CME Group Inc. (CME)

November 8, 2018

COMPANY DESCRIPTION

CME Group Inc. is one of the world’s largest derivatives marketplaces. The Company supports trading in a wide variety of interest rates, equities, energy, commodities, foreign exchange and metals. CME products can be traded almost around the clock or through its trading floors in either Chicago or New York. It also operates one of the largest counterparty clearing services with the capacity to clear transactions both on and off exchanges. CME was established in 1898 and went public in December 2002.

INVESTMENT THESIS

We expect CME to continue to report strong volume growth driven by volatility in the foreign exchange and interest rate markets, higher volume in certain equity markets (Russell 2000, FTSE), the continuing globalization of the energy benchmarks and more over-the-counter clearing services. The shares also offer a dividend yield of 1.6% and are typically categorized as growth-income. In sum, we view favorably the company’s solid growth prospects, carefully managed expenses, improving margins and strategic efforts.

RECENT DEVELOPMENTS

On October 25, the company reported third-quarter operating earnings of $1.45 per share, up from $1.19 in the same period a year earlier and above the consensus estimate of $1.43. Third-quarter results exclude a $0.24 per share charge for the amortization of purchased intangibles and acquisition-related costs, down from $0.28 a year earlier.

Third-quarter revenue increased 2% to $904 million, growth was across the board with the exception of clearing and transaction fees. Average daily contract volume decreased 1% to 15.6 million, while the average rate per contract rose from $0.749 to $0.753.

Adjusted operating expenses rose 1% on higher compensation costs and professional fees, while adjusted net income climbed 22% to $495 million.

In March 2018, CME agreed to acquire NEX Group in a transaction worth $5.5 billion. Headquartered in London, NEX offers electronic FX and fixed-income cash execution platforms. The acquisition is expected to be completed during the fourth quarter of 2018.

EARNINGS GROWTH & ANALYSIS

CME expects a tax rate of 25% in 2018, down from 35% in 2017, helped by the passage of the Tax Cuts and Jobs Act on December 22, 2017. We look for trading volumes to remain solid. We are raising our 2018 EPS estimate to $6.80 from $6.30 and our 2019 forecast to $7.40 from $6.70. Our long-term EPS growth rate projection is 9%.

RISKS

Risks to our estimates and price target include low interest rates, regulatory changes to market structure and counterparty credit risk. A sharp decline in any of the company’s markets could result in lower volume for a sustained period of time.

VALUATION

CME shares are trading at the top of their 52-week range of $136-$188, and at 25.5-times our 2019 EPS estimate. We believe the company’s above-average earnings growth, strong operating margins and returns on invested capital warrant an above-average forward P/E. Multiplying our revised 2019 earnings estimate by 30.4 generates a valuation of $225. Our target, if achieved, offers investors the prospect of a nearly 21% return, including its dividend.

CME Group Inc. (CME)
Current Price: $188.69
Target Price: $225
Current Valuation: 25.5 times FY19 EPS
Target Valuation: 30.4 times FY19 EPS