractive at the moment. One notable weakness of the industry is its sensitivity to rates and the economic environment, as they significantly affect the volume of debt issuance. Due to rising rates and elevated inflation, Moody’s issuance volume dropped 31% in 2022 as the credit market remained muted.

This is a major reason why I currently prefer S&P Global over Moody’s. In order to reduce the cyclicality and volatility of its business, S&P Global acquired IHS Markit in 2020 which substantially expanded the size of its analytics segment and diversified the business. The company also has other notable segments such as Indices which help reduce its reliance on ratings. Ratings now only account for roughly 30% of total revenue compared to around 50% in the prior year. Meanwhile, Moody’s still relies heavily on ratings with 50% of revenue generated from the segment.

This leaves Moody’s very exposed to the volatile economy we are seeing currently. For context, S&P Global’s revenue declined by 4% in 2022 while Moody’s revenue declined by 12%. The financial conditions eased during the past few months but it may turn out to be a temporary bounce. Inflation remains a huge concern with the latest CPI (consumer price index) showing a surprising acceleration on a MoM (month over month) basis. The Fed may also need to raise rates higher, which will further contract the economy. This will continue to put strong pressure on Moody’s credit rating segment.

Moody's

Q4 Earnings and Valuation

Moody’s fourth-quarter earnings results continue to feel a significant impact from macro headwinds.

The company reported revenue of $1.29 billion compared to $1.54 billion, down 16% YoY (year over year). This is led by the decline in MIS revenue which was down 34% YoY from $871 million to $576 million. Issuance volume was also down 35% YoY as the credit market remains weak due to inflationary concerns. The decline in MIS was slightly offset by the growth in MA revenue, which was up 7% YoY from $668 million to $714 million. This is driven by increasing needs for visibility, higher pricing, and new product launch.

The bottom line also deteriorated due to the weakness in MIS. Operating income was $306 million compared to $514 million, down 40.5% YoY. This is due to operating expenses only down 4% YoY despite revenue being down 16% YoY. The operating margin also decreased 870 basis points from 33.4% to 24.7%. Adjusted diluted EPS was $2.33 compared to $1.60, down 31.3% YoY. The company guidance for FY23 suggests a mid-to-high-single-digit increase in both revenue and EPS. But this is largely due to much easier comps and macro volatility still presents a huge risk.

Valuation is another reason why I do not prefer Moody’s at the moment. Moody’s and S&P Global have historically traded at nearly identical multiples but the trend has diverged in recent months. As shown in the chart below, Moody’s is currently trading at a PE ratio of 40.52x, which represents a meaningful premium of 17.9% compared to S&P Global’s 34.36x. This isn’t justified in my opinion as the company reported inferior earnings and is also more exposed to macro headwinds. I do not see much upside potential for Moody’s at current levels.

Data by YCharts

Investors Takeaway

I like Moody’s but I do not see much upside potential at current levels. The ongoing volatility in the macro economy should continue to be a meaningful risk to the company, not to mention the high possibility of a recession happening later this year. The significance of the impact is demonstrated in its latest earnings with EPS down over 30% YoY. After the recent rally, its valuation is also above S&P Global, which does not make sense to me. I think shares are fully valued here and I rate the company as a hold.

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.

Comments

[kalu0003]

@felix Fung,
do you mind sharing some of your better options? Thanks

[bluescorpion0]

why does MCO have so much more capex than SPGI?

[Markos Katsanos]

I think the hold rating is too optimistic for MCO because you are probably going to lose a lot of money if you continue to hold MCO at current levels ($301.45).
As you correctly pointed out in your analysis the stock is overvalued and also the chart looks ominous. I see a double top formation (first top in mid-August 2022, second top in the beginning of February 2023) with a target price at $240 (>20% downside) in the near term.
I think a sell or short recommendation would be more appropriate.

[user1416]

Moody's is still a high quality name and their moat (in ratings) is probably better than SPGI. Right now though, you have to accept the cyclical nature if you hold MCO. I added to both names in 2022 but agree that SPGI is a better value and has the better portfolio following the merge with IHS Markit.

[MoneyPig]

You are not alone. SPGI is often recommended over MCO.