2023-04-06 19:22:29 ET
Summary
- S&P Global Inc. is a leading financial services company through its Indices, Ratings, Market Intelligence, Commodity Insights and Mobility businesses.
- The Company's proprietary Dow and S&P 500 indexes are synonyms for the U.S. market, and its rating methods are defining the global standards.
- With 81% of its revenues derived from recurring arrangements and every segment besides Ratings growing in 2022, S&P Global demonstrated its resiliency in economic downturns.
- As there's still a lot of uncertainty surrounding the macroeconomic environment, S&P Global is still trading below its historical averages.
- Times of pessimistic markets are usually the right time to buy high quality companies like S&P Global Inc. I estimate 2022 marked a bottom year for the company, and rate the stock a Strong Buy.
S&P Global Inc. ( SPGI ) has seen its stock recover 18.2% from its October 2022 lows, yet its price still reflects uncertainty regarding the economic environment. With its most important business directly tied to the Fed interest rates, it's understandable why the stock is still trading below its historical valuation. SPGI has shown resiliency in 2022, with every segment besides Ratings growing revenues and maintaining or expanding margins. The company's management has set clear targets for the mid-term, and I'm positive it will reach them. According to my evaluation, these targets are not reflected in the current stock price.
Thus, I rate S&P Global Inc. stock a Strong Buy and estimate its fair value at $412.6 per share. I do believe it will take time and additional economic clarity before the stock goes on a run. That being said, I find SPGI's current valuation very attractive for long-term investors.
Introduction - What Led Me To Research S&P Global?
Recently, I wrote an article about MSCI Inc. ( MSCI ), claiming it's the best play on index makers, as 58% of the company's business is its indexes. I found MSCI to be a potential long-term compounder, with steady double-digit growth for the foreseeable future. Sadly, I also found MSCI to be overvalued, which led me to look in different directions seeking exposure to index makers, a line of business I strongly believe in.
S&P Global is unquestionably the number one index maker in the world, with over $2.6T AUM (assets under management) linked to its indexes. The company's own Dow (DJI) and S&P 500 (SP500) indexes are synonyms for the U.S. market, and presumably provide the best risk-adjusted effortless return an investor could ask for. We can only imagine the multiple a stand-alone SPGI index business would trade at when MSCI is trading at a 51.3 P/E multiple at the time of writing. However, the index business is only 12% of SPGI's revenues.
In addition to its indexes, SPGI is a worldwide leader in credit ratings, along with Moody's ( MCO ) and Fitch. Despite its cyclical nature, the ratings business is very high quality, thanks to its unassailable moat. The two lines of business combined represent between 40%-45% of SPGI's revenues.
I view the other businesses, in market intelligence, commodity insights, and mobility, as much more competitive and of lower quality (as reflected by their margins). When 55%-60% of the company's operations aren't that attractive in my opinion, I usually refrain from investing in it. Yet, I felt I have to take a deeper look at SPGI's long-term strategy, and how the business is going to leverage its more attractive offerings, as it's very possible that the two gems of the business are enough to justify investing at the company's current valuation.
Company Overview
S&P Global is a provider of credit ratings, benchmarks, analytics, and workflow solutions in the global capital, commodity, and automotive. After acquiring IHS Markit for $44B, completing the merger in 2022, and announcing its Engineering segment divestiture , the company's reports are in flux with pro-forma adjustments. That, along with the massive declines in the Ratings business resulted in a tough cookie to chew for investors, with its stock now trading 27% below its 2021 highs. Let's try to make sense of all the mess.
The company operates five reportable segments: Market Intelligence, Ratings, Commodity Insights, Mobility, and Indices.
Created and calculated by the author using data from SPGI's 10-K
As 2022 was a down year for the Ratings and the Indices segments, I find 2021 more representative of the company's steady-state business. As we can see, 44.0% of the company's revenues came from the "gems," whereas 56% came from the lower margin segments. Looking at EBIT, we get a clear picture - 59.1% of total EBIT came from Indices and Ratings, despite their lower share of revenues.
Market Intelligence
Market intelligence mainly includes software-based solutions for data, analytics, portfolio & risk management, ESG, and credit ratings. Key customers served by Market Intelligence include investment managers, investment banks, private equity firms, professional services firms, and governments.
Revenues for the segment grew at a 7.1% CAGR between 2020-2022 to reach $4.1B, with an average EBIT margin of 30.4%. The majority of this segment's revenues are subscription based. For the mid-term, management is guiding for 7%-9% annual organic revenue growth, and 35%-37% EBIT margins.
Ratings
Ratings are used by investors to make decisions about purchasing bonds or other fixed-income investments. S&P Global provides ratings for more than 150 years in over 25 countries. Under Ratings, the company disaggregates its revenues between transaction and non-transaction. Transaction revenues include fees associated with the issuance of debt, whereas non-transaction revenues primarily include fees for ongoing monitoring of credit ratings.
Revenues for the segment decreased by 25.6% in 2022 to reach $3.0B, due to a massive decline in global debt issuance. The average EBIT margin between 2020-2022 amounted to 60.6%. In regular years, the majority of this segment's revenues are transaction-based, whereas, in 2022, transaction-based revenues decreased by 45% and were attributed to only 40% of the segment's revenue.
For the mid-term, management is guiding for 6%-9% annual organic revenue growth, and 58%-60% EBIT margins.
Commodity Insights
Commodity Insights provide information and benchmark prices for the commodity and energy markets. Key customers are producers, traders, and intermediaries within energy, petrochemicals, metals & steel, and agriculture.
Revenues for the segment grew at a 4.9% CAGR between 2020-2022 to reach $1.8B, with an average EBIT margin of 44.2%. The majority of this segment's revenues are subscription based. For the mid-term, management is guiding for 8%-9% annual organic revenue growth, and 48%-50% EBIT margins.
Mobility
The Mobility segment provides solutions serving the full automotive value chain including vehicle manufacturers (OEMs), automotive suppliers, mobility service providers, retailers, consumers, and finance and insurance companies. Mobility was fully acquired with the IHS Markit merger, it operates globally across both the new and used car markets, with staff located in over 17 countries.
Revenues for the segment grew at a 13.3% CAGR between 2020-2022 to reach $1.4B, with an average EBIT margin of 36.5%. The majority of this segment's revenues are subscription based as well. For the mid-term, management is guiding for 7%-9% annual organic revenue growth, and 41%-43% EBIT margins.
Indices
Indices derives revenue from asset-linked fees when investors direct funds into its proprietary indexes, sales-usage-based royalties, as well as data subscription arrangements. The company's S&P 500 index is the underlying index for the world's 3 largest ETFs based on AUM.
Revenues for the segment grew at an 11.3% CAGR between 2020-2022 to reach $1.4B, with an average EBIT margin of 67.7%. The majority of this segment's revenues are asset-linked and recurring. For the mid-term, management is guiding for above 10% annual organic revenue growth, and 67%-69% EBIT margins.
Investment Thesis - Recurring Revenues, Steady Growth, Recovery in Ratings
I described my initial view of SPGI in the beginning. After taking a closer look, I was intrigued by the fact that 81% of its revenues are derived from recurring arrangements. This 81% includes subscription, non-transaction, asset-linked, usage-based, and variables, which are all sensitive to changing economic environments, but not to a material extent.
The most important fact is that besides the transaction-based ratings business, every segment of SPGI grew revenues and either kept or improved margins in 2022. In my view, SPGI's resiliency in one of the worst years for the markets is very impressive.
So my investment thesis for S&P Global is simple. 2022 was a rough year for its most important Ratings business, and the overall economy weighed on the realization of the merger synergies. I find the company's Indices and Ratings businesses to be the unquestionable worldwide leaders of their industries, and the other segments to be resilient, as reflected by their 2022 results.
SPGI's management has provided us with clear and defined targets:
I believe those targets are more than achievable and as we'll see under the Valuation section, if management does deliver on those targets, then according to my estimations, the stock is undervalued.
Competitors & Multiples
Every financial service company is different than the others. I compiled a list of 7 competitors with I find relevant for comparison, however, none of these are perfect parallels for S&P Global.
Created by the author using data from Seeking Alpha; Data as of April 6th, 2023
Like most of its peers, SPGI is on a dip compared to its 52-week high. The company provided below-average returns in the last 10 years, although the average is completely swayed because of MSCI. Overall, SPGI comes second in the list in dividend growth and total returns.
Created by the author using data from Seeking Alpha; Data as of April 6th, 2023
Looking at growth, SPGI is a victim of the traditional CAGR calculation investors usually use, which takes into account only the last year and the base year. Due to 2022 being a bad year for the company, its 3-year CAGRs look disappointing. If we were to use its 2021 results, SPGI's growth is above average.
Created by the author using data from Seeking Alpha; Data as of April 6th, 2023
Looking at margins, SPGI was above its peers' average in 2022, despite it being an outlier low margin year for the company. Historically, the company's numbers are closer to MSCI, with around 48% EBIT margins.
Created by the author using data from Seeking Alpha; Data as of April 6th, 2023
Overall, I understand why MSCI is getting a premium over SPGI, as the former is less cyclical and is projected to outgrow SPGI. What I don't understand is why Moody's is trading at much higher multiples. Based on that, I find SPGI undervalued, and expect it to trade at least at its peers' average.
Valuation
I used a discounted cash flow ("DCF") methodology to evaluate SPGI's fair value. I assume the company will grow revenues at a CAGR of 7.2% between 2022-2030, which is according to the company's long-term growth targets. I believe revenues will grow at that pace due to high growth in AUM linked to existing indexes, as well as the continued introduction of new offerings. Additionally, I expect a full recovery and a return to historical trends in the Ratings segment. Lastly, I project Market Intelligence, Mobility, and Commodity Insights to continue to grow according to the management's guidance.
I project SPGI's EBITDA margins to increase incrementally up to 53.0%, according to the management's long-term guidance of adjusted EBIT margins between 48.0%-50.0%. I find management's guidance to be more than feasible, as the company achieved it for 3 straight years between 2019-2021, and full cost synergies from the IHS Markit merger are yet to materialize.
Created and calculated by the author based on SPGI's financial reports and the author's projections
Taking a WACC of 7.6%, I estimate SPGI's fair value at $132.4B or $412.6 per share, which represents a 22.2% upside compared to its market value at the time of writing. This valuation represents a 32.9 P/E multiple on my 2023 earnings projection, which is in line with the company's 5-year average.
At the time of writing, SPGI is trading slightly below its 5-year average forward P/E ratio, and 17.2% below its 52-week high. I believe 2022 marked a bottom for the company's results, with a mix of merger costs, significant AUM declines, and a huge slowdown in global debt issuance. The company is now positioned and priced for great returns for the foreseeable future.
One important thing to emphasize is that I don't expect SPGI stock will reach my fair valuation in a matter of a week or month. It's going to take at least a few quarters as investors await clarity regarding the company's margins and the timing of recovery in the company's economy-sensitive businesses. The stock may very well drop significantly if we experience a market drawdown or if the Fed decides to raise rates more than expected, which will result in continued depression in the debt market.
Risks
One of the main concerns of investors in data and analytics companies is the rise of AI. Supposably, improvements in Chat-GPT-like products could reduce the need for professional analysts, which is one of the main assets of companies like S&P Global. However, it's important to understand financial AI is materially different from other information cohorts, and it requires specific computing. Regarding that, SPGI is actually one of the leaders, with its acquisition of the Kensho AI company.
Let me first give you a number of data points in terms of what Kensho is exactly doing today for the organization. So a product called Kensho link has saved over 2-million-hour ingesting data sets, strategic data sets, expanding data sets for our customers. Also, link has at this moment achieved 1 million unstructured private market, private entity data into our database, into our platforms, and connected to the market intelligence ID numbers of those entities. There are two other products called EXTRACT and NERD that have enriched 73 million documents on the Cap IQ Pro platform. It has ingested $10.5 million investment research reports on the Cap IQ Pro platform. And Scribe, which is our language speech to text model, is saving 250,000 hours of men work per year for transcripts. Annual savings of that are approximately $9 million.
Kensho is today already developing a financial language model called FinLM, which is trained on the S&P Global data assets. It's very expensive to develop large language models. The cost of the compute is very high. But if you have stronger data sets, higher quality data sets, actually that's a differentiating factor. So we're avoiding very significant compute time and costs. Kensho is developing something new. That's the Kensho Solver which is the AI solution to answer the most complex financial number questions.
--- Ewout Steenbergen, Executive Vice President & CFO, Q4-22 Call .
Another cause for concern is a worse-than-expected economic environment. For 2023, SPGI's management is expecting 2.2% global GDP growth, a 0%-2% market increase, United States CPI at 4.3%, and global market debt issuance to grow by 2.5%. A more severe recession or a slower recovery in debt issuance are clearly contracting factors for the company's results. That being said, the company has demonstrated its resiliency in 2022 despite very difficult headwinds. Through its strong balance sheet and multi-decade businesses, it wouldn't be a bold take to say S&P Global will be able to withstand another difficult year and come out strong when the economy improves. Unexpected changes in the economy could affect the near-term numbers, but over the long term, I wouldn't say this is an issue.
Conclusion
Times of uncertainty are usually the best times to buy long-term compounders like S&P Global Inc. I can't predict when the debt market stabilizes and recession fears evaporate, but when that happens, patient SPGI investors will be major beneficiaries. This isn't a cyclical company on one of its many down cycles, this is a very steady 150 years old company with one or two years of underperformance as a result of the unique macroeconomic circumstance. As S&P Global Inc. stock trades 22.2% below my estimated fair value, I rate SPGI stock a Strong Buy.
For further details see:
S&P Global: Behind Its Pro Forma 2022 Mess Hides A Strong Buy