2023-06-09 11:55:29 ET
Summary
- Artificial Intelligence and data-driven model could be a game changer for the company.
- Defensive character and cyclical support are two key supportive catalysts that cannot go unnoticed.
- As LSEG demonstrated it can deliver positive operational leverage, we believe it deserves a higher valuation rating.
After more than a year since our last update , London Stock Exchange Group plc ( OTCPK:LDNXF , OTCPK:LNSTY ) reached our target price set at 8700p. In our initiation of coverage called " We See The Upside ", our buy rating was supported by 1) higher volatility estimates in a challenging period, 2) better-than-expected synergies from the Refinitiv integration, and 3) limited exposure to Ukraine and Russia. Looking at the Fiscal Year 2022 financial snap, we can say that it was a good investment call and we achieved a total return of 18.75% (including the dividend payment), outperforming the S&P 500 index.
Why is LSE still a buy?
- Cyclical support : in this volatile market, clearing and trading revenue are still important. In this scenario, here at the Lab, we are 2-3% above Wall Street consensus estimates. We forecast volume-sensitive revenue to slightly increase as funds (Pension, Hedge), family offices, and private investors reposition investments. However, if Q1 levels remain, we still estimate a revenue uplift of approximately 2% for LSEG;
- Defensive character : this is still related to point 1) because it is still unclear where we are heading. What we like about diversified financials such as stock exchanges is that infrastructure services are defensive businesses. Our call is not between tech, growth, value, or dividend player strategies, what we are interested in is higher trading activity levels;
- Recurring revenue : it is important to emphasize that LSEG has clear top-line sales which are non-volume sensitive and is led by data. In numbers, the company reached >70% of sales that are recurring and is well-placed thanks to the Refinitiv acquisition;
- Artificial Intelligence and data : here at the Lab, we believe that Refinitiv and Thomson Reuter Eikon platforms are going to be supportive catalysts for the company. Already in 2018, the company announced : " AI to Increase Personalization for Financial Professionals on its Financial Desktop Platform "; however, these days, AI could be the next revolution in investment decisions and portfolio monitoring. As recently communicated, Reuters could enable the platform and investors to 1) increase productivity, and 2) provide transformative value.
Change to our estimates:
Aside from the above macro reasons to continue to hold LSEG as an investment, here below is our main take on the financials. Post Q1 results, we apply the following changes:
- Updating Refinitiv synergies but we are behind the company targets: £350 million in revenue and £400 million in the cost basis. As integration continues, more synergies may emerge. We were already ahead of Wall Street numbers, as a reminder, our 2022 £151 million run rate cost was much higher than Wall Street forecast at £88 million;
- Here at the Lab, the LSEG business mix shift is going towards recurring data-driven revenue. This provides supportive operational leverage to enhance higher profit growth. This was already evident in FY 2022 results, revenue growth was at 6.6% while cost basis growth signed a plus 3.4%. In our base case assumption, we are forecasting 5%-6% revenue growth and 2%-3% cost growth in 2023. As the company demonstrated it can deliver this positive operational leverage, we believe it deserves a higher valuation rating;
- This upside is also confirmed by the company's ability to generate free cash flow and so we forecast an EPS growth of 11% this year;
- London Stock Exchange Group is still levered; however, the company has the ability to return significant cash to shareholders thanks to dividends and buyback, while deleveraging. We also believe that there is no risk in cutting DPS (Fig 1) - in addition, the full-year dividend was increased by +12.6% to 107p;
- To support our point 4) we believe that the £750 million buyback program will be completed by Q1 2024 (Fig 2).
Valuation
Following the company's Q1 trading update , we decided to make the above changes in our forecasts, primarily reflecting better estimates for Data and Analytics revenue. Our target price increased by 11% to 9600p from 8700p. In our estimates, the company will trade at a 20% premium compared to its historical average multiple. However, we believe this reflects its earnings defensiveness and its attractiveness. Downside risks include regulatory risks, lower integration synergies, dilutive M&A, lower monthly trading volume, and inflationary cost pressures with wage inflation. Here below is our diversified financials coverage:
- Euronext Continues To Deleverage
- Deutsche Börse: VIX Is A 2023 Key
For further details see:
London Stock Exchange Group: Again A Buy