We are downgrading our recommendation on
CME Group Inc.
) to 'Underperform' from 'Neutral' based on its disappointing
first-quarter 2012 earnings that lagged on a year-over-year basis.
Lower-than-expected volumes, clearing and transaction fees and
higher operating, non-operating and tax expenses affected the top
line and operating margin.
CME reported its first-quarter 2012 operating earnings per share
of $4.02, which were at par with the Zacks Consensus Estimate, but
lagged the year-ago earnings of $4.36 per share. Net income slipped
8.9% to $266.6 million.
CME's diversified product portfolio is significantly exposed to
extreme interest rate volatility, firm government regulations and
limited credit availability in the current unstable capital and
credit markets, which can hamper liquidity and can lead to a
decline in the customer demand. Although the company has
diversified product offerings, it is still immensely dependent on
the trading volume of two product lines - interest rate swap and
equity - for a significant portion of its clearing and transaction
fee revenues, which again contributes significantly to net
Moreover, the trading activity is inherently variable, both
seasonally and cyclically, whereas many of CME's costs are fixed.
Besides, the ongoing consolidation in the industry remains a
challenge for further market share gains. Recently, arch-rival
) launched competitive grain derivative contracts with lower margin
costs and expanded trading hours that also impelled CME to follow
suit. Moreover, the company also failed to takeover London Metal
Exchange that could boost the former's Comex metal exchange.
Nevertheless, on the positive side, CME holds 98% market share
of the U.S. futures trading with a clearing house notional value of
over $35 trillion. Operating leverage is another key positive.
Increased electronic trading volume adds scalability (and hence
leverage) to CME's operating model and has also helped the company
maintain an operating margin of over 60% coupled with consistent
bottom-line growth, in the past 4 years. Besides, the BM&F
Bovespa exchange in Brazil, non-transaction related opportunities
and potentially the over the counter ("OTC") offerings should
continue to contribute modestly to the top-line growth in 2012.
Although market volatility, increased competition and regulatory
concerns are pruning CME's industrial position, it has been able to
reduce its total debt to $2.1 billion in 2011 from $2.5 billion in
2010. Further, the company had excess borrowing capacity for
business operations of approximately $1.0 billion at the end of
Overall, the company's efforts to promote, expand and cross-sell
its core exchange-traded business through strategic alliances,
meaningful acquisitions, newer product initiatives along with its
global presence should drive decent growth in the long run.
The Zacks Consensus Estimate for CME's second-quarter 2012
currently stands at $4.01 per share, down about 8.4%
year-over-year. For 2012, the Zacks Consensus Estimate stands at
16.51 per share, down 3.1% over 2011.
CME currently carries a Zacks #4 Rank, which implies a 'Sell'
rating for the short term.
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