- Shares are down by about a quarter in 2022
- Drainage works have wide ditches
- Trading activity has grown strongly
It’s been a tough year for her CME (US: CME) Despite some impressive financial performance. With shares down nearly a quarter in 2022, could this present an opportunity for investors seeking access to massive power in trading futures, options, cash and over-the-counter (OTC) products?
There are two aspects that indicate that CME will be in a good position to catch the slump and benefit from the next cycle. First, businesses are naturally largely insulated from a downturn because this usually leads to more trading and more volatility. Just check out 2020. Second, it provides continuous product innovation and a wide moat built from some of the most important and heavily traded exchanges and OTC markets, particularly the most traded futures and related options contracts.
Talk about the trench? The business includes the Chicago Mercantile Exchange (CME), the City of Chicago Board of Trade (CBOT), the New York Mercantile Exchange (NYMEX), and the Commodity Exchange (COMEX) as well as the business of money markets, central clearing houses and more. divisions. Running several futures exchanges was the perfect solution, but there is growing excitement among clients about its integration with NEX’s Electronic Broking Services (EBS) FX platform, which enables CME to go toe-to-toe, or even beat Refinitiv in forex trading.
Finally, it is the dominant and largest derivatives exchange in the United States. It is worth noting that in this year of great turmoil in the bond market, it is the right place for companies to manage interest rate risk, which suddenly came to the fore. The moat of CME stems from its size, which means better liquidity, pricing, and a wider range of assets and derivatives to trade, generating further growth and the ability to add new products.
slack elasticity? Volatility in the financial markets tends to be positive for the CME. Doubt would be if the Fed decides to cut interest rates back to zero, which is certainly a far fetched situation. Price uncertainty is likely to persist for years as we enter a new macro dynamic.
Evaluation concern? This would be a reasonable concern. The Chicago Mercantile Exchange trades at about 23 times earnings, which outperforms its peers. Meanwhile, earnings per share (EPS) is expected to grow 2.4 percent annually for each of the next three years, versus more than 9 percent for peers.
Recent results have been encouraging, however, and suggest the valuation may be justified with 50 percent earnings growth in the past year. Volumes are rising across the various components of the business. For example, in stock index activity, the first three quarters of this year were the first, second, and third largest quarters on record for average daily volumes (ADV); Same for stock index options.
In the year-to-date for the third quarter (Q3), total ADV increased 44 percent and options ADV increased 74 percent compared to the same time frame last year. “It is important to note that our growth is driven not only by volatility, but also by product innovation,” notes Tim McCourt, Global Head of Equity and Foreign Exchange Products.
For example, one of the most successful innovations was the launch of the Micro E-mini (future products smaller in size) in 2019. “We view the micro as a useful tool to continue to attract new international customers and US residents, given its size,” says McCourt. Smaller contract and lower upfront financial commitment.”
Due to the premium pricing of these, against benchmark stock prices, the $3.2 million small equity contracts traded per day are equivalent in revenue to nearly $1 million E-mini contracts (the E-mini contracts are the same as an earlier generation of contract-making innovation futures trading is affordable for investors outside of large institutions), despite being one-tenth of the theoretical size. In general, premium products like these S&P 500 futures and more specialized adjusted total interest rate futures, sector futures, and dividend futures charge three to four times the benchmark stock price.
Interest rates, stocks and forex products are at peak levels for large open interest holders with interest rate products at all-time highs. In addition, the third quarter marks the fifth consecutive quarter of total ADV growth year-over-year. FX has gone “alive” and the sector’s ADV is up 41 percent.
Fixed income trading also remains positive. ADV interest rate futures and options rose 28 percent in the third quarter. The Chicago Mercantile Exchange has now posted six consecutive quarters of double-digit year-over-year growth for the asset class. The tailwind must continue.
“All Open Market Committee [the Federal Reserve’s open markets committee that sets US target interest rates] The meeting is in progress and with inflation high and uncertain, every jobs report and every CPI reading matters. You can see this very clearly with 34 million contracts trading in a single day on October 13th, after the CPI release, and uncertainty could remain here for years as inflation ratings for rents and shelter tend to delay the real economy by up to 18 months,” Sean Tully , global head of pricing and OTC products, noted on a recent earnings call.
In total, the third quarter recorded revenue of $1.2 billion (£1.0 billion) and operating income of $739 million for the third quarter of 2022 which was driven by a 26 per cent growth in total trading activity.
As of the end of last quarter, the company had about $2.2 billion in cash and $3.4 billion in debt. The company paid a dividend during the third quarter of approximately $363 million. Shareholder returns depend on strong and continuous cash generation and relatively low capital expenditure requirements. The company has returned more than $18.8 billion to shareholders in dividends since implementing a variable dividend policy in early 2012. Capital expenditures in the third quarter were just $20 million.
Deutsche Bank analyst Brian Bedell recently upgraded CME to Buy from Hold, after the stock’s drop of nearly 33 percent from its 52-week high in March indicated there was now a more positive risk-reward equation.
In light of its roughly 5 percent dividend yield, Biddle said in a note to clients, “We view the stock as offering excellent value with a strong income stream, which could easily become more attractive should the challenging market and macro backdrop continue for some time.” He also believes there is a “modestly better” volume outlook for CME.
With relatively low capital requirements to generate free cash flow growth and consistently high profits, and a relatively secure position as the premier derivatives market in the United States, the CME appears well-positioned, but valuation may still be a concern.
More of Neil Wilson’s analyzes of US stocks are featured in Investors’ Chronicle Alpha. The service also regularly scans the S&P 500 for US stocks that have quality, affordable growth characteristics and earnings promotion momentum.