2023-09-13 06:58:41 ET
Summary
- MSCI is a leading financial services company operating in the ESG industry, with ESG accounting for over 10% of its sales.
- ESG investing is facing challenges and political pressure, but MSCI believes in the growth potential of the ESG market.
- MSCI's overall growth and financial performance are strong, with consistent double-digit subscription run rate growth and a positive long-term outlook.
Introduction
MSCI Inc. (MSCI) , which stands for Morgan Stanley Capital International, is a fascinating company operating in the financial sector. As I wrote in June, the company is one of the largest financial service companies in the world. It services more than 6,600 clients in almost 100 nations.
The company operates three major business segments, with its Index segment generating more than $1.3 billion in revenue last year.
USD in Million | 2021 | Weight | 2022 | Weight |
---|---|---|---|---|
Index | 1,252 | 61.3 % | 1,303 | 58.0 % |
Analytics | 544 | 26.6 % | 576 | 25.6 % |
Environmental, Social and Governance and Climate | 166 | 8.1 % | 228 | 10.2 % |
All Other - Private Assets | 81 | 4.0 % | 141 | 6.3 % |
The MSCI business primarily revolves around its indexes, which act as benchmarks for investors. These indexes cover equity, fixed income, and multi-asset class investments, allowing clients to assess performance, allocate assets, and create investment products such as ETFs.
The company also focuses on a wide range of other services, including ESG and climate investing. Most of its customers are asset managers and banking & trading companies.
Since my last article, the company has returned 11%, beating the S&P 500 by roughly 700 basis points.
In this article, I'll dive into the company again in light of challenges and opportunities in the ESG industry and the company's favorable outlook.
So, let's dive in!
How Important Is ESG?
ESG stands for Environmental, Social, and Government.
Environmental criteria consider how a company safeguards the environment , including corporate policies addressing climate change , for example. Social criteria examine how it manages relationships with employees, suppliers, customers, and the communities where it operates . Governance deals with a company's leadership, executive pay, audits, internal controls, and shareholder rights . - Investopedia
Don't get me wrong, I'm pro-ESG. However, I'm not necessarily in favor of the way people are dealing with ESG. It is obviously important that companies operate in an ethical manner, take care of their employees, do not discriminate, and respect government regulations to protect shareholders.
The problem is that ESG has become very political. People cannot agree on what is ESG and what isn't. It is often associated with bad decisions leading to inefficiencies and underperformance. For example, the energy transition is very ESG. It has done a number on energy markets and grid reliability. People dislike that.
ESG is increasingly important for MSCI. It now accounts for more than 10% of sales after growing by almost 40% last year.
According to MSCI (emphasis added):
Lead the enablement of ESG and climate investment integration by delivering the data, information and applications necessary to identify, assess and incorporate material ESG and climate risks and opportunities . The global adoption of ESG and climate-focused investment considerations and the establishment of ESG and climate reporting frameworks are both rapidly accelerating. As demand from our clients for ESG and climate solutions increases, MSCI's research, tools and solutions will aim to provide the transparency our clients need to better integrate ESG and climate risks and opportunities into their investment processes . Our ESG ratings and climate data and research are also utilized in our index, analytics and private asset tools and solutions - from ESG and climate indexes to incorporation of ESG and climate data in risk analysis to climate and emissions assessments specific to real estate assets and private equity portfolios.
Having said that, support for ESG is dropping.
According to Bloomberg's recent industry survey, the outlook for ESG investing appears increasingly pessimistic.
A significant portion of Bloomberg terminal clients participating in the survey anticipate that ESG funds will lag behind general market benchmarks in the coming year.
Furthermore, a growing number of respondents, especially those not directly involved in ESG, view it as a fleeting trend rather than a lasting investment strategy.
Approximately 70% of individuals not directly engaged in ESG regarded the investment strategy as a transient trend. Only 18% of actively engaged respondents expected ESG concerns to become more critical in business and markets, a decline from 25% in the previous survey.
While this is just a survey, there are actual developments on a higher level.
For example, the political landscape in the United States has seen an increase in opposition to ESG, with Republican-led efforts challenging the Securities and Exchange Commission's push for transparent corporate disclosure requirements related to ESG factors.
According to Bloomberg, this political pressure was echoed in the survey, with some respondents characterizing ESG as shifting from risk management to left-wing political activism. Approximately 80% of anti-ESG comments originated from U.S.-based terminal clients.
I believe this assessment is spot on. ESG has become a political weapon to pressure companies into behaving a certain way.
Having said that, ESG is not dead. Bloomberg makes the case that the E, S, and G need to be separated. I believe monitoring the social and government aspects is very important. Especially transparency is key in investing.
This is also why MSCI got involved. The company saw potential in becoming a leader in this emerging field, recognizing that ESG data could serve as a valuable measure of risk and opportunity for investments.
As much as I disagree with the environmental aspect of almost every corporate assessment, having the right tools to incorporate other aspects in risk management is important.
During this year's Barclay's Annual Global Financial Services Conference (held in September), the company focused on the importance of ESG in its 10-year strategic plan, emphasizing three key drivers: the market opportunity, the emergence of climate risk, and the regulatory environment.
MSCI believes that climate change and climate risk represent an existential threat to society and financial markets, making climate an area of significant growth potential. The regulatory landscape, particularly in Europe, is also driving product development to help clients meet reporting requirements.
Again, while I have my doubts about the predictability of weather (let alone climate) on a longer-term basis, it's hard to disagree with the assessment that more risk management is desired.
This ESG vision also fits into the company's bigger picture, which aims to connect and support the entire capital "supply chain."
With regard to growth, the company mentioned that it is only scratching the surface when it comes to addressing the broader market, including insurance companies, banks, trading firms, wealth managers, and corporates.
MSCI believes that ESG and climate are multi-billion addressable markets.
Moreover, during the aforementioned conference, the company also commented on the political pressure on ESG, stating that despite the political rhetoric, asset managers and pension plans continue to utilize MSCI data because it represents financial risk and opportunity.
Despite being a massive ESG critic, I believe that the company's ESG business has a bright future. I just hope that we get changes in ESG. It needs to become more passive instead of a tool to pressure money flows into certain directions (i.e., it shouldn't cause underinvestment in oil and gas).
More Growth & Valuation
MSCI is growing well beyond ESG.
In the second quarter, the company achieved significant milestones with a 17% growth in adjusted EPS, 13% organic revenue growth, and an 11% increase in organic subscription run rate.
The flagship index segment achieved a remarkable 12% subscription run rate growth, with a notable 14% growth in the Asia Pacific region.
Record-breaking sales were attributed to their newly launched float data products, which generated nearly $8 million in gross sales. These deals not only led to deep client engagement but also served as entry points for future recurring subscription sales.
Its capital allocation strategy remained consistent, focusing on share repurchases, dividend support, and strategic acquisitions, with $468 million in share repurchases during the quarter.
The company also achieved its 38th consecutive quarter of double-digit subscription run rate growth in the index business.
Analytics performed exceptionally well, with the highest second-quarter retention rate ever (over 95%) and significant recurring net new sales growth (46%) in equity portfolio management.
Additionally, MSCI reported impressive climate run rate growth of 70% across product lines, coupled with a climate retention rate of over 97%.
Our ESG run rate growth firmwide grew 18%, and the retention rate from our ESG and Climate product segment remain resilient at 97%. This shows that despite tightening budgets, our clients continue to make ESG and Climate a top priority. - MSCI 2Q23 Earnings Call
Having said that, the company also commented on its longer-term outlook.
It expects low-double-digit annual revenue growth, with high single-digit to low-double-digit EBITDA growth, which means it expects stable margins.
In the current inflationary environment and the pressure on companies like MSCI, that's not half bad.
Analysts agree with management.
Looking at the data and charts below, we see that the company is expected to maintain annual EBITDA growth close to 11% and EBITDA margins between 60% and 61%. Free cash flow is expected to grow at a faster rate, indicating a higher cash conversion rate.
Leo Nelissen (Based on analyst estimates)
The company is expected to see a net debt decline to $3.2 billion in 2024. It currently has a 2.7x net leverage ratio and barely any debt maturities until 2029. The company has an investment-grade credit rating of BBB- with a stable outlook from both S&P and Fitch.
MSCI is currently trading at 32x EBITDA. If we maintain a 30x EBITDA multiple, the company is roughly 22% undervalued.
This puts the price target at roughly $660.
This is my bullish case, which relies on MSCI growing its EBITDA by at least 10% per year. Any weakness could cause larger corrections, which is always a major risk when dealing with growth stocks.
The current consensus price target is $589.
In light of these numbers, I would buy MSCI close to $460 to improve the risk/reward a bit.
FINVIZ (Automated Technical Analysis)
On a long-term basis, I expect MSCI to outperform the market by a considerable margin.
Takeaway
MSCI is a leading company in the financial sector that provides a diverse range of services to its clients worldwide. Although Environmental, Social, and Governance ((ESG)) factors have gained significant importance for MSCI, it is currently facing challenges due to its politicization. The proper separation of Environmental, Social, and Governance aspects is crucial, and there should be a focus on transparency in investing.
Nonetheless, MSCI's strategic emphasis on ESG aligns with the growing demand for climate risk assessment and regulatory compliance. Despite political pressures, asset managers and pension plans continue to rely on MSCI data for financial insights, which comes with tremendous growth opportunities.
Beyond ESG, MSCI's growth is also impressive, marked by strong financial performance, consistent double-digit subscription run rate growth, and expansion into diverse product lines. The company's long-term outlook appears robust, with analysts anticipating stable margins and an improving cash flow conversion.
Although I would suggest waiting for a correction, I remain bullish on this stock.
For further details see:
MSCI: Thriving Through ESG And Beyond