Interest Rate Products Drive CME’s Performance

CME group (NASDAQ:CME) released its quarterly earnings for Q3 2013 on November 4. As expected, its revenue increased almost 5% year-on-year on the back of higher transaction and clearing fees (+6.4%). Meanwhile, market data revenue dropped nearly 5% year-on-year, while all other revenues essentially remained flat. The growth in transaction and clearing fees was primarily driven by a 29% increase in interest rate contract trading volumes.

Going forward, we expect CME’s trading volume to continue growing as it continues to take market share in the European derivatives market, a segment that is growing rapidly. We have a revised price estimate of nearly $66 for the company’s stock, almost 10% below the current market price.

See our full analysis for CME group

Interest Rate Products Driving Volumes And Transaction Based Revenue

Interest rate contracts remain the largest and fastest-growing segment in CME’s business portfolio. Daily trading volume in these products averaged 5.8 million, which is almost 29% above its prior year level. Each of the four major components of this segment – Eurodollar futures, Eurodollar options, treasury futures and treasury options – are performing well, with volume growth in excess of 20% in each category during Q3. CME has also been performing well in the interest rate OTC (over-the-counter) clearing market as its market share in the dealer-to-client business increased from 5% in Q1 2013 to 33% currently. ^[1]

Going forward, we expect interest rate product volumes to continue increasing rapidly as the European OTC clearing mandate forces more OTC trades onto centralized clearing platforms, and as CME rolls out more innovative products to capture market share.

Revising Our Expectations For CME’s Margins

CME’s EBITDA margin for the first nine months of this year was around 69%, lower than our expectation of around 70% for the whole year. Increases in employee compensation and licensing expenses seem to be the major reason behind this drop. In Q3, employee compensation includes some deferred compensation while licensing fees has remained elevated due to the addition of OTC revenue share expense in that line item. Given that we are in the last quarter of the year, we do not expect margins to change drastically from these levels for the whole year, and have adjusted our projections accordingly.

Lower Capital Expenditures Likely To Boost Free Cash Flows

CME’s capital expenditures so far this year have been around $91 million, and management believes that it will end up between $130-$140 million, a little lower than our prior estimates. We have adjusted our projections to reflect the new data, and the update has caused our price estimate to increase by almost $2 per share.

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1. CME Group Management Discusses Q3 2013 Results – Earnings Call Transcript, SeekingAlpha, November 4, 2013 [↩]