CME Group: Dollars in Derivatives

11/18/2015 8:00 am EST

Focus: STOCKS

Stephen Biggar

Director, Product Strategy, Argus Research Corporation

Our latest featured buy recommendation operates a futures and derivatives exchange and clearing company offering risk management products, notes Stephen Biggar of Argus Research.

We expect CME Group (CME) to benefit from hedging and speculative activities and look for further gains in contract volumes.

We believe that the revenue growth outlook is healthy for most CME products, which include derivative contracts related to interest rates, equities, foreign exchange, energy, agricultural commodities, and metals.

Volatility has remained high in many categories as investors hedge or speculate on market events, including the potential for higher interest rates, volatile oil prices, and currency movements.

The company also expects Asia to remain a key growth area over the next three-to-five years. We look for 8% revenue growth in both 2015 and 2016, to $3.3 billion and to $3.6 billion, respectively.

Our financial strength rating on CME Group is the highest on our five-point scale. The company scores above average on important financial criteria such as debt levels, interest coverage, and profitability.

In March 2015, the company raised its quarterly dividend by 6.4% to $0.50, or $2.00 annually, for a yield of about 2.1%.

The company has a strong record of increasing its payout; over the past five years, the dividend has grown at a compound annual rate of 18%. The payout ratio on projected 2015 earnings is 50%.

The company also occasionally pays an annual special dividend based on operating results, potential M&A activity, and other forms of capital return. It paid a $2.00 per share special dividend in January 2015.

CME’s P/E ratio of 22-times our 2016 EPS estimate is in the upper half of the historical range of nine-to-29.

However, based on favorable operating metrics and a healthy industry environment, we expect additional multiple expansion.

Compared to the peer group, CME shares trade at a premium P/E, which we think is warranted based on the company’s above-peer-average operating margins of 60%.

Our dividend discount model, which assumes annual dividend growth of 9% over the next five years, indicates a fair value of $110 per share. Based on our blended valuation analysis, we arrive at a target price of $107.

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