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ICE

1 Number I'm Watching at Intercontinental Exchange

Volatility is a great thing for stock exchanges. It certainly has been for Intercontinental Exchange (NYSE: ICE), where big jumps in trading volume in March helped make its first-quarter report one for the ages. Did the company pull a repeat in the second quarter? We'll find out soon when it reports earnings on July 30. Here is what I will be looking for.

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Volatility should help

Intercontinental Exchange is one of the world's leading operators of securities exchanges and financial data providers. The company has grown largely by acquisition from an over-the-counter energy trading exchange to its modern form, which encompasses venerable exchanges such as the New York Stock Exchange, the New York Board of Trade, and Euronext. As it has grown, ICE has ventured into mortgage operations, with its ownership of the Mortgage Electronic Registration Systems (MERS), a sort of clearinghouse for mortgage data. ICE also owns Simplifile, which helps automate the home purchasing process.

Market turmoil in March helped drive record results in the first quarter as trading and clearing revenue increased 44%. Overall revenue rose 23% to $1.6 billion, while earnings per share were up 38% to $1.17. Given the chaos in the market throughout April and May, volatility should have another positive impact on the company. The pain in the credit markets should drive volume for credit default swaps and other credit derivatives.

The mortgage business will be on fire this year

The mortgage arm of ICE should perform well in this low-interest-rate environment. On the first-quarter earnings call, management expected mortgage services to contribute $170 million in revenue this year, a 21% increase from the prior year. With the additional benefit from a mass refinancing wave, there should be upside to that number. In addition, ICE will benefit from a general trend toward automation in the mortgage industry. CFO Scott Hill had this to say on the earnings call regarding the mortgage business: "Our mortgage services business benefited from strong refinancing trends as well as continued adoption of digital mortgage solutions. Recent events have highlighted the urgent need for further automation in the mortgage industry, and our investments position us well to help facilitate the necessary evolution."

A new competitor

The New York Stock Exchange will experience new competition when the Members Exchange opens in September. The Members Exchange is made up of a consortium of big banks and big buy-side accounts. One member is Virtu Financial, one of the biggest high-frequency traders on the stock exchanges. If Virtu ends up routing all of its order flow to the new exchange, that could have a material effect on Intercontinental Exchange's revenue. In addition, if Members Exchange provides cheaper data, then Intercontinental Exchange could lose some share there.

But revenue growth is key

The biggest number I will focus on is revenue growth. Currently, the Street is looking for $1.4 billion in Q2 revenue, which would be a decrease from the $1.6 billion the company reported in Q1. With the continuing volatility, Intercontinental Exchange should come in similar to the first quarter. In the second quarter of 2019, Intercontinental Exchange reported $1.3 billion in revenue. First-quarter revenue was up 23% year over year, and a similar increase would put second-quarter revenue at $1.6 billion, or flat sequentially.

Intercontinental Exchange is trading around 21 times expected 2020 earnings per share, and its dividend yield is 1.2%. It's probably fairly valued at these levels. If revenue growth disappoints, it would be hard to get excited about the stock. While the mortgage business does provide an interesting avenue for future growth, it's still a small fraction of the company's business. The company will still be driven by trading volume and the addition of new products.

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Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Intercontinental Exchange. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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