DBOEY - Deutsche Börse: An Interesting Growth Play In The European Financial Sector

2023-03-06 21:59:49 ET

Summary

• Deutsche Boerse is a German market infrastructure provider with strong fundamentals and good business diversification.
• Its growth has been quite strong over the past few years and its profitability is also quite good.
• Despite this strong backdrop, its valuation is at a discount compared to its own history and its peers.

Deutsche Börse ( OTCPK:DBOEY ) is an interesting growth play within the European financial sector, due to a combination of strong fundamentals, good growth prospects, and an attractive valuation.

Company Description

Deutsche Boerse Group is a German company operating in the financial sector, being one of the world’s leading market infrastructure providers. It offers investors, financial institutions, and companies’ access to capital markets and related data and services. It currently has a market value of about $34 billion and trades in the U.S. on the over-the-counter market.

Deutsche Boerse is the operator of the German stock market and also has a strong position in the listed derivatives market in Europe. Beyond that, it also offers other services, such as data & analytics, fund, and securities services. Indeed, its business is divided into four main segments, of which Trading & Clearing is the largest one accounting for about half of its revenue.

According to the company, some 60% of its annual revenue have a recurring basis, which is quite impressive considering that its core business is cash equities and derivatives trading, which is obviously highly correlated to capital markets and can be volatile. This shows that the company’s strategy to diversify its business away from trading was successful, both through organic initiatives and acquisitions.

This strategy is not much different from other peers in the exchange industry, which have gradually invested in other segments to diversify their revenue and be less exposed to capital markets, such as Intercontinental Exchange ( ICE ) or the London Stock Exchange Group ( OTCPK:LNSTY ).

This strategy also means that Deutsche Boerse is currently well exposed to several structural growth trends in the financial industry, namely the rising allocation to passive investing and ESG funds, increasing penetration of listed products versus over-the-counter, and outsourcing of back office services (funds and securities). These areas have been its major growth focus in recent years and this strategy is not expected to change much over the next few years, boding well for its growth prospects in the near future.

Deutsche Boerse’s current strategy program ends this year, thus the company is expected to update the financial community about its business prospects in the coming months, having already achieved its financial targets one year ahead than expected showing that the execution of its business strategy performed quite well over the past few years.

Beyond its ‘legacy’ products and offering, Deutsche Boerse has also bought a majority stake in Crypto Finance AG in 2021, integrating into its business an independent company that offers trading, custody, and investment services for digital assets. This shows that Deutsche Boerse is adapting its business profile for innovation and new developments in the financial industry, with crypto being potentially a new growing source for its operations over the long term.

Financial Overview

Regarding its financial performance, as shown previously, the company was able to grow consistently its business over the past few years, both organically and through several small bolt-on acquisitions.

The operating landscape was also helpful, with volumes being relatively high during the past few years, of which the pandemic led to a trading boom and was a boost to structural trends, with its ‘core’ cash and derivatives businesses being volume-sensitive and benefiting greatly from this trading environment.

This explains why the company was able to report higher growth than it was expecting some years ago, reaching a record year in 2022, with net revenue increasing at a compounded annual growth rate of 14% from 2019-22. According to Deutsche Boerse, 10% of this growth was explained by cyclical and structural growth drivers, while M&A was responsible for the remaining 4% of revenue growth, showing that Deutsche Boerse is well exposed to growth trends in the financial industry and does not rely that much on acquisitions to grow its business.

During the past year, higher interest rates and volatility were also a boost to volumes, namely in its derivatives segment with investors using futures and options to hedge risk. This led to higher cyclical growth than what the company was expecting, plus it also led to higher interest income in its securities services segment from rising interest rates.

Indeed, net interest income was a key revenue growth driver in 2022, increasing from just €50 million in 2021, to €260 million over the last year. Net interest income together with higher revenue from collateral management, led to a strong increase in revenue within its securities services segment of 31% YoY to more than €1.1 billion in the year.

While the securities services segment performed quite well, other segments also had a positive operating performance, given that Deutsche Boerse was able to report higher revenue across all its business segments. This is a great achievement during a period that was challenging for the capital markets, showing the strength of its business model.

In 2022 , Deutsche Boerse’s revenue amounted to €4.3 billion, an increase of 24% YoY, while good cost control during an inflationary environment led to practically the same growth rate in its EBITDA and net profit (€1.4 billion in 2022).

The company’s profitability is quite good, given that its EBITDA margin was 58% in the past year, as cost pressure was compensated by higher revenue and the company was able to protect its business margins. This trend is not expected to change much in the coming quarters, as inflationary pressures should lead to higher staff costs and other administrative expenses, which the company expects to offset from higher revenue.

This positive backdrop is reflected in the company’s guidance, expecting to grow its annual revenue to between €4.5-4.7 billion in 2023, and reach an EBITDA between €2.6-2.8 billion. At the bottom of its guidance, its EBITDA margin is close to 58%, showing that its profitability is not expected to change much in the short term.

Regarding its financial position, Deutsche Boerse has a capital-light business model and not surprisingly its financial leverage is acceptable. However, the company has not reported yet its net debt position at the end of 2022, which is expected to report when it publishes its annual report 2022. Therefore, the most recent data is related to June 2022, when its net debt-to-EBITDA ratio was about 1.7x, which I think it is a reasonable level for a company with a recurring business profile and high margins.

This comfortable financial position enables the company to distribute a good part of its annual results to shareholders, even though its dividend policy is somewhat conservative. As shown in the next graph, Deutsche Boerse’s dividend payout ratio has been about 50%, and its proposal related to 2022 earnings is to increase its dividend at a smaller rate than earnings (13% vs. 24%, respectively), which will lead to a dividend payout ratio of 44%.

While this shows that Deutsche Boerse’s dividend is safe, on the other hand is also a sign that management is not likely to aggressively hike its dividend in the future and prefers to increase gradually the annual dividend.

Therefore, Deutsche Boerse’s income appeal is not fantastic, considering that, at its current share price, it trades at a forward dividend yield of 2.2%. While the dividend is safe and the company has strong fundamentals, this yield is quite low compared to other stocks and fixed-income alternatives, and therefore Deutsche Boerse’s investment case is more geared to growth rather than income.

Conclusion

Deutsche Boerse is an interesting company in the European financial sector, due to solid business fundamentals and has reported strong business growth recently. Moreover, it is currently trading at some 18x forward earnings, at a discount to its historical average of 20.5x over the past five years, and also compares favorably to most of its peers that are trading at 20-25x earnings, making it a good growth play right now in the financial sector.

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