Summary
- Morningstar has seen a massive valuation re-rating over the past year.
- Solid organic growth and low interest rates meant that shares got propelled too high beforehand.
- A reversal of valuation multiples and real operational weakness makes it very hard to get upbeat, even if shares have been cut nearly in half from their highs.
In April of last year, I believed that shares of Morningstar ( MORN ) were not a star at the time. The company and its shares have enjoyed strong operational performance accompanied by higher valuation multiples over time, as higher interest rates have started to create some multiple compression in 2022. This came after shares fell from a high of $350 early in 2022 to $270 per share by April.
Nonetheless, valuation multiples remained quite demanding, too demanding to get upbeat on the shares at the time.
Information Is Valuable
Morningstar got a big boost when it acquired CBRS in 2019, the fourth-largest credit agency at the time, allowing Morningstar to post sales in excess of a billion. The overall company was very profitable, posting operating margins over $200 million.
At the time a $140 stock, Morningstar was awarded a $5.7 billion enterprise valuation, for a 5.6 times sales multiple. With earnings trending at $4 per share, the valuation came in excess of 30 times earnings, driven by the stable operations, long-term growth and M&A track record.
Despite these premium valuations, shares have steadily moved higher, amidst solid growth and lower interest rates. Shares hit a high of $350 late in 2021, only to fall to $270 in April 2022. The company has come a long way in the meantime, with 2021 sales having advanced to $1.7 billion on which adjusted earnings of $6.36 per share were reported, as the list of reconciliations to GAAP earnings looked quite fair.
Strong growth from a billion sales mark to the reported revenue numbers came on the back of organic growth as well as additional M&A efforts announced in the meantime, with PitchBook and Sustainalytics posting strong growth, as the company preserved a net cash position despite the dealmaking efforts.
At the peak of $350, the 43 million shares appraised the company at $15 billion peak valuation, equal to about 9 times sales and about 50 times adjusted earnings. With shares down to $270, the equity valuation fell to $11.6 billion, still equal to 7 times sales and 42 times adjusted earnings, a huge multiple.
The company used its strong balance sheet to acquire Leveraged Commentary & Data from S&P Global Inc. ( SPGI ) in a $650 million deal at apparently a steep multiple. The $56 million revenue contribution came in at 11 times sales, a big premium to Morningstar's own valuation. The steep valuation made me cautious.
With the earnings yield having grown to 2.3% amidst the pullback in the share price, the valuation was still far too rich given the (Treasury) action at the time, still regarding Morningstar as a quality name. After all, Morningstar is still very well positioned to benefit from long term trends, notably in ESG.
Coming Down
Since April, shares have fallen to the $200 mark, shedding another quarter of their value, quite a soft performance amidst rising interest rates. Over the summer, the company posted a 13% increase in second quarter sales, despite some currency headwinds.
Third quarter sales rose 9%, driven by a similar organic growth achievement as margins took a huge beating with adjusted earnings per share down more than 44% to $0.77 per share. The company was hit by foreign exchange losses, lower activity levels in transaction-based product areas, notably rating activities. To offset some of the pain, the company hiked the full year dividend to a run rate of $1.50 per share, translating into a very modest yield, while announcing a half a billion buyback program as well.
In February, Morningstar posted fourth quarter sales of $475 million, up just over 2% on a reported basis and up by similar percentages based on the organic performance. That was about the good news as quarterly adjusted earnings were down 61% to $0.58 per share. For the year, Morningstar posted a 10% increase in sales to $1.9 billion driven by organic growth. Full year adjusted earnings were down 39% to $3.87 per share, and while this number is quite clean, the decline in the numbers was more pronounced in the second half of the year.
Lower profits, some M&A activity and buybacks meant that net debt has risen to $700 million. This is quite high with adjusted operating profits reported at $300 million for the year, translating into a 2-3 times leverage ratio, albeit that earnings are still taking a beating here. Moreover, the company has been buying back a chunk of shares to please investors, yet the incurred interest costs associated with the debt comfortably outpacing the earnings yield which the shares provide, certainly after earnings have taken a beating in the second half of the year. This means that buybacks are actually dilutive to earnings per share here.
And Now?
The 43 million shares outstanding now represent an $8.9 billion equity valuation at $207 per share, a number which rises to $9.6 billion if we include the current net debt load. The problem is that adjusted earnings are only trending at $2-3 per share at best based on the two recent quarters, and perhaps closer to $6 per share if activity levels pick up a bit again to "normal" levels.
That however stands in sharp contrast to the $207 current valuation, which now includes a net debt position as well. Given all this, I remain cautious here, even as sales multiples have fallen to 4–5 times and Morningstar historically should be able to post decent margins.
The softness of the recent results is in part reasonable given the market conditions, but I cannot escape the feeling that there is genuine weakness in involved here as well, with former stars like PitchBook and Sustainalytics seeing a rather rapid slowdown in growth as well.
All of this makes me quite cautious and makes it too early to go bottom finishing in my perspective.
For further details see:
Morningstar: Very Soft Performance