Moody’s is a credit rating, research, and risk analysis firm. The company provides credit ratings and related research, data and analytical tools, quantitative credit risk measures, risk scoring software, and credit portfolio management solutions and securities pricing software and valuation models. Moody’s Investors Service (MIS) provides credit ratings and research covering debt instruments and securities, and Moody’s Analytics (MA), offers leading-edge software, advisory services and research for credit and economic analysis and financial risk management.
Business overview – capturing the opportunity in Asia
Moody’s is in a strong position to capture the increasing demand for credit analysis and risk products and services in the developing world, their GDP expands at a faster pace as their capital markets evolve. By way of example in 2014, Moody’s generated $6 of revenue per $1 million of outstanding debt in Asia compared to $34 in the US.
The company sees two main growth opportunities for its Moody’s Investors service (MIS) business in the developing world; 1) global cross-border debt ratings and 2) domestic debt ratings. From 2008 to June 2014, the MIS emerging markets business compounded revenues at an impressive 18% per annum. This is a high growth geographic region, but at the moment represents a small portion of overall revenues and immaterial to really move the needle in the short term. With economic growth expected to be much faster in China and India compared to rest of the world’s major economies, this represents exciting markets for the company to expand into.
We are attracted to Moody’s business model and long-term growth opportunities with the potential to translate into the low double digit revenue growth through a mix of secular and cyclical drivers.
Moody’s is widely recognised as operating in an oligopolistic industry as the second biggest credit rating agency (CRA) dominating the global financial markets. The leading two ratings agencies market shares have remained relatively stable at nearly ¾ of the total share. This is a business with an attractive economic moat through strong industry characteristics, inelastic pricing and high barriers to entry. With increasing regulation and associated costs for financial institutions we view this as reinforcing the significant barriers to entry for new competitors.
Moody’s business fundamentals
An attractive level of recurring revenue, set to grow in the mid-single digits, provides good revenue and earnings visibility. As outlined in the long-term guidance below by division, the company benefits from the relative price inelasticity for its products and services, a very appealing trait that highlights the strength of its business model.
|Figure 1. Moody’s Revenue Quarter 1 2015|
|Source: Company Investor Presentation|
How has Moody’s performed year to date?
Moody’s has rallied from a low point of $85 earlier in the year to its current level of $110. Investors have become very excited about quality businesses like Moody’s and are prepared to pay a high valuation premium vs lower quality stocks per graph below.
|Figure 2. Valuation Spread Between High and Low Quality Stocks|
|Source: SG Cross Asset Research/Equity Quant|
We are pleased that the fund has taken advantage of the pullback during the earlier part of the year when we added to our positions in the $84-$93 level range. With the stock currently at $110 we are not adding to the 3% position within the Clime International Fund, trading at 21 times next year’s earnings and currently showing a profit on book cost of 10%.