Moody’s: Dominant Business But A Little Pricey (NYSE:MCO)

Thesis

Moody’s Company (NYSE:MCO) operates a duopoly with S&P World (SPGI) within the credit standing business. Moody’s is a dominant market chief with a large financial moat and a flawless observe document of capital allocation. Moreover, 69% of the corporate’s income is recurring, which I imagine ought to assist profitability throughout financial hardship. Regardless of Moody’s nice observe document, I assign a maintain as a result of the corporate appears pretty valued at $327 per share, plus MCO is not doing in addition to its competitor, SPGI. I’ll clarify every of the important thing drivers of my thesis under.

Firm Description

Moody’s Company is a world built-in threat evaluation agency offering credit standing opinions, analytical options, and insights that empower organizations to make higher, quicker choices. The corporate operates in two segments: Moody’s Analytics and Moody’s Funding Providers.

Enterprise Segments

Moody’s Analytics (52% Income, 37% Adjusted Working Revenue)

MA is a subscription mannequin with excessive retention charges. This section affords a gamut of risk-related knowledge and analytics content material, together with credit score analysis, quantitative credit score scores, economics analysis, enterprise intelligence, know-your-customer instruments, business actual property knowledge, coaching companies, ESG, and threat administration software program for monetary establishments. 94% of MA’s income is recurring. Section income elevated by 15% YoY, whereas complete income declined by 12%. I imagine that this section is about to learn from the rising curiosity in ESG. The corporate guided for low-to-mid-teens p.c progress within the medium time period in its investor presentation for Q1 23.

Moody’s Investor Providers (48% Income, 63% Adjusted Working Revenue)

MIS supplies traders with credit score scores, threat evaluation, and analysis for shares, bonds, and authorities entities. This section is closely influenced by macro circumstances. MIS’s income declined by 30% in 2022, primarily resulting from bond issuance. I imagine that as macro circumstances (rates of interest and inflation) get higher and GDP progress resumes, income ought to rebound. The corporate guided for low-to-mid-single-digit progress within the medium time period in its investor presentation for Q1 23.

Financial Moat

I assign Moody’s a large financial moat due to their community impact, intangible property, and toll moat. What do I imply by community impact”? Effectively, bond traders worth credit score scores and credit score scores present worth to bond traders, and so forth. The extra clients use Moody’s companies, the extra beneficial they change into. In my view, this can be very troublesome for a brand new firm to interrupt into credit score scores. It’d take them years simply to ascertain credibility, not to mention have repeated clients. Moody’s has been round for greater than 100 years. This implies the corporate has established relationships with hundreds of corporations and traders who worth their scores. The corporate’s model is related to credit score scores and credit score threat. A toll moat is when a enterprise is a provider of one thing the shopper wants. Bond traders and bond issuers aren’t the one ones that worth credit score scores. Index suppliers and authorities regulators do too. For instance, the Bloomberg U.S. Combination Bond Index solely considers scores from both S&P, Moody’s, or Fitch. This makes Moody’s companies a should if an organization or authorities desires its bond to be credible. I imagine that the aggressive benefits listed above will assist Moody’s maintain maintain of its market place within the close to future.

Capital Allocation

Moody’s has executed a surprising job of deploying its capital. The corporate has used capital for strategic acquisitions, dividends, and share repurchases. MCO has made three key acquisitions within the final six years. Bureau van Dijk, a European supplier of privately held firm knowledge, for $3.5 billion in 2017, RDC, a supplier of anti-money laundering and KYC instruments, for $700 million in 2020, and RMS, a supplier of local weather analytics, for $1.9 billion in 2021. The corporate had a dividend payout ratio of 37% in 2022. Moody’s has spent $3.4 billion on share repurchases within the final 5 years. This benefited EPS by reducing common diluted shares by 5% prior to now 5 years. MCO’s 5-year common ROIC is 23.08%. General, I feel the corporate has executed a superb job allocating capital and shareholders have benefited from that. I imagine that capital allocation is essential for a enterprise as a result of if an organization is profitable in reinvesting capital, it may well broaden its operations and return extra money to shareholders by way of share repurchase applications and dividends, and Moody’s has executed simply that.

Competitors

Moody’s has a number of opponents, together with Bloomberg, Morningstar, and Fitch. However maybe their largest competitor is S&P World. Under is a desk evaluating each corporations in some key objects.

Regardless of SPGI’s higher efficiency, each corporations’ shares have carried out pretty effectively prior to now 3 years. Moody’s inventory has outperformed SPGI’s prior to now 5 years by 2%. It’s value mentioning that SPGI’s income is extra diversified past scores and analytics. Plus, Moody’s is extra uncovered to macro circumstances. In 2022, Moody’s income declined by 12% because of the backdrop within the bond market, whereas SPGI’s elevated by 22%. In 2020, SPGI accomplished its merger with IHS Markit to broaden its analytics section and diversify the enterprise much more.

Valuation

Moody’s inventory is presently buying and selling at a P/E ratio of 37x and an EV/EBITDA ratio of 29x. Each ratios are buying and selling above their 5-year common. Moody’s projected not less than 10% income progress for the subsequent 5 years of their Q1-22 investor presentation, however income declined by 12% in 2023. The corporate stored the identical steering of their Q1-23 investor presentation, which tells me they’re fairly assured about progress regardless of the income slowdown. My assumptions are that MA’s income will develop at a CAGR of 10% within the subsequent 5 years and MIS’s by 8%, which interprets into complete income rising at 9.5%. Given these assumptions, I used to be capable of forecast the corporate’s financials 5 years into the longer term. Utilizing a reduction fee of seven.5%, I discounted the money flows and terminal worth again into the longer term. Provided that, I bought an fairness worth of ~$52 billion, or $285 per share, which represents a draw back of 13% from the present value of $327.

Why Maintain?

A few of you may be questioning why I assigned a maintain if there’s a 13% draw back and never a promote. Effectively, let me clarify. A 13% draw back for me would not essentially imply one has to promote the inventory; it signifies that now is not a superb time to purchase in. Plus shares, comparable to Moody’s, have been nice compounders for years. In my view, the present value would not look very engaging because the inventory is buying and selling near its 52-week excessive, and primarily based on its buying and selling historical past (P/E and EV/EBITDA), it appears overvalued.

Dangers

1) Every so often, you see a narrative within the press criticizing Moody’s scores. In January 2017, Moody’s entered into an $864 million settlement with the U.S. Division of Justice and attorneys common from numerous states regarding civil claims on structured finance scores. The corporate additionally gave SVB Financial institution a credit standing of A earlier than it collapsed again in March.

2) Moody’s publicity to bond issuance is not any joke and must be taken significantly. Bond issuance might be influenced by macroeconomic variables comparable to rates of interest, inflation, and credit score spreads. 31% of Moody’s income comes from transaction-based sources. The first driver of transaction-based income is new issuance. As new issuances decline, so does Moody’s income.

Conclusion

The underside line is that Moody’s has a superb enterprise mannequin underpinned by a large financial moat. MA nonetheless has extra room for progress. I imagine that top recurring income from MA ought to assist offset some losses within the MIS section. I anticipate the MIS section to get better as macro circumstances get higher. Administration has executed a superb job of returning money to shareholders by way of dividends and share buybacks. I assign a maintain on the corporate resulting from its present value (pretty valued), and buying and selling multiples. As at all times I’ll go away you with a quote.

“The inventory market is a tool to switch cash from the impatient to the affected person.” – Warren Buffet