CME - If You Like (Special) Dividends You Will Love CME Group

2023-12-08 07:00:00 ET

Summary

• CME Group Inc., a Chicago-based stock exchange operator, has reported strong earnings and its stock price is on an uptrend.
• The company benefits from turmoil and stock market volatility, making it a resilient investment during a recession.
• CME Group pays reliable special dividends and has a high balance sheet rating, which contribute to its attractiveness as an investment option.

This article was coproduced with Leo Nelissen.

This year has been fascinating.

Although it wasn't an easy year for a lot of assets, including bonds, real estate, and dividend stocks, in general, we learned a lot as we went through a banking crisis, a number of rate hikes, the ongoing war in Ukraine, the terrorist attacks on Israel, a nonstop decline in the ISM Manufacturing Index , and so much more.

With all of this in mind, if there's one thing this year has taught me, it's a confirmation of my investing strategy that allowed me to be free of worry - despite (temporary) selloffs in some of my assets.

Although I obviously cannot speak for others, my focus on high-quality stocks has allowed me to remain calm, save money during upswings, and deploy it during selloffs in companies that I believe will withstand anything.

One of these companies is CME Group Inc. ( CME ) , the Chicago-based stock exchange operator.

After a few volatile years, the company is back!

CME reported stellar earnings, its stock price has continued its uptrend, monthly volumes are very strong, and its valuation remains attractive.

Despite the current economic and market challenges, I am confident in my investment in this financial giant.

It boasts one of the highest balance sheet ratings in the world (AA-) and consistently pays a reliable special dividend , which I anticipate will be substantial in the years ahead.

So, without further ado, let's dive into the details!

Betting On Quality

I'm a picky investor.

I'm even pickier when it comes to financial stocks.

While I like a number of banks - especially during steeper selloffs - I mainly buy companies with wide moats, as I believe that banks and most asset managers do not have very beneficial business models.

Banks, for example, tend to sell off violently during recessions, which often ruins the longer-term total return.

Over the past ten years, banks ( KBE ) have returned 63%. Financial stocks ( XLF ) have returned 155%. CME Group has returned 309%.

One major factor of long-term outperformance is downside protection during recessions.

While banks tend to do well during bull markets, steep selloffs during recessions are what ruin the bigger picture.

CME does not have the risks that most banks and financials are dealing with.

One can make the case that CME benefits from turmoil.

Why?

Because CME Group owns some of the biggest exchanges in the United States.

• "CME (Chicago Mercantile Exchange):

CME offers a wide range of futures and options contracts, including interest rate products (e.g., Eurodollar futures and options, Treasury futures), equity index products (e.g., E-mini S&P 500 futures, Nasdaq-100 futures), foreign exchange products (e.g., currency futures), agricultural commodities, and more.

• CBOT (Chicago Board of Trade):

CBOT trades various futures and options contracts, including agricultural products (e.g., corn, soybeans, wheat), interest rate products (e.g., U.S. Treasury futures), and equity index products (e.g., Dow Jones Industrial Average futures).

• NYMEX (New York Mercantile Exchange):

NYMEX specializes in energy and metals products, trading contracts for crude oil, natural gas, heating oil, gasoline, and metals like gold, silver, copper, and other base metals. This includes the WTI crude oil contract.

• COMEX (Commodity Exchange, Inc.):

COMEX focuses on metal products, including contracts for gold, silver, copper, and other base metals."

Although lasting recessions are a net negative for CME, as financial players tend to reduce their activity during a prolonged recession, the average recession is bullish for CME's business, as it tends to increase stock market volatility. The higher the volatility, the more money CME makes.

• The 2008 recession did hurt CME's stock price, as investors sold everything related to the financial sector. However, free cash flow accelerated at an almost unprecedented pace.
• The pandemic caused investors to sell CME stock. Free cash flow, however, accelerated by roughly 50%.
• On top of recession benefits, the company has consistently grown its earnings power during good economic times.

Before we dive into recent developments that benefit shareholders, I wanted to highlight a few ways CME is growing its business.

During the 3Q23 earnings call , the company mentioned the importance of staying at the forefront of industry trends and consistently investing in the development of new products.

One notable innovation is the successful transition from LIBOR to SOFR products. This transition showed CME's ability to navigate and lead during industry-wide changes, providing clients with reliable and efficient solutions.

After all, LIBOR was the world's most important foundation for bond pricing.

Currently, the company consistently sees days with close to 6 million in daily traded SOFR contracts.

Furthermore, CME's focus on cross-margining programs and capital efficiency initiatives demonstrates a dedication to creating innovative solutions that optimize capital usage for market participants.

The company's portfolio margining program, particularly in the Fixed Income Clearing Corporation, has proven to be a valuable tool for participants, unlocking significant capital savings.

Related to that, CME has access to tons of data, as it manages some of the world's leading exchanges.

Hence, as part of its data offerings, CME has announced fee adjustments, indicating a strategic approach to monetizing the data segment of its business.

The company recognizes the importance of data-driven insights in today's financial landscape and actively invests in developing and enhancing data products.

This has always been one of the reasons why I bought CME. I'm very optimistic about long-term service growth.

Great News For Shareholders

Based on everything said so far, CME is firing on all cylinders.

In the third quarter, CME reported robust financial performance with a total revenue of $1.34 billion, marking a 9% increase compared to the same period last year.

Key contributors to this growth were clearing and transaction fees, as well as market data revenue, both experiencing a 9% increase over 3Q22.

With regard to the aforementioned growth initiatives, CME Group invested approximately $13 million in cloud migration during the quarter, aligning with their strategic move towards cloud-based operations.

The adjusted operating margin for the quarter expanded to 66.5%, marking an increase of approximately 240 basis points compared to the same period last year.

Due to strong expense discipline, the company lowered its core expense guidance (excluding license fees) to $1.475 billion, a $15 million decrease from the original guidance.

As a result, the company achieved a net income of $818 million, with adjusted diluted earnings per share of $2.25, representing a 14% increase from the third quarter of the previous year.

Furthermore, the company continues to shine despite lower volatility.

The CBOE VIX has fallen below 14 again, making the current environment one of the least volatile in more than three years.

Despite these issues, CME is doing well, showing that it is able to grow even in an environment of subdued volatility.

In November , the company broke a number of volume records, growing average daily volumes ("ADV") to 28.3 million. That makes November 2023 the best November ever!

In other words, this is great news for shareholders!

CME Group is a company that is committed to rewarding its shareholders through regular and special dividends.

Over the past ten years, CME has paid a special dividend every single year!

CME Group currently pays a quarterly dividend of $1.10 per share.

This translates to an annualized yield of 2.0%.

Technically speaking, this dividend has been hiked by 9.3% per year over the past five years, which is an impressive number.

However, that growth rate is a bit irrelevant, as CME tends to distribute almost every penny of free cash flow by using special dividends.

It has very low capital requirements due to its mature business and ability to innovate without having to incur massive costs.

It also has one of the healthiest balance sheets in the world with an AA- rating, meaning it does not need to focus on debt reduction.

In January, the company paid a $4.50 special dividend. CME usually announces special dividends in December and pays these dividends in January.

Combining this special dividend with its regular dividend would result in an annualized yield of 4.1%.

Odds are that this total yield can be maintained, as the company is expected to generate $3.5 billion in free cash flow this year, followed by a potential surge to $3.6 billion in 2024.

This would imply a 4.4% 2023 free cash flow yield and a 4.6% yield in 2024.

Thanks to this yield, free cash flow outlook, and ability to grow its income on a long-term basis, the company has a yield that competes with that of bank stocks and a growth profile that supports the long-term total return.

Valuation

When it comes to the valuation, I like to focus on operating cash flow. After all, the majority of operating cash flow is used for dividends. That's because the company's CapEx requirements are so low.

Currently, CME trades at a blended 24.3x operating cash flow multiple. The five-year normalized multiple is 26.5x.

This year, OCF is expected to grow by 6.5%, followed by 12% growth in 2024.

When combining a return to a 26.5x multiple and its expected growth rates, the company has the potential to return between 10% and 16% per year through 2025.

Year-to-date, CME is already up more than 30%.

As a long-term investor in CME, I'm adding on corrections to keep this ticker a cornerstone of my dividend growth portfolio.

Takeaway

In a challenging year, my focus on quality stocks, notably CME Group, proved rewarding.

Despite economic uncertainties, CME showed resilience and adaptability, achieving a 9% revenue increase in its latest quarter - despite subdued volatility.

Furthermore, the company's commitment to innovation, successful product transitions, and cost discipline contribute to its long-term potential.

Meanwhile, shareholders benefited from robust financial performance, with CME breaking volume records in November.

With a solid dividend track record and impressive financials, CME Group remains a key asset in my portfolio, offering stability, growth, and a >4.0% annualized yield with consistent free cash flow growth.

Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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