Is CME Group Stock Fairly Priced?

[Updated 12/17/2021] CME Group Valuation Update

CME Group stock (NASDAQ: CME) has gained 26% YTD, and at its current price of $229 per share, it is trading at the same level as the fair value of $229 – Trefis’ estimate for CME Group’s valuation.  The exchange posted better than expected results in the third quarter of 2021, with net revenues increasing 3% y-o-y to $1.1 billion. It was driven by a 5% y-o-y growth in the clearing and transaction fees, partially offset by lower other revenues. The clearing & transaction fees benefited from higher average daily volume (ADV) in interest rates and energy contracts, leading to a 14% y-o-y rise in aggregate ADV. Further, the company reported a 125% y-o-y increase in the adjusted net income to $926.5 million. This was due to higher investment income, followed by a net gain of $343.5 million on the deconsolidation and contribution of the optimization business to OSTTRA (Note – OSTTRA is a joint-venture between CME Group and IHS Markit which offers post-trade Services for OTC Markets).

Exchanges benefited from higher trading volumes in 2020, due to the Covid-19 crisis and the economic slowdown. However, CME Group managed to post a slight growth in the year. It was because of a slight drop in the clearing & transaction fees, which overshadowed the increase in non-trading revenues. The trading revenues suffered due to lower ADV in interest rate contracts and a decline in the average rate per contract. Further, the same trend continued in the first three quarters of 2021, with cumulative nine months revenues decreasing by 6% y-o-y to $3.5 billion. The clearing & transaction fees declined 8% y-o-y to $2.8 billion due to a 3% decline in the ADV. We expect the same trend to continue in the fourth quarter, enabling the CME Group revenues to remain around $4.7 billion – almost 4% below the previous year’s figure. Despite negative growth in revenues, the company’s net income margin is likely to improve in FY2021, resulting in a net income of $2.4 billion and an EPS figure of $6.60. This coupled with a P/E multiple of just below 35x, will lead to the valuation of $229.

Below you’ll find our previous coverage of CME Group where you can track our view over time.

[Updated 09/16/2021] CME Group Stock Is Trading 13% Below Its Fair Value

CME Group stock (NASDAQ: CME) has gained a meager 4% YTD, and at its current price of $189 per share, it is trading 13% below its fair value of $216 – Trefis’ estimate for CME Group’s valuation.  The stock has lost approximately 11% since its second-quarter 2021 results in July, despite outperforming the consensus estimates for revenues and earnings. It reported net revenues of $1.18 billion, which is marginally less than the year-ago period. This could mainly be attributed to a slight drop in clearing and transaction fees, partially offset by an 8% growth in market data and information services. The clearing and transaction fees suffered due to a 12% and 24% y-o-y drop in the equity indexes and metals average daily volume (ADV), respectively. This took away the positive effect of a 25% increase in the interest rates ADV. Further, the average rate per contract also witnessed a slight drop due to a shift in the product mix. On the flip side, the company reported a 1% y-o-y growth in the net income to $511 million, driven by some decrease in the operating expenses.

The company reported $4.9 billion in revenues for 2020 – marginally ahead of the 2019 figure. This was due to some negative growth in clearing and transaction fees. While all CME’s peers benefited from higher market volatility in 2020, leading to growth in clearing and transaction fees, CME suffered due to lower ADV in interest rate contracts and a decline in average rate per contract. The same trend continued in the first quarter of 2021, with total ADV decreasing by 19% y-o-y. However, ADV saw some recovery in the second quarter on a year-on-year basis. Moving forward, we expect the company to report stagnant growth in clearing and transaction fees. While the non-trading revenues are likely to see some growth in the year, the overall CME Group revenues are expected to remain around $4.9 billion – the same level as the previous year’s figure. Despite stagnant revenues, the company’s profitability numbers are likely to improve in FY2021 – net income is likely to grow 14% y-o-y to $2.4 billion. It will likely result in an EPS of around $6.61 in FY2021. This coupled with a P/E multiple of just below 33x, will lead to the valuation of $216.

[Updated 07/26/2021] What To Expect From CME Group Stock In Q2?

CME Group stock (NASDAQ: CME), the world’s largest financial derivatives exchange, gained roughly 18% – increasing from about $182 at the beginning of 2021 to around $216 currently, outperforming the S&P500, which grew 12% over the same period. The exchange has surpassed the consensus estimates over the last two quarters, mainly driven by strong ADV (average daily volume) growth on a sequential basis. This has led to positive investor interest in the stock.

There were two main reasons behind the rise in ADV on a sequential basis: First, the approval of the $1.9 trillion stimulus package. Second, the increase in retail investor participation.

But is this all there is to the story? 

Not quite, despite the recent gains, Trefis estimates CME Group’s valuation to be around $212 per share – slightly below the current market price, based on a key opportunity and one risk factor.

The opportunity we see is an improved trajectory for CME Group’s revenues over the subsequent quarters. The company reported $4.9 billion in revenues for the full year 2020, which is marginally ahead of the 2019 figure. The growth was restricted due to a slight drop in the clearing and transaction fees, which constitutes more than 80% of its revenues. The clearing & transaction fees for CME suffered in 2020, unlike its peer NASDAQ, because of lower contract volumes on a year-on-year basis driven by lower ADV in interest rate contracts. Additionally, its average rate per contract also saw a slight dip in the year.

The exchange posted better than expected results in the first quarter of FY2021. CME reported total net revenues of $1.25 billion, which is 18% less than the year-ago period. This could mainly be attributed to a 21% drop in clearing and transaction fees. While the ADV increased on a sequential basis, it dropped on a year-on-year basis – ADV in the first quarter decreased 19% y-o-y. The decline was a result of lower volatility as compared to the first quarter of 2020, as economic uncertainty regarding government policy and its impacts has declined. That said, trading volumes are expected to normalize with recovery in the economic conditions. But it is likely to take some time. Overall, we expect the CME revenues to touch $5.1 billion in FY2021 – 4% ahead of the 2020 figure.

The adjusted net income margin is likely to see some improvement in FY2021 from 43.1% to 49.1%. As a result, the company’s net income is likely to grow 18% y-o-y to $2.5 billion, leading to an EPS of $6.94. The EPS of $6.94, coupled with the P/E multiple of just below 31x will lead to a valuation of around $212.

Finally, how much should the market pay per dollar of CME Group’s earnings? Well, to earn close to $6.94 per year from a bank, you’d have to deposit about $694 in a savings account today, so about 100x the desired earnings. At CME’s current share price of roughly $216, we are talking about a P/E multiple of close to 31x. And we think a figure around that amount will be appropriate.

That said, a financial exchange is still a risky proposition. While growth is likely, change in current market sentiment can harm the near-term outlook. What’s behind that?

CME is heavily dependent on clearing & transaction fees, which, in turn, depends on ADV. The ADV benefited from higher retail investor participation over the recent quarters. While retail investor participation has significantly increased, it is also to be noted that they don’t have much loss-taking capacity. Hence, an unexpected course correction in the market can result in substantial losses for them, pushing them out of business, and hurting the trading volumes. To sum things up, we believe that CME Group stock is slightly overvalued. 

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[1] Month-to-date and year-to-date as of 12/17/2021
[2] Cumulative total returns since 2017