RELX - RELX: Taking A Breather (Rating Downgrade)

2023-09-22 07:12:12 ET

Summary

• RELX's shares aren't cheap based on a comparison of its valuations with historical averages, peers, and its future growth expectations.
• Weakening investor sentiment towards AI plays and a potential rate hike in the later part of 2023 might be de-rating catalysts for the stock.
• I downgrade my rating for RELX to a Hold, considering its key valuation metrics and downside risks.

Elevator Pitch

I have a Hold rating assigned to RELX PLC ( RELX ) [REL:LN] stock.

My opinion is that RELX's shares could take a breather following the stock's outperformance in the recent 12 months. RELX's current valuations are rich, and there could be a de-rating of the company's shares if AI plays fall out of favor and the company gets hit by higher interest costs. As such, I have revised my investment rating for RELX from a Buy earlier to a Hold now.

Shares Have Performed Well In The Past Year

I previously upgraded my rating for RELX from a Hold to a Buy almost a year ago with my prior September 29, 2022 write-up . RELX's shares have gone up by +42.8% (source: Seeking Alpha price data) since then.

In my late-September 2022 article, I noted that RELX's stock price and valuation metrics didn't reflect the company's favorable financial prospects. I was proven to be right, taking into account RELX's most recent interim financial performance.

Revenue for RELX increased by +13.4% YoY to £4,499 million for 1H 2023, while the company's EBIT grew by +19.9% YoY to £1,486 million in the most recent interim period. It is worthy of note that RELX's actual 1H 2023 top line and operating income turned out to be +1.5% and +4.4% (source: S&P Capital IQ ) better than the sell-side analysts' consensus financial projections, respectively.

In the next section, I highlighted how RELX's valuations have re-rated favorably on the back of the company's above-expectations 1H 2023 financial results.

Stock Is Priced For Perfection

RELX's shares have gotten much more expensive based on both historical and peer comparisons after the strong run-up in its stock price since September last year.

As per valuation data obtained from S&P Capital IQ , RELX's current consensus next twelve months' Enterprise Value-to-Revenue, EV/EBITDA, and normalized P/E valuation multiples now are 24%, 16%, and 22% higher than their respective 10-year mean valuation metrics.

Peer Valuation Comparison For RELX

Source: S&P Capital IQ

RELX's key valuation ratios are much higher than the company's listed peers as presented in the peer comparison table above.

The stock's valuations also seem to be pretty rich when one compares its P/E multiple with its earnings growth rate. RELX's Price/Earnings-to-Growth or PEG metric is estimated to be 2.8 times, which is calculated by dividing its forward P/E ratio of 23.9 times by its consensus FY 2022-2026 normalized EPS CAGR of +8.6% (source: S&P Capital IQ ). As a reference, a stock is generally deemed to be fairly valued if its PEG multiple is around 1 times.

Positive Sentiment Towards AI Beneficiaries Won't Last Forever

At the company's 1H 2023 earnings call , a sell-side analyst from Goldman Sachs ( GS ) referred to RELX as "the first company in media to announce a new product incorporating generative AI." The analyst was likely referring to RELX's May 2023 media release that revealed the introduction of "legal generative AI platform" branded as "Lexis+ AI."

It is clear that RELX's status as a generative AI play was also one of the key factors driving its share price appreciation, apart from its better than expected financial performance for 1H 2023.

But there are signs that the generative AI investment theme might be running out of favor with the investment community. A recent September 22, 2023 Bloomberg news article highlighted that there is a "$14 billion outflow from Taiwan stocks" starting in the middle of June this year as "an artificial intelligence frenzy cools."

Also, RELX appeared to be playing down the importance of AI as the most significant long-term growth driver for the company. RELX emphasized at its most recent interim earnings briefing that "generative AI is just one of those technologies" supporting the "gradual improvement in our long-term growth trajectory." This comment was made by the company in response to a question by an analyst about quantifying the impact of generative AI on its future top line and margins.

Higher Than Expected Interest Costs Might Increase The Risk Of An Earnings Miss

Seeking Alpha News reported earlier on September 20, 2023 that "the bulk of Federal Reserve officials still see one more interest-rate hike" in 2023 and "fed funds rate projections for 2024 and 2025 both increased by half a percentage point." This isn't good news for RELX.

Net interest costs for RELX rose by +79% YoY from $76 million in the first half of 2022 to $136 million for the most recent interim period. RELX guided at its 1H 2023 results call that the company's interest expense "will be slightly higher than that in the second half (vis-a-vis 1H 2023) based on where interest rates are right now."

Assuming that a rate hike does materialize in the remaining months of 2023, RELX might be at risk of reporting below-expectations earnings as a result of a more meaningful increase in interest costs.

Closing Thoughts

RELX's shares are no longer deserving of a Buy rating. The stock's valuations are pretty demanding, and there are risks relating to weaker investor sentiment towards AI beneficiaries and a larger interest cost burden.

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