2023-05-08 05:06:42 ET
Summary
- S&P Global reported its Q1-23 results, demonstrating a deflated rating market as debt issuance remains low, and ongoing integration efforts post the IHS Markit merger.
- Market Intelligence revenues grew by 5.1%, Ratings revenues decreased by 5.1%, Commodity Insights increased by 9.0%, Mobility grew by 10.5%, and Indices stayed flat at 0.6%.
- Besides Ratings, every segment saw Adj. EBIT margins increase, but there's still significant room for expansion en route to reaching the management's 2025/2026 targets.
- Even after a 23.5% increase since October 2022 lows, the market is still not fully pricing in S&P Global's long-term potential.
- I reiterate a Strong Buy rating with a fair value estimate of $414.8 per share, reflecting a 17.1% upside.
S&P Global Inc. ( SPGI ) reported Q1-23 results that beat expectations, as pro-forma revenues grew by 3% to $3.1B, and Adj. EPS came in at $3.15, a $0.23 beat. Additionally, the company reaffirmed its guidance for 2023 and announced the divestiture of its Engineering segment, which should result in $750M of after-tax proceeds.
As the company continues to make progress toward its long-term goals and the integration of IHS Markit, the market environment is still putting pressure on the company's core segments in Ratings and Indices.
Even after a 23.5% increase since October 2022 lows, the market is still not fully pricing in S&P Global's long-term potential. Thus, I reiterate a Strong Buy rating with a fair value estimate of $414.8 per share.
Background
A month ago, I published an article covering SPGI and rated the stock a Strong Buy, as I estimated 2022 marked a bottom year for the company. I urge you to read that article, in which I explained my investment thesis thoroughly, as well as described the company's operating segments, revenue streams, and major risks, and provided a detailed competitor comparison.
In short, my investment thesis regarding the company is based on its ability to withstand tougher economic periods and come out on top, as a much stronger and resilient enterprise. With 81% of its revenues coming from recurring arrangements, every segment of the company besides transaction-based ratings grew in 2022, despite one of the worst years for the markets in history.
Regarding valuation, I showed that SPGI traded at a discount compared to what I view as lower-quality competitors, and I estimated there was significant room for upside, as the stock traded 18.2% below its fair value at the time.
After a 5.0% increase since the last article, it's time to focus on the company's results and provide an updated analysis. Spoiler alert: As the company still trades at a discount, I reiterate a Strong Buy rating and reaffirm my price target.
Q1-23 Highlights
I have to say, for a financial analytics company, S&P Global's financial reports post the IHS Markit merger sure make life hard for analysts. There are a whole lot of adjustments, non-GAAP metrics, and many many data points. I tried to make sense of all the pro-forma mess in my previous article, and while I'm not a huge fan of adjusted numbers myself, the post-merger GAAP financials are too misleading, so we are forced to rely on the company's adjustments.
Financial Results
S&P Global reported consolidated revenues of $3.2B, a 3% increase from the prior year period. Based on its historical seasonality, the group is on pace to deliver 4.7% adjusted revenue growth for the entire year (11.0% on a reported basis). I'm glad to see the company is on pace to meet my $1.4B sales estimate, which means it's on pace to beat the initial consensus expectations as well.
Created by the author using data from SPGI financial reports
As we can see, besides Ratings, every segment saw revenue growth compared to the prior year period. Market Intelligence increased by 5.1%, Ratings decreased by 5.1%, Commodity Insights grew by 9.0%, and Mobility grew by 10.5%. Indices grew by 0.6%, as linked AUM decreased by 6%. If the markets continue to trend upward, we might see growth acceleration in the segment in the very near future. However, there's some lagging effect there, and clearly, we can't foresee how the markets will perform in the near term.
Created by the author using data from SPGI financial reports
Looking at Adj. EBIT per segment, we see an even better picture, as margins increased across the board, except for Ratings. Market Intelligence Adj. EBIT increased by 16.3%, reflecting a 3.0 percentage point margin expansion. Ratings Adj. EBIT decreased by 6.4%, with an 85 bps margin contraction. Commodity Insights Adj. EBIT grew by 17.0%, reflecting a 3.1 percentage point expansion. Mobility Adj. EBIT grew by 14.8%, with a 1.5 percentage point expansion, and Indices Adj. EBIT increased by 4.3%, reflecting a 2.5 percentage point improvement in margin. On a consolidated basis, Adj. EBIT grew by 2.9%, and the Adj. EBIT margin increased by 1.0 percentage point.
Billed Issuance
Continued pressures due to persistent higher interest rates and still relatively high inflation continue to weigh down on global debt issuance, and early signs of recovery in Q1 were watered down with the regional bank crisis.
S&P Global Q1-23 Investor Presentation
Despite the tough environment, S&P Global's management forecasts positive billed issuance growth for the company in the range of 3%-7%, based on their underlying projection that global issuance (which includes issuance that isn't billed by the company) will decrease by 3.5%.
Integration
The company's management has set clear targets for the integration of IHS Markit in 2023. First, they targeted $600M in cost synergies to be achieved in 2026. Second, they target $350M in revenue synergies by 2026, with $157.5 achieved by 2024. As of Q1-23, S&P Global reported it already achieved 85% of its cost synergies target for 2023, and it's on track to achieve its 2024 revenue synergies goal.
Economic Factors Affecting The Company
With its 5 continuing segments, S&P Global is exposed to many different and sometimes contradicting market trends. Generally, I prefer to invest in companies that aren't significantly sensitive to external factors beyond their control, as I view it as a representation of lower quality. Many companies I cover, like LVMH ( LVMHF ) and Ferrari ( RACE ) are essentially numb to external factors. With S&P Global, that is not the case.
The company's Ratings segment is sensitive to two major factors. One, the cost of debt (which is a complex factor that reflects, among others, the federal interest rate), and Two, the macroeconomic environment. As a recession looms, debt issuance is deflated not only because the cost of debt is high, but also because the desire for investing in new projects is lower. Additionally, the company's Indices business is very sensitive to the market, as SPGI makes money off of AUM-based fees.
Other company segments might have titles that insinuate sensitivity to external factors like Commodity Insights, Market Intelligence, and Mobility, but those are actually exposed to similar risks to other software companies, like tightened consumer budgets.
So the question is, what's different with S&P Global, and why do I deviate from my general strategy. The answer is, I don't think I am actually deviating with S&P Global. It's true that the company is sensitive to some external factors, but these are factors that have very steady upward trends throughout history. Yes, the upward trend stops occasionally due to major significant events, like what we're seeing now. However, these events occur maybe once in a decade, and S&P Global has always come out stronger from the other side of the crisis.
S&P Global Q1-23 Investor Presentation
Updated 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 6.6% between 2023-2030, 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 52.3%, 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 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 $133.0B or $414.8 per share, which represents a 17.1% upside compared to its market value at the time of writing.
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 months. 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.
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 S&P Global 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. The company is now positioned and priced for great returns for the foreseeable future. Thus, I reiterate a Strong Buy rating for the stock.
For further details see:
S&P Global: Significant Upside Despite Near-Term Headwinds