DBOEY - Deutsche Börse AG: Earnings Are Strong But CEO Search Brings Uncertainty

2023-10-05 17:15:22 ET

Summary

• Deutsche Börse AG's earnings are growing and the company's Securities Services business' EBITDA benefited from higher interest rates in Q2 2023.
• Deutsche Börse AG will have a new CEO after Theodor Weimer retires at the end of next year.
• A new CEO will bring uncertainty in future M&A decisions, which has been pretty successful and a 4% CAGR addition for the company's secular growth since 2019.
• Deutsche Börse AG has EPS growth potential, given it can continue to make potential value-adding acquisitions in tangential areas to its core Trading & Clearing business.
• If demand for the core Trading & Clearing business remains strong, the company's forward P/E valuation of under 16 is attractive, and the stock has an upside once macro conditions normalize.

Deutsche Börse AG ( DBOEY ) is a leading European financial exchange and financial services company.

The company has four business segments.

In terms of Q1 2023, 49% of Deutsche Börse AG's revenue came from Trading & Clearing, 29% came from Securities Services, 13% came from Data & Analytics, and 7% came from Fund Services.

For the Trading & Clearing segment, Deutsche Börse AG has a leading derivatives exchange for European benchmark products, and also the largest global power trading platform in addition to a leading Germany equity market platform.

In Q1, around 60% of the net revenue of €1.2bn was recurring, which is generally viewed as more stable.

Growing Revenue and Profits Per Share

Deutsche Börse AG is growing.

From 2019 to FY/22, management estimates that secular trends helped the company's revenue grow at a 6% CAGR and acquisitions helped the company grow at an additional 4% CAGR.

Previously, management had a compass 2023 mid-term plan of 10% CAGR net revenue growth, 10% CAGR EBITDA growth, and 10% CAGR cash EPS growth.

Given the secular growth and stronger than expected cyclical growth, management achieved the compass 2023 plan one year earlier than planned.

From 2019 to 2022, Deutsche Börse AG actually achieved a net revenue CAGR of 14% and a cash EPS CAGR of 15% versus the 10% target.

In terms of future outlook for growth, management has a ' Horizon 2026 ' plan that the company will give more details on during its investor day on November 7.

Given the quality of its businesses and its growth, Deutsche Börse AG's profits have grown over time.

Basic earnings per share was €4.46 in 2018, €5.47 in 2019, €5.89 in 2020, €6.59 in 2021, and €8.14 in 2022.

Given Deutsche Börse AG ((DBOEY)) is an ADR, the EPS for the ADR is a fraction of the basic earnings per share mentioned in the annual report of 2022.

Specifically, the market capitalization and the price of Deutsche Börse AG ((DBOEY)) as an ADR implies that the ADR is one tenth of the basic earnings per share or around that mentioned in the annual report of 2022.

With the profit growth, Deutsche Börse AG's dividends have grown.

Dividend per share has increased from €2.70 in 2018 to €2.90 in 2019, €3.00 in 2020, €3.20 in 2021, and €3.60 in 2022.

Again because, Deutsche Börse AG ((DBOEY)) is an ADR, the dividend of the ADR is also around a tenth of the dividend per share mentioned in the annual report for 2022.

In terms of dividend payments, Deutsche Börse AG has a policy of generally returning 40% to 60% of net profits back to shareholders through dividends.

Rather than buy back stock, the company uses the rest of the net profits to make acquisitions.

Acquisitions Have Helped Growth

Since Theodor Weimer became CEO in 2018, management has had a pretty good track record on acquisitions, many of which have helped complement the company's existing businesses.

In terms of purchases, Deutsche Börse AG bought Axioma in 2019, and ISS institutional shareholder service in 2021. Deutsche Börse AG has agreed to also buy SimCorp, which has a leading SaaS investment management platform and ecosystem, in a deal that hasn't closed just yet.

In terms of their size, the acquisitions haven't been too big which doesn't produce as much risk if it doesn't work out and Deutsche Börse AG has smartly financed its acquisitions.

In terms of the balance sheet, the company has a target of having less than 1.75x net debt to EBITDA and management has generally met those targets, with net debt to EBITDA ratio of 1 in 2019 and 2020, 2 in 2021, and 1.2 in 2022.

Not counting the SimCorp purchase, which hasn't closed, Deutsche Börse AG has made over €4.2bn in M&A since 2019, where the acquisitions contribute around 15% of net revenue and the average EBITDA of the acquired assets in 2022 YTD were over 35%.

The acquisitions have helped Deutsche Börse AG diversify by helping increase the company's Data & Analytics net revenue share from 5% in 2019 to 15% as of May 2023, for instance. Recurring net revenue has increased from 51% to around 60% as of May 2023 in part due to acquisitions.

For the future, management thinks there is potential for even more value creating acquisitions.

Compared to other purchases in recent years, SimCorp is a bigger purchase at 3.9 billion euros if the deal closes.

Given management anticipates EBITDA of over €2.6–2.8 billion for 2023, there is a chance that Deutsche Börse AG will be higher than the 1.75x net debt to EBITDA goal if the SimCorp deal closes depending on how much over the EBITDA is and how much the company pays in dividends.

Nevertheless, management nevertheless smartly hedged €2 billion at a 3% interest rate level for the SimCorp deal.

New CEO in 2025

While it has worked in recent years as acquisitions have contributed around 4% CAGR of secular net revenue growth since 2019 that's relatively high margin, the acquisitions growth strategy could be more uncertain in the medium term.

Deutsche Börse AG's CEO, Theodor Weimer, is turning 65 at the end of next year and he has said in June that he will not pursue another term. The board of Deutsche Börse AG is currently searching for a future replacement CEO but hasn't found one just yet.

Although Theodor Weimer will still remain CEO until the end of next year, there is nevertheless some uncertainty the CEO helps decide which M&A to do.

If the new CEO takes a different approach and makes bigger acquisitions, there could be more uncertainty if the company overpays too much or if the acquisition's growth and margins fail to meet estimates.

Deutsche Börse AG's growth and financial performance will also depend on how the future CEO does.

Since Weimer became CEO in 2018, Deutsche Börse AG's financial performance has been pretty good.

H1 2023 and Q2 2023

Deutsche Börse AG's 2023 first half results have been pretty strong.

In the first half of 2023, Deutsche Börse AG experienced 18% organic net revenue growth, with 6% due to secular revenue growth and 12% due to cyclical reasons.

Organic operating costs rose 10% year over year due to inflation as well as investments in growth projects.

EBITDA increased 18% year over year to €1.505 billion.

In Q2 2023, Deutsche Börse AG's net revenue rose 20% year over year and EBITDA increased 25% year over year to €733.0 million.

Net income attributable to shareholders rose 30% year over year to €443.2 million. Earnings per share also increased 30% year over year.

One reason for the strong Q2 2023 results was that Deutsche Börse AG has benefited from higher interest rates for the quarter.

As result of higher interest rates, the company's Securities Services business' EBITDA increased 112% from €141 million in Q2 2022 to €298 million in Q2 2023.

If interest rates remain around where they are for longer, there's potential for the segment to have substantial net interest income which could yield strong division EBITDA.

Given the strong results in Q2 2023, management believes it will exceed its previous guidance for 2023. The company previously said it expected net revenue of €4.5–4.7 billion and EBITDA of €2.6–2.8 billion for the year.

Now they expect to exceed the upper end of the original guidance range, so they expect net revenue for 2023 to be higher than €4.7 billion and EBITDA to be more than €2.8 billion.

Interest Rates

Right now, higher interest rates have helped Deutsche Börse AG's recent quarterly results.

If they go too high, however, interest rates could cause a lot of problems in terms of economic growth. If there is too much economic uncertainty, valuations of leading financial stocks could decrease and put pressure on Deutsche Börse AG's valuation.

If valuations decrease, the stock price of Deutsche Börse AG could decease as the year 2020 shows. The decrease in stock price is despite the fact that basic earnings per share rose from 2019 to 2020.

Risks

If there are substantial macro problems such as interest rates rising too much, the profits of Deutsche Börse AG could decrease even given the company's high quality businesses.

There is downside if management makes a bad acquisition.

Market demand for Deutsche Börse AG's core Trading & Clearing business could weaken due to various economic factors. The weakening demand could also lead to weakening demand for the company's other tangential businesses.

Improving AI technology could affect trading volumes. If it weakens demand for Deutsche Börse AG's core Trading & Clearing business, it would be a headwind.

Higher Treasury yields could decrease valuations.

If leading financial stock valuations weaken for economic or other market reasons, Deutsche Börse AG's valuation could weaken. Leading financial stock valuations could weaken if economic conditions in the U.S. or Europe weaken or if China's economy, which is already slowing, gets worse.

A weakening Euro would not be good for Deutsche Börse AG ((DBOEY)) which are in U.S. dollars.

Valuation

Deutsche Börse AG is a high quality company given its history of profitability, its substantial competitive advantages, and its history of growth since Theodor Weimer became CEO in 2018.

In Q2 2023, the company had a strong quarter and benefited from higher interest rates, which could be a tailwind if interest rates remain where they are.

In terms of the ADR, Deutsche Börse AG ((DBOEY)), analysts are expecting annual EPS of $1.07 per share for the fiscal period ending December 2023, which gives the stock a forward P/E ratio of under 16.

Despite the EPS growth in recent years, the stock hasn't risen much since 2020 and is actually down from the 2022 highs.

One reason is that the company's forward P/E valuation has decreased as U.S. Treasury rates are considerably higher than several years ago and relatively stable stocks that also pay dividends like Deutsche Börse AG are not as attractive as a result.

There is also more uncertainty as a result of who will replace Theodor Weimer as CEO at the end of next year as it could affect future M&A decisions and growth.

In the near term, the investor day on November 7 will be important as management will talk about the company's 'Horizon 2026' new strategy and mid-term guidance.

Given the macro uncertainties and where U.S. Treasury rates are, the forward P/E multiple of under 16 seems fair.

Long term, if the board finds a good CEO and Deutsche Börse AG's Trading & Clearing business continues to do well and grows, the company will likely be able to continue to find new M&A opportunities in tangential sectors that add value. If that happens, Deutsche Börse AG increasing its EPS by 20% in two years is feasible, and an upside of 20% in two years is realistic assuming the same forward P/E valuation.

While Deutsche Börse AG has grown cash EPS faster than the previously estimated 10% CAGR from 2019 to 2022, investors can't really count on cyclical growth tailwinds in the long term. There are also downsides in the near term if U.S. Treasury rates put more pressure on valuations or if economic conditions weaken further.

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