EUXTF - Euronext: Headwinds Now But Expected Synergies In The Future

2023-10-10 15:41:14 ET

Summary

• Euronext's stock is facing headwinds in the near term given a potential recession in the United States could put pressure on valuation. High U.S. Treasury yields have also put stress on valuations.
• For the Borsa Italiana Group's purchase, Euronext expects to achieve cumulated run-rate EBITDA synergies of €115 million by the end of 2024 versus current €44.2m in run-rate EBITDA synergies.
• In Q2 2023, Euronext announced a buyback program of up to €200 million beginning July 31 that could help EPS growth.
• If Euronext's core trading business remains strong, the stock trades for an attractive forward EV/EBITDA multiple of 10.55.

Euronext N.V. ( EUXTF ) is a leading provider of European market infrastructure. As of December 31, 2022, the company is the largest equity listing venue in Europe and attracts the majority of listings from domestic and international companies in Europe.

Euronext has a history of acquisitions such as buying a majority stake in Nord Pool in 2020, a leading power trading infrastructure operating in the Nordic region, and more recently, the purchase of Borsa Italiana Group for €4.444 billion in 2021 to further expand its markets.

As a result of its acquisitions, Euronext operates seven nationally regulated securities and derivatives markets across EU countries such as France and Italy.

While Euronext has expanded its business through M&A in the past, the increase in U.S. Treasury bond yields has made debt more expensive and M&A harder to do. The lack of meaningful positive M&A since the purchase of Borsa Italiana Group closed in the middle of 2021 may not have helped the stock in recent years.

Given various headwinds such as uncertainty in the capital markets and high U.S. Treasury yields, Euronext's share price is over 40% below their highs in late 2020. Nevertheless, the company has growth potential and Euronext is trading at a relatively attractive forward EV/EBITDA multiple of 10.55 , especially if U.S. Treasury yields normalize.

Uncertainty in Capital Markets Given Potential for Recession

One reason for Euronext's stock's decline in recent years is more uncertainty.

In the United States, interest rates have risen substantially in the last year and a half and as a result, there's been more pressure on consumers.

Given inflation hasn't decreased as much as many had hoped, there is a chance that the Federal Reserve might have to leave interest rates at a relatively high level for longer .

If interest rates are high, it's going to be harder for economic growth.

With the high interest rates and other data, the New York Fed is pricing in a 56% probability that the United States will enter into recession by September 2024.

There's also more uncertainty in Europe. Interest rates in major economies across Europe have increased since 2022 and economic conditions in many European countries are not strong.

According to the ECB, the interest rate on the main refinancing operations, which provide the bulk of liquidity to the banking system, was 4.5% as of September 20, 2023, up from 4.25% in August 2023 and 0.5% in July 2022.

Given economic conditions, the ECB lowered its growth forecast in September, trimming the growth projection in the year to 0.7% from the previous 0.9%.

If there is a bad enough recession, the valuation of leading financial stocks could decrease at least temporarily.

While Euronext is a stock with competitive advantages, Euronext's valuation could come under pressure if other capital market quality stocks trade at lower valuations given the macro headwinds.

High Treasury Yields

Another headwind that has faced Euronext stock is that the high U.S. Treasury yields have likely put pressure on dividend stocks whose yields aren't as attractive anymore.

Given the various economic developments over the past year, the 2-year U.S. Treasury yield is 5.08% and the 5-year U.S. Treasury yield is 4.76% as of October 8.

That compares to Euronext's dividend yield of 3.48%.

Furthermore, Euronext's free cash flow yield of 7.64% isn't all that great considering where near-term U.S. Treasury yields are.

Given the circumstances, many investors would likely rather have the safety of short-term U.S. Treasury yields than shares of an exchange company that's only yielding 2% to 3% higher. That's put pressure on Euronext's valuation in my view.

Q2 2023 Growth

Another reason for Euronext's stock not rallying could be weaker numbers for Q2 2023 given the company's abnormally strong 2022 Q2 results .

Versus the same quarter of 2022, Euronext's Q2 2023 hasn't been strong. Like for like at constant currencies, total revenue fell 0.5% compared to last year. Adjusted EBITDA year over year fell 2.1% in terms of like-for-like at constant currencies. Adjusted EPS did not increase or decrease year over year at €1.34.

The main reason for the weaker numbers is that revenue in the company's trading business, which is Euronext's biggest segment, declined 8.5% year over year given a much less volatile environment than in Q2 2022.

Capital market activity such as trading is inherently unpredictable. Volatility can be very strong in some quarters such as Q2 2022, and weaker in other quarters such as Q2 2023, and that can affect Euronext's results.

To management's credit, Euronext has diversified and in Q2 2023, 61% of revenue was non-volume driven which could be less volatile.

Risks

In addition to the headwinds, Euronext's stock faces other risks.

Improving AI technology will affect demand for capital market exchanges and capital market services. If AI technology weakens demand for capital market exchanges, Euronext could face a headwind.

If U.S. Treasury yields increase further, valuations for dividend stocks like Euronext could come under pressure.

If economic conditions weaken sufficiently enough, valuations for leading stocks could weaken and negatively affect Euronext's valuation.

Management could make a bad M&A decision.

If the euro depreciates versus the dollar, Euronext N.V. profits would be worth less in dollar terms.

Potential

While Euronext faces headwinds now, it still has a lot of potential.

In terms of EBITDA, Euronext's Borsa Italiana Group's purchase will likely be a tailwind.

In terms of financials, the purchase of Borsa Italiana Group was originally expected to generate a total of €60 million pre-tax run-rate synergies by year 3 after the deal closed.

In terms of the Borsa Italiana Group's purchase now, management has achieved €44.2m in run-rate EBITDA synergies as of the end of Q2 2023 and management believes it will achieve €70m in cumulated run-rate EBITDA synergies by the end of 2023, and €115 million by end of 2024.

Assuming that happens, Euronext will have €70.8 million in more run-rate EBITDA synergies by the end of 2024, and that would help the company get closer to a leverage level where management could do more M&A to potentially add to growth. By comparison, Euronext had a 2022 adjusted EBITDA of €861.6 million .

While it had a net debt to EBITDA of 3.2x post-acquisition of Borsa Italiana Group around the middle of 2021, Euronext had a net debt to adjusted EBITDA of 2.4x at the end of 2022 and a 2.2x net debt to adjusted EBITDA in Q2 2023.

Another positive is Euronext announced a buyback program of up to €200 million for a period of 12 months beginning July 31, 2023. That's 3% of the company's shares outstanding.

Assuming all else is the same, I think Euronext can grow EPS by 10%-15% by the end of 2024 just through the expected additional realized Borsa Italiana Group synergies, the benefit of the float shrinkage from the stock buyback program, and the additional organic growth from the technology solutions and advanced data services business.

If U.S. Treasury yield conditions normalize, Euronext's valuation could rebound as well, offering more upside. Currently, the company trades for a forward EV/EBITDA multiple of 10.55 which would be more attractive if U.S. Treasury yields were lower.

Euronext has become what it is through M&A. As such, I think it is likely the company will make more acquisitions in the future. While high U.S. Treasury yields make acquisitions difficult, there might be more opportunity if economic conditions normalize or begin to normalize in a few years.

To be fair, the various market headwinds such as interest rates and government bond yields are pretty strong now, so I would be 'equal weight' on the stock in a diversified portfolio even though I think there is at least 10%-15% upside in a few more years.

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