NDAQ - Nasdaq: A Future Dividend Aristocrat

2023-03-23 08:41:33 ET

Summary

• Nasdaq has shifted its focus to areas where it sees more opportunities for future growth.
• Investors could get a nice return on FCF and dividend increases.
• One thing that worries a lot of people is the strong focus on ESG.

Thesis

I think Nasdaq Inc. ( NDAQ ) offers an interesting investment opportunity. They have a long-term view, as they always say in their presentations, and they also want to increase dividend payments, which could be important for future returns. So a good entry price below the current EV / EBIT could offer shareholders a return in the region of 15%+. But even at the current price, they could make a market-beating return.

Analysis

Nasdaq unveiled its new corporate structure to underscore its new strategy. They want to focus on the trends that they believe will drive higher growth in the future. These are ESG, where they want to be the leading platform, anti financial crime and modernizing markets.

As you can see from SAM penetration, they still have room to grow in these markets. In addition, they are also trying to grow their SaaS revenue, which has increased by 13% year on year. The Financial Crime division recorded organic growth of 21% year-on-year, while AUM in the Capital Access platforms declined by 11%.

As the Nasdaq 100 is a tech-heavy index, the interest rate rises have had a real impact on these companies and also on the index itself as people withdraw capital to invest in other assets or indices. It will be interesting to see how this develops and how people react to the FED's decisions. Will they withdraw even more cash or will they start to put capital into the index once the rate hikes are over?

But Nasdaq is still the leading exchange for US IPOS for the tenth year in a row, and they have a long-term vision of where they want to be in a few years' time. And that is very important to shareholders that the company is thinking long term and not just trying to meet analysts' estimates every quarter.

According to the Q4 earnings call , the digital assets business is expected to launch in the first half of 2023. This segment will offer crypto products to combat financial crime, technology for digital asset exchanges and crypto index products. So products where they have expertise and are part of their core competencies.

Full Year 2022 Results

For FY2022, which was quite a challenging year due to the macroeconomic environment, they posted quite good results . Revenues were up 5% YoY and ARR up 8% YoY. As 2022 was the first year that travel restrictions were lifted, costs in this segment were up 68% YoY. This, combined with some other cost increases, led to a decline in operating margins from 51% in Dec 21 to 49% in Dec 22. But if you look at a longer time frame , they have grown net sales by 9% per annum over the last five years and improved margins by 500 basis points over that five-year period.

They are a quality company that has shown in recent years that they can execute well, and that usually comes with a hefty price tag. However, its FCF yield of 4.64% and EV/EBIT of 18.46 are not as expensive as the ratios of some other quality companies.

Nevertheless, you can see that the current EV/EBIT is close to historical highs and the long-term average is lower. Personally, I like a ratio of around 13 as a guideline for building a position.

In this picture we can see where they are spending their free cash flow. They are using it to buy back shares, where they still have $650 million left in the program, but this is just to offset dilution as the share count is stable at ~500 million. They have also increased their dividend at a CAGR of 10% over the last 5 years and have a current payout ratio of 30%, which they plan to increase to 35-38% by 2027. So you could classify Nasdaq as a dividend growth company. Their FCF CAGR is also 12%, which is a good sign.

In general, Nasdaq is a well-managed company, as evidenced by its 5-year average ROE of 15%. In contrast, the 5-year average ROC does not look as good as it is only around 8%. And if we compare gross margins to other exchanges, Nasdaq's 57% is not great either, as some of its competitors have gross margins in the 85% and above range. Interesting comparisons are the London Stock Exchange ( OTCPK:LDNXF ) and Euronext ( OTCPK:EUXTF ), which I have covered in recent days.

However, they have still returned 21% per annum since 01/01/2017 and the S&P 500 has only returned ~12% per annum over the same period.

Reverse DCF

To justify the current share price, EPS would have to grow by 11% per year over 10 years. The historical CAGR for Nasdaq is around 13%. So from our point of view, there is not a lot of undervaluation or overvaluation in the shares. So the shares look fairly valued if you are looking for a 10% annual return over the next few years.

Net debt of 4.9 billion is a little high due to the Verafin acquisition, but the weighted average cost of capital is 2.2% and no long-term debt is due until 2026. Moreover, FCF is strong, so debt should not be a major issue.

Conclusion

Nasdaq is a strong company that has probably shifted its focus to some new businesses because of the regulatory tailwinds that will drive demand. With Puro Earth, they have a marketplace for carbon removal that is part of their long-term strategy. Interestingly, ESG is an important part of their new strategy. In fact, for many people they are doing too much with ESG because there are some people who do not like the whole ESG thing. But they have a long-term strategy in segments where they see the biggest growth opportunities.

Personally, I like the fact that they take a long-term view and are also a candidate for people who like to invest in companies that grow their dividends. However, I would not build a position at the moment because of the low ROC and the better future prospects of some of its competitors. But it is still a good company that has a good chance of outperforming the S&P 500 over the next 5 to 10 years.

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