2023-05-08 11:48:55 ET
Summary
- While MSCI Inc. beat estimates on Q1 earnings, its softer-than-expected revenues, particularly for the ESG and Climate segment, resulted in weakness in its share price.
- The company saw a challenging near-term outlook for the ESG and Climate segment as a result of political headwinds in the U.S. and regulatory headwinds in Europe.
- I am of the view that both ESG and Climate remain long-term structural growth drivers for MSCI, and the sell-off represents an attractive buying opportunity.
- MSCI remains cautious on spending and investments, while having further downside levers to pull if necessary.
- After applying the 5-year average P/E for MSCI to my 2024 EPS, my 1-year price target for MSCI is $588, representing 28% upside from current levels.
MSCI Inc. ( MSCI ) plunged by 12.5% after it released Q1 2023 results . I looked deeper into the company's earnings report and listened into the management call to generate some key insights into the company's recent earnings.
MSCI's earnings result
MSCI Q1 2023 beat on EPS, but it came as revenues were weaker than expected while expenses came in better than expected.
1Q23 revenue grew 6% from the prior year to $592 million , slightly missing consensus expectation of $594 million.
Operating expenses came in better than expected at $278 million, up 2% from the prior year.
As a result, adjusted EBITDA came in better than expected at $345 million, rising 8% from the prior year as the beat in expenses offset the weakness in revenues. Adjusted EBITDA margin for 1Q23 came in at $58.2% compared to the 56.9% seen in the prior year.
Adjusted EPS came in at $3.14, 5% above market consensus and up 5% from the prior year.
Why did MSCI stock price fall after earnings?
Since MSCI beat earnings, why did the stock price fall almost 12.5% after its results were reported?
The weakness in stock price after the earnings report came from the weakness in operating revenue.
MSCI CEO Henry Fernandez had this to say on the call about the recent earnings:
We have not been immune to the market turmoil, which impacted sales in areas such as ESG and Real Estate, but our resilience and leadership in the industry continue to stand out.
This weakness in revenue was a result of top-line misses from the Analytics segment, ESG and Climate segment, and Private Assets segment, offset by the beat in Index segment.
I show the operating revenues by segment below:
- Index segment grew 3% organically, beating expectations by 0.9%.
- Analytics segment grew 6% organically, missing expectations by 2.6%.
- ESG and Climate grew 38% organically, missing expectations by 2.5%.
- All Other - Private Assets grew 8% organically, missing expectations by 2.8%.
ESG and Climate segment weakness
The miss in ESG and Climate revenue in the quarter as well as management's comments on multiple quarters of weakness in the segment was what drove valuation down, in my view.
Management's expectations for multiple quarters of weakness in ESG and Climate is due to the politicization of the ESG and Climate theme in the United States, as well as the regulatory uncertainty in Europe. For ESG in the United States, while there has been a slowdown from wealth managers and retail investors, MSCI continues to see healthy and steady demand from institutional investors.
This slowdown in the ESG and Climate segment definitely comes as a surprise as it has been supporting the elevated valuations for MSCI given that it provides the company with outsized growth opportunities.
However, I do think that the ESG and Climate opportunity remains a key structural driver for MSCI.
ESG will continue to see a structural opportunity set in the next few years, while Climate is only in the infancy stage of its development.
Even with the lower growth in the ESG and Climate segment, this still places MSCI as best-in-class growth company within its peer group.
I do think that while the outlook for ESG looks choppy for now, the structural case for the ESG and Climate segment remains resilient. As noted by management in their earnings call, despite the political and regulatory uncertainties in the near-term, there is still strong engagement with institutional clients and their pipeline continue to be unchanged, with ongoing discussions with some large deals that got delayed in the first quarter and likely pushed back to a subsequent quarter.
As MSCI continues to invest and launch new products for the ESG and Climate segment, we will see applications and use-cases increase and MSCI remains well positioned to capitalize on a large total addressable market.
MSCI outlook and guidance
MSCI reiterated its FY2023 operating expense guidance of between $1,090 million and $1,130 million, which is slightly below consensus.
The commentary from the earnings call suggests that they remain in their downturn playbook as they choose to remain prudent on spending on investments and reduce costs. In the quarter, management has moderated the pace of headcount growth, although they continue to be hiring in key growth areas of the company.
While the first quarter 2023 market performance was better than expected, management continues to have a cautious outlook and assume that the market will pull back from the first quarter numbers in the short-term and potentially see a rebound in the second half of 2023.
Management cited further downside levers it can leverage as it needs to, like further slowing or even stopping growth in headcount. As management's view remains cautious, I expect expenses growth to be kept well controlled.
Index segment performance
In 1Q23, the Index segment's subscription run rate grew 12% organically. In terms of inflows into MSCI-linked ETFs, there were $7 billion inflows. Bulk of the increases in inflows came from market appreciation in the first quarter of 2023. By markets, emerging markets, and developed markets ex-U.S. saw inflows while by-products, its market cap weighted products, saw inflows.
Index asset-based fees fell 8% from the prior year but 3% above market estimates. More importantly, as a result of the rebound in assets under management, or AUM, in the first quarter of 2023 from the fourth quarter of 2022, this trend for asset-based fees seems to be improving as a result of market appreciation.
Run rates across segments
The Index segment organic recurring subscription run rate grew 7% organically and met expectations. However, the run rates for the other three segments came in softer than expected.
The ESG and Climate segment organic recurring subscription run rate grew 30% to $279 million, weaker than market expectations and decelerating from the 47% growth in the prior year.
The Analytics segment organic recurring subscription run rate grew 6% to $622 million, in-line with market expectations and flat sequentially.
The Private Assets segment organic recurring subscription run rate grew 10%, also below expectations.
Resilient operating metrics
Organic recurring subscription run rate growth came in at 12%, once again decelerating one percentage point from the prior quarter. That said, I do think that despite the slight deceleration in the organic recurring subscription run rate growth, it remains far above the levels we have seen before 2Q21.
Quarterly retention rate came in at 95.2%, and it continues to depict a resilient retention rate trend, as it has demonstrated since 1Q18. Specifically, both the index and ESG and Climate segments have retention rates above 96% while Analytics and Private Assets have retention rates at 94% and 92% respectively. I think the resilient retention rates we see demonstrates the benefits of the investments MSCI has been making into its products, as well as its client servicing capabilities.
Valuation
MSCI trades at 31x 2024 P/E today. In the last five years, MSCI has traded at an average of 40x P/E, reflecting a 23% discount as a result of the selloff after its earnings report as a result of the weakness in the ESG and Climate segment. I think that the selloff represents an attractive buying opportunity.
Applying 40x P/E to my estimate of MSCI 2024 EPS, my 1-year price target for MSCI is $588, representing 28% upside from current levels.
Risks
Market risk
If the global equity markets were to decline or if the market environment turns unfavorable, MSCI could see not just outflows but also lower AUMs, as a result of market prices falling. This would then lead to lower asset-based fees.
ESG and Climate uncertainties
As a result of political issues in the United States and regulation uncertainties in Europe, the ESG and Climate segment, long known as a key long-term growth driver for MSCI, could be at risk. This has driven the premium valuation for MSCI as it is deemed to be a key beneficiary of this long-term structural growth opportunity in ESG and Climate. There are risks that the political and regulatory headwinds could materialize and hamper growth in the segment.
Conclusion
A large part of the MSCI Inc. share price decline after the first quarter earnings was a result of the uncertainty around the ESG and Climate segment's future growth. I do think that both ESG and Climate will remain long-term structural growth drivers for MSCI, and that this is just a short-term uncertainty that we will have to tide through as part of a long-term structural trend.
I think that in a challenging market, MSCI is differentiating itself and its ability to deliver. With the ongoing bear market, we are seeing today, management continues to take a conservative approach and use its downside levers to control expenses and manage their investments. This has resulted in upside and beat in operating expenses as we have seen in the current quarter and management continues to have additional downside levers to pull if it comes to that scenario.
I do think that the selloff from the earnings report represents an attractive MSCI Inc. buying opportunity. As stated earlier, after applying the 5-year average P/E for MSCI to my 2024 EPS, my 1-year price target for MSCI Inc. stock is $588, representing 28% upside from current levels.
For further details see:
MSCI: Attractive After Selloff As Long-Term Structural Drivers Remain Intact