BGCP - BGC Partners Could Create An Interesting Entry Point

Summary

• Macro and geo headwinds weigh negatively on the financial sector. Investors should rethink their strategies, at least for financial stocks that are more sensitive to headwinds.
• In the financial services industry, BGC Partners, Inc. should catch traders' attention.
• It shouldn't be too long before the stock price could see another significant weakness implying a sell rating if yields are good.
• For those looking to take a position in anticipation of the next rally, current levels probably do not offer a good chance to make the most of it.

Macroeconomics and Geopolitics Weigh Negatively on the Financial Sector

The financial stocks sector underperformed the market as can be seen from the performance of their respective benchmarks in the chart below, where the Financial Select Sector SPDR ETF ( XLF ) is down 13.64% over the past year, while the SPDR S&P 500 Trust ETF ( SPY ) decreased by 17.73%.

Runaway inflation, recession risk, the aftermath of the war in Ukraine and the COVID-19 infection in China, among others, also weighed on the performance of US-listed financial services companies. These are the same macroeconomic and geopolitical factors that have been creating strong headwinds for months, making investors more aware of the risk involved in investing in US-listed equities across sectors and geographies.

The US Federal Reserve is raising interest rates to counter the rapid rise in the price of goods and services. Therefore, banks, and more generally all financial services companies that benefit from interest rate spreads, should expect rising share prices.

But the benchmark fell instead, albeit through cyclical swings, meaning trader sentiment was more affected by headwinds than the possibility that financial stocks are finally poised to benefit from higher interest rates.

Given the robustness of the factors, this trend is unlikely to leave the markets anytime soon. Investors should rethink their strategies for the financial stocks that seem more sensitive to the headwinds.

In the Capital Markets Sector, BGC Partners, Inc. Is Poised for A Significant Drop

One financial company that appears to be on the verge of a drop in its stock price is BGC Partners, Inc. ( BGCP ).

This stock represents a New York-based capital markets operator that recently appears to be much more sensitive to changes in trader sentiment about the risk of investing in publicly traded stocks than to rising demand for investments in fixed-income securities.

On the back of the US stock market trend, the next price cycle of BGC Partners, Inc. stock could be a downturn and also significant as investors are almost certain to trade based on the information from the minutes of the mid-December 2022 FED meeting.

The FED minutes show a unanimous consensus among policymakers that it is premature to lower the cost of money through rate cuts in 2023.

The Federal Reserve is clear on its interest rate policy, and while some propaganda tries to paint a different story through sophisticated statistics and charts that border on tolerability, investors will do what is normally done in stock markets when interest rates rise.

Investors will not bet on stocks until market valuations are below the intrinsic value of US-listed stocks, calculated as the present value of future cash flows. The discount rate is just an interest rate.

BGC Partners in the Capital Markets Sector

BGC Partners, which operates as a financial broker for those seeking to trade assets across a variety of financial markets, saw equity commissions drop sharply at a rate of 11.6% year-over-year in Q3 2022, leading, among other things, to an annual decline of 12.1% in total quarterly revenue to $416.6 million.

This significant drop in brokerage revenues from equity trading occurred while commissions may have been adjusted for inflation, which, if this is the case, could even indicate a sharp drop in trading volume conducted using BGC Partners' technology.

The company stresses that overall, the drop in sales appears much more severe than if the impact of the US dollar's appreciation against the Euro and other world currencies were to be neutralized.

BGC Partners' update to its revenue and earnings guidance for the final quarter of 2022 indicates that the company expects continued headwinds from the stronger US dollar. The latter is said to have very likely resulted in lower sales when instead sales could very well be at least $14 million above the $415 million median of the previous target range of $390 million to $440 million.

However, for non-US traders, investing in US financial markets is an operation that becomes more expensive if the US currency appreciates against its home currency at any point.

A more expensive transaction due to a stronger US dollar would inevitably affect the volume of trade ordered abroad and thus sales.

Whenever traders walked away from the stock market due to a general increase in risk aversion, the impact on BGC Partners' share price was visible, sometimes with very significant declines.

That's What Higher Risk Aversion Does to BGC Partners’ Shares

Lower equity volumes may not only result in a significant drop in revenue at BGC Partners, but also have an adverse influence on the share price, and the chart below shows the top 3 for 2022.

The first fall in the share price followed the Russian invasion of Ukraine.

The second decline followed the end of the market rally in the summer of 2022, as investors' unwarranted optimism gave way to risk aversion amid reminders from the FED of the need for aggressive monetary tightening to curb runaway inflation.

And the third fall in the share price came after the FED's 50 basis point rate hike last December, as disillusioned investors instead looked to the FED’s board minutes for a hint of a turnaround in the monetary policy.

As for the war in Ukraine, this event led to a disruption in supplies of Russian gas and oil and other commodities to Europe, causing energy and commodity prices to soar to unprecedented levels. This has resulted in investors' attention being diverted entirely from almost everything else in the financial markets to oil and gas commodities and their listed producers.

Energy prices (crude oil and natural gas) ranging from late February 2022 (around the Russian invasion of Ukraine) through the third quarter of 2022 (inclusive) are now well above the average for the last 12 months at the time of this writing. Most likely, this trend corresponded to an increase in the trading volume of energy and commodities on various brokerage platforms. BGC Partners, on the other hand, saw lower energy and commodity volumes in Q3 2022 and therefore failed to attract trading, while traders elsewhere likely continued to bid for gas and oil.

Whether it's a technical glitch or an ineffective publicity campaign, it will certainly be important for the company and its shareholders to get to the bottom of the issue. However, before that happens, potential investors need to be aware that this sub-segment of energy and commodity brokerage revenue may still not perform as expected. It already had a significant impact on revenue.

So far, it's already had a significant impact on revenue.

Year-over-year, energy and commodity brokerage revenue decreased 7.2% to $69 million in the third quarter of 2022 and decreased 10.8% to $66.7 million in the second quarter of 2022.

Referring to equity brokerage revenue, commissions were down 11.6% year-on-year to $48.4 million in the third quarter of 2022 and 4.2% year-on-year to $58.3 million in the second quarter of 2022.

In an environment of rising interest rates, investors generally prefer bonds and fixed-income securities, which offer more competitive yields.

In fact, the company reported some “areas of strength across Rates”, especially, and to a lesser extent, in its other credit and foreign exchange sub-segments. However, none of this was enough to offset strong headwinds from lower trading volumes in both Energy & Commodities and Equities.

Negative Trends in Sales, Earnings and Cash Flow: The Stronger US dollar Is to Blame, But Not Only

Despite the “improvement in the overall macro trading environment” noted by BGC Partners, total brokerage revenue (which accounts for approximately 90-95% of total revenue) for the first three quarters of 2022 was $1.25 billion vs $1.45 billion for the corresponding period in 2021.

The company says revenues could have been much higher had the US dollar not strengthened against the Euro and other world currencies.

But if that's the reason, then it would be wise to consider the possibility that the US dollar could remain strong for several more quarters, as that would explain why economists are now projecting a US trade deficit of $60 billion or more. Or as the following chart from tradingeconomics.com shows , a US trade deficit lower than the projected average over the last 5 years.

A stronger dollar would be strategic as it would exercise greater control over fossil fuel exports and guarantee adequate storage of energy sources in anticipation of increasingly abnormal weather conditions. It would also support some imports, particularly from China, where the economy, which is recovering from devastating COVID-19 lockdowns and restrictions, is the target of US direct investment.

In terms of earnings, the third quarter of 2022 was better than the same period in 2021, mainly due to a decrease in employee benefits. On an adjusted basis and after the application of taxes, diluted earnings per share were $0.16 for the third quarter of 2022 compared to $0.14 for the third quarter of 2021. However, on a fully diluted weighted basis, the average number of common shares outstanding in Q3 2022 was 496,985 compared to 530,432 in Q3 2021.

Additional information on BGC Partners' business includes a negative trend in operating cash flows and free cash flow per share for the trailing 12 months ended September 2022.

The free cash flow per share, the development of which is shown in the chart below, is useful in determining changes in the earnings per share.

The Financial Condition Is Precarious

Furthermore, BGC Partners attributes the decrease in total liquidity available to approximately $511 million as of September 30, 2022, from approximately $595 million as of December 30, 2021, to the execution of share buybacks, debt refunds, dividend payments and employee investments.

BGC Partners pays a quarterly cash dividend of $0.01 per share for a forward dividend yield of 1.06% as of this writing. Following the outbreak of the COVID-19 virus in mid-March 2020, the company cut its quarterly dividend from the previous $0.14. This was likely implemented in a bid to increase balance sheet resilience against headwinds from the pandemic-induced crisis. Since then, no increase has been made.

The company's financial situation appears precarious as BGC Partners' Altman Z score of 0.61 indicates a risk of bankruptcy within a few years, while BGC Partners' weighted average cost of capital of 8.92% vs. BGC Partners' return on invested capital of -0.06% points to value destruction.

The Stock Valuation

Shares of BGC Partners, Inc. traded at $4.01 per unit for a market cap of $1.71 billion.

While over the past 12 months traders have seen the stock fall nearly 13% through swings, current stock prices are also about 11% off the last high of $4.49 on Dec. 9, 2022.

The recent trend doesn't mean the stock is about to bounce back.

It could be that the fourth quarter results, which are expected on February 15, 2023, will be followed by a significant rebound in the share price if the company's projections are supported by facts.

In its Q3 2022 earnings report, the company said it “expects sustained levels of increased secondary market trading volumes in Rates, Credit and Foreign Exchange” for all of 2023.

However, aside from possible rallies following the release of quarterly results, the share price will come under severe pressure from the unfavorable macroeconomic and geopolitical factors described in this analysis.

This headwind will, over time, lead to the formation of very convenient entry points (relative to current levels) that the trader may want to take advantage of and eventually have a greater chance of better capitalizing on any subsequent potential share price rebound.

Based on the following technical indicators, current share price levels do not appear to provide a convenient entry point. BGC Partners, Inc. shares are currently trading above the long-term trend of the 200-day simple moving average line of $3.80 and above the midpoint of $3.895 of the 52-week range of $3 to $4.79.

After the current recovery attempt, the share price should experience another significant weakness due to renewed risk aversion amid rising recession fears in the markets.

Traders should wait for this before buying stocks. Or maybe sell them now, but only if the transaction offers a good return.

Conclusion

BGC Partners, Inc. is seeing lower revenue going forward and the cause is not only due to a stronger dollar and risk aversion, but could also be due to a platform not attracting sufficient trading volume.

The first two factors could continue for some time, while the structural issue requires resources that the company is currently consuming rather than producing.

Borrowing money is not going to be easy now as financing costs are rising and banks are very reluctant to finance companies with uncertain prospects.

Inflation and recession risk are weighing on a significant portion of BGC Partners, Inc.'s business, primarily in the form of increased investor risk aversion.

BGC Partners, Inc.’s stock price development suggests an underlying downtrend that will continue due to headwinds from macro and geopolitical factors. But there will also be ups and downs to capitalize on appropriately.

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