CME - CME Group: Money Machine

Summary

• CME Group Inc. balances growing earnings power with flexible and high dividend payoffs.
• CME Group has traditionally been rewarded with high multiples for these great attributes.
• CME Group shares, however, have been lagging a lot, so the appeal is alluring, with appeal rapidly on the increase.

Shares of CME Group Inc. ( CME ) have fallen to their lows, which raises some questions, as the markets at large have seen a move higher as of recent, while the carnage (quite an understatement) in the crypto world actually makes the case for the importance of properly functioning exchanges.

The baseline

CME reported 2021 revenues of $4.7 billion, which was actually down from $4.9 billion in a hyperactive year 2020. Clearing and transaction fees is by far the largest segment of the business, responsible for nearly $3.8 billion in revenues, directly tied to activity levels of trading cleared through CMEs platforms. This was complemented by a smaller $577 million market data and information service, and $348 million other revenue contribution.

Amidst incredible expense control, CME managed to report operating earnings flat at $2.6 billion, for margins far in excess of 50%. Amidst some one-time items the company posted a GAAP profit of a similar number, equal to $7.29 per share as adjusted earnings came in at $6.67 per share, down five cents on the year before.

The balance sheet of nearly $200 billion is quite large due to the nature of the activities, but if we focus on straight-line cash and debt holdings (with other assets and liabilities related to the clearing activities), a very modest net debt load of a half a billion dollars appeared.

Needless to say, investors were willing to attach high valuations to the firm. Shares traded at $225 at the start of the year, after trading for years around the $200 mark, resulting in an $80 billion valuation with 359 million shares outstanding and a 33-34 times earnings multiple being applied to the business.

What Is Going On?

Since the start of the year, shares have been coming down quite a bit as higher interest rates have hurt market levels across many segments, albeit that short activity levels have moved up quite a bit.

Shares traded at $250 in March, but ever since have fallen to $175 per share here, levels already seen in 2018. In fact, CME already was a near-$150 stock back in 2007. The company posted solid first quarter sales, with revenues up more than 7% to $1.35 billion. More impressive was operating leverage with expenses down, allowing earnings per share to rise thirty-five cents to $1.90 per share.

Second quarter sales growth slowed down to 5% as sales came in at $1.24 billion as expense discipline remained, and earnings rose forty cents to $1.82 per share. By the end of October, CME posted third quarter sales growth in excess of $10%, as revenues rose to $1.23 billion amidst higher activity levels.

So far this year, the company has earned $5.64 per share, with adjusted earnings reported at $6.05 per hare, for a run rate of around $8 per share. With shares now down to $175 per share, the 33-times earnings multiple seen at the start of the year has contracted to 22 times earnings amidst lower share price levels and higher earnings power.

A concluding remark

The truth is that the operating performance of CME Group Inc.'s business remains very strong. Over the past decade, the company has grown sales from about $2.8 billion to $4.8 billion, in a rather steady fashion, as margins have been stable and sky-high over this period of time.

The company has a special dividend policy which includes a steadily growing dividend and flexible dividend cash payments to effectively pay out all the generated cash flows, while preserving dividend flexibility if activity levels cool down.

The reality is that strong growth and a strong dividend track record has typically resulted in strong earnings, accompanied by high multiples awarded to the earnings numbers. Hence, I am surprised by the softer share price performance in combination with the stronger earnings power, as CME Group Inc. earnings multiples have fallen a third, from 33 times earnings to 22 times earnings, in less than a year.

That looks a lot more compelling already, yet a current 4.5% earnings yield is still having to compete with risk-free rates. Any further pullback to a 5% earnings yield makes me quite enticed to CME Group Inc. shares given its long-term track record and positioning here.

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