SPGI - S&P Global: High Quality Has Its Price

2023-07-17 09:53:36 ET

Summary

• S&P Global is a high-quality supplier of ratings, benchmarks, analytics, and data to global capital and commodity markets.
• Compared to major competitors, the company seems to be reasonably valued.
• When however valuating S&P independently through a DCF, the company's valuation seems to be elevated.

It is very rare that high-quality companies, such as S&P Global ( SPGI ) trade at attractive or even reasonable valuations. In this article, I'll dive deeper into SPGI's current valuation to explore if this rare situation might be the case right now.

Company Overview

With its headquarters in New York, S&P Global is a prominent supplier of ratings, benchmarks, analytics, and data to the global capital and commodity markets. The company is diversified well between four major different business segments, which are sorted below by revenue share as of 2022.

1. S&P Global Market Intelligence : This section offers cross-asset analytics and desktop services that incorporate multi-asset class data, research, and analytical capabilities. Their services assist clients in making strategic decisions, managing risks, developing investment plans, and adhering to legal and other obligations.

2. S&P Global Ratings: The company's largest division, assigns credit ratings to both public and private businesses, governments, and other organizations. These ratings, which are an essential part of the world financial system, help investors in assessing the credit risk of borrowers.

3. S&P Global Platts : Information and benchmark pricing for the commodity and energy markets are provided in this part. For the markets in oil, natural gas, electricity, nuclear power, coal, petrochemicals, metals, and agriculture, this includes news, pricing, analytics, and conferences.

4. S&P Dow Jones Indices : The S&P 500 and the Dow Jones Industrial Average are located in this sector, which is also the largest global repository for index-based concepts, data and research.

The company operates globally, but with still a heavy focus on its home market, the US.

SWOT Analysis

To get an understanding of SPGI's internal strategic capabilities (strengths and weaknesses) and its external strategic environment (opportunities and threats), I conducted a small SWOT analysis, which helps us understand major influences for S&P Global.

Strengths:

1. Market Position : S&P Global enjoys a significant competitive advantage due to its dominating position in the credit ratings, indices, commodities pricing, and analytics industries.
2. Brand Reputation : The constant delivery of high-quality, trustworthy financial data by S&P Global contributes to its solid reputation for reliability and trustworthiness in the financial markets, enhancing its brand value and inspiring customer confidence. This credibility, which is essential in an industry characterized by unpredictability, makes S&P Global the go-to source for organizations looking for reliable market intelligence, further boosting its global reputation.
3. Diversified Product Portfolio : It provides a wide range of goods and services that address many customer needs, decreasing reliance on any one revenue source.
4. Extensive Global Presence : As can be seen above in the countries of operation of S&P, its operations span several nations, enabling it to connect with a large consumer base and diversify its revenue.
5. Technological Capabilities: By leveraging AI, machine learning, and big data analytics, S&P Global can increase the accuracy, breadth, and timeliness of its data and insights.

Weaknesses:

1. Regulatory Risks : S&P Global operates in an area with strict regulations, therefore any changes to the laws or instances of non-compliance may have a significant impact on the way the company does business.
2. Reliance on Financial Markets : Its effectiveness and margins are closely correlated with the state of the world's financial markets. Economic downturns may have an immediate impact on its business.
3. Competition : Despite being a market leader, S&P Global faces fierce competition from other top competitors including Moody's and MSCI for example.
4. Risk of Litigation : Due to the nature of their business, there is always a chance of litigation, especially when their evaluations are viewed as inaccurate or deceptive.

Opportunities:

1. Growing Demand for ESG Ratings : S&P Global has a sizable potential due to the growing ESG (Environmental, Social, and Governance) ratings industry. They are currently already capitalizing from this trend, but the increasing awareness in this field could substantially benefit rating companies like S&P Global.
2. Increasing Emphasis on Risk Management : Since the 2008 financial crisis, corporations have placed a greater emphasis on risk management, creating numerous chances for S&P Global to broaden its offerings.
3. Emerging Markets : As these markets mature and demand more sophisticated financial infrastructure, developing economies present a significant market opportunity for credit rating and other financial services.
4. Digitalization and Technology Advancement : Their analyses and ratings can be more accurate with further development and integration of cutting-edge technologies like AI and ML (Machine Learning), giving them a competitive edge.

Threats:

1. Economic Instability : The demand for S&P's services may decline as a result of abrupt economic downturns or unstable financial markets.
2. Regulatory Changes : Changes in regulations in any of the nations where it conducts business could be detrimental.
3. Competition : S&P Global's market share may decline due to fierce rivalry from other well-established companies as well as fresh competitors, particularly in the digital industry.
4. Reputation Risk : Their reputation and customers' trust could suffer significantly if their grading system or analytical services are thought to contain errors.

Valuation

S&P is trading at a forward PE ratio of 36 as we speak. This seems elevated when we factor in the company's average 5-year PE ratio of 32:

If we take a look at the major competitors of S&P, Moody's Corporation ( MCO ), and MSCI Inc. ( MSCI ), they all seem to be trading at roughly the same valuation right now.

I even think that SPGI is currently the best deal of the three, if we factor in that both of these competitors are pretty reliant on only one of S&P's business segments and S&P is therefore more diversified than the two.

In the case of MSCI, around 58% of its business is done with its Index business and for Moody's around half of its revenue comes from its rating service. With both of these segments behaving cyclical, S&P seems to be more diversified than the two, which in turn justifies a valuation premium in my opinion.

If we take a look at the EV/EBITDA metric, SPGI is even trading at a lower metric than its main competitors:

The Seeking Alpha Quant rating system is currently rating S&P with a valuation grade of "F", suggesting the company is heavily overvalued. While I agree that is certainly expensive right now and in general, I think the comparison with the whole financial sectors - and therefore with banks, etc. - doesn't really justify the strong business of S&P Global.

I believe we can all agree that SPGI is a premier business recognized for its great performance and quality. This becomes especially apparent if we look at its stock performance over the last 10 years, with being up around 600%.

Such high-quality "compounders" rarely trade at an attractive price or even at a fair price, due to their sheer quality. The same thing is true for MSCI and Moody's, which is why comparing the three might give us an indication which of the three is currently the best deal, but won't help us if we want to know if SPGI is generally at a good point to enter a position. Therefore, I conducted a Discounted Cash Flow Analysis ((DCF)), to evaluate S&P independently from its peers.

• Revenue: For 2023, I predicted a revenue growth rate of 5%. This is in line with management's current guidance for 2023 . After that, I used a CAGR of 10%, which resembles S&P's 10-year average revenue growth rate.
• EBIT Margin: For the EBIT margin, I used the average of the last 3 years and anticipated that it will stay flat at 47% for the next 8 years.
• Financial Result And Taxes: I averaged the values of the last three years and therefore used -30% to calculate the Net Profit for the years 2023 to 2030.
• Tax Rate: For 2023 the management expects a tax rate of around 23%, to keep things simple, I anticipated that this rate will stay flat till 2030.
• Free Cash Flow: For 2023 we also got a Free Cash Flow guidance - $3.7 to $3.8 billion - from SPGI's management. With the metrics for 2020 to 2023, I averaged out the EBIAT to FCF ratio and assumed it'll stay flat over the next years.
• WACC: I used the current WACC of SPGI, which currently sits at around 8.5%.
• Perpetuity Growth Rate: The perpetuity growth rate assumed for the analysis is 3.5%.

This analysis gives us a target share price of $344. With considering this and assuming SPGI's business will develop like we predicted, there is currently a potential downside of ~20%. However, one has to keep in mind that this analysis heavily relies on expectations, data from the past, and assumptions I made. Given that over the last 10 years, SPGI hasn't missed one earnings expectation, there might be more upside potential than anticipated here.

Conclusion

Based on our reasonable conservative Discounted Cash Flow analysis, we arrive at a price target of $344, which indicates the company could be overvalued by ~20%.

My personal position in S&P Global is currently up around 15%, so I actually pretty much hit our "fair" price target of this DCF when buying it in April. Like mentioned above, S&P Global is a high-quality company that rarely trades at fair valuations. For this reason, I'm happy I got in at a reasonable price and despite the elevated valuation, I currently don't plan to sell one single share of the company, which is why I rate the company a "Hold". Compared to its peers MSCI and Moody's, I think S&P is the "best" deal right now.

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