2023-09-04 08:58:35 ET
Summary
- S&P Global experienced a decline in organic revenue growth in FY22, primarily due to weaknesses in the Ratings business.
- The Rating business is expected to stabilize due to factors such as refinancing demands, S&P's pricing power, and peaking interest rates.
- S&P Global's other business lines, including Market Intelligence, Commodity Insights, Mobility, and S&P Dow Jones Indices, are expected to continue growing and benefit from recurring revenue and structural growth tailwinds.
S&P Global ( SPGI ) is a conglomerate of five exceptional businesses, comprising Market Intelligence, Ratings, Commodity Insights, Mobility, and S&P Dow Jones Indices. S&P Global maintains a dominant position in each of these sectors, delivering distinctive services to its clientele. However, their business experienced a -4% decline in organic revenue growth in FY22, primarily due to weaknesses in the Ratings business. Starting from Q2 FY23 , S&P Global has shown positive growth in its Ratings business, and I anticipate that the global debt issuance will begin to stabilize. Consequently, I believe that S&P Global should be capable of achieving double-digit growth over the long term.
Weak Rating Business Caused by High Interest Rate
The global credit rating business is primarily dominated by just three key players: S&P Global, Moody’s (MCO), and Fitch. In most debt issuances, the issuer is required to obtain a credit rating report as part of the underwriting process. According to S&P Global’s management team, global debt issuance is closely linked to global GDP growth over the long term. The Rating business accounts for over 27% of S&P Global's total revenue, and its growth is propelled by factors such as debt issuance volume, pricing, and market share gains.
In FY22, S&P's Rating business experienced a significant 26% organic decline, which in turn dragged down the group's overall organic growth to -4% for S&P Global. The weakness in the S&P Rating business is closely tied to the sluggish state of the debt insurance market. According to SIFMA , the total value of U.S. fixed-income securities insurance plummeted from $13.4 trillion in 2021 to $8.9 trillion in 2022.
Sifma US Fixed Income Issuance Report
Stabilization of Debt Issuance
Starting from Q2 FY23 , S&P Global has begun to show positive organic sales growth in their Rating business. During their earnings call , their management pointed out the stabilization of corporate issuance, encompassing both high yield and investment-grade issuance. They also provided guidance of 4% to 8% growth in the rating business for the full year.
I believe that S&P Global's Rating business should begin to stabilize for several reasons:
Refinance Demands : Corporates typically cannot postpone refinancing activities for their long-term debts. As these debts approach maturity, they are obligated to either refinance them or repay them. S&P Global's July refinancing study indicates a significant demand for refinancing over the next five years. Furthermore, S&P Global's management anticipates that these refinancing demands will become more frequent as the market adjusts to the new normal of high interest rates. This suggests a steady source of business for the Rating segment.
SPGI Q2 FY23 Investor Presentation
S&P's Pricing Power : S&P Global, being a market leader, possesses the ability to raise prices for its credit rating services. I believe that these price increases can help counterbalance any weaknesses in the insurance segment. The competitive landscape in the credit rating industry has remained relatively stable over the past decade, with limited new entrants. This stability has allowed incumbent players to maintain strong pricing power over their customers.
Peaking Interest Rates : Recent data shows that U.S. core inflation remained at 0.2% month-over-month for both June and July. If this trend continues with another month of 0.2% increase, it becomes highly unlikely that the Federal Reserve will raise interest rates again. Additionally, the decline in new job openings in the U.S. starting from January 2023 suggests a cooling-down of the overall economy. It is possible that interest rates have reached their peak at this point. As rates begin to decline, I expect that debt issuance activities will start to recover, further benefiting S&P Global's Rating business.
S&P’s Other Business Lines
In addition to its credit rating business, S&P Global also holds outstanding portfolios:
S&P Global Market Intelligence : This business provides data and analytics to trading and investment professionals, governments, corporations, and universities. These data and analytics help customers manage risks, conduct valuations, and generate alpha. For instance, S&P Capital IQ is widely used in the investment field. Most services operate on a subscription-based model, making it highly recurring in nature. The business has been growing at a high-single-digit rate in the past, and I expect it to continue growing at a similar rate in the future.
Commodity Insights : S&P Global serves as a provider of information and benchmark prices for the commodity and energy markets. Similar to the Market Intelligence business, the majority of revenue comes from subscription-based services. Commodity and energy information, along with price data, are mission-critical for corporate hedging and energy production. Additionally, this business is highly recurring.
Mobility : In 2022, S&P Global merged with IHS Markit to form the Mobility business. It provides automotive information to auto OEMs, suppliers, dealers, retailers, and insurance companies. The Mobility business grew by 8% organically in FY22 and increased by 10% in Q2 FY23. S&P Global continues to witness growth in its CARFAX business and is experiencing growth in both dealer and automotive OEM customers.
Indices : S&P Global offers various indices for ETF managers and investors for benchmarking purposes. The S&P Dow Jones Indices are widely used in the investment field, and the business' growth is driven by the increasing popularity of ETFs and index funds. According to the Financial Times , the passive funds market share has risen from 16.8% in 2012 to 35% in 2022. Due to high fees and poor performance, I believe active investment will continue to lose market share to ETFs and index funds over the next decade. Therefore, I expect S&P Global's Indices business to remain strong.
In summary, I favor all five of these business lines because they are highly recurring and benefit from structural growth tailwinds.
Recent Financial Results and Outlook
S&P Global announced their Q2 FY23 results on July 27th, 2023. Their adjusted revenue grew by 7% year over year, and adjusted EPS improved by 11% year over year. Their management expressed signs of stabilization in the macro environment. As for full-year guidance, they reiterated their goal of achieving a 50-100 basis points margin expansion and 4%-6% adjusted revenue growth.
In my model, their estimated net debt leverage for FY23 is 1.2x, indicating a very strong balance sheet. The company expects adjusted free cash flow to be in the range of $4.2 billion to $4.3 billion in FY23, and they maintain their commitment to paying dividends and repurchasing their stock. I believe their capital allocation policy has remained consistent over the past decade.
Risks
Other than the rating business, I think S&P Global contains the following potential risks:
Volatility in Commodity Insights Business : As the Commodity Insights business provides information and benchmark prices for the commodity and energy markets, it might be impacted by fluctuations in commodity and energy prices. A relatively flat price trend in commodities and energy would be detrimental to S&P Global, as it would result in lower demand for commodity or energy hedging. Considering that subscriptions account for more than 88% of the total segment revenue, I wouldn't expect significant revenue fluctuations year over year.
Mobility Transactional Business : This business is somewhat tied to both new and used automotive sales. Additionally, 22% of segment revenues come from one-time transactional sales of data, which are linked to OEM marketing spending and safety recall activities. The Mobility business also includes some consulting and advisory services for automotive OEMs. These transactional aspects could exhibit volatility from year to year.
Valuation
In the DCF model, I estimate that S&P Global can achieve 11% normalized organic revenue growth and 1% growth through acquisitions. With margin expansion driven by operating leverage and effective corporate expense management, I project their EPS to grow at a mid-to-high-teens rate over the next decade.
SPGI DCF Model- Author's Calculation
S&P Global operates an asset-light business model with minimal capital expenditures. The model forecasts a free cash margin of 39.4% in FY32. Additionally, I've assumed a 10% Weighted Average Cost of Capital, a 4% terminal growth rate, and a 23% tax rate. According to my calculations, the fair value of equity is estimated to be $134 billion. Therefore, based on my estimates, the fair value per share is $428.
End Notes
In summary, I believe that the S&P Rating business is beginning to stabilize, and S&P Global is poised to achieve double-digit organic revenue growth. With high-margin operations, strong cash generation, and a superior growth rate across their businesses, I recommend a 'Buy' rating for S&P Global, especially when considering the valuation.
For further details see:
S&P Global: Rebounding From Weak Ratings Business