Expanding Into Cloud And Commodities Fuels Optimism Despite Analyst Divides

Key Takeaways

• Expansion into cloud services and investment in trading infrastructure are poised to bring technology advantages and improve client retention.
  
• Geopolitical uncertainties and the need for risk management are expected to drive higher demand for diversified product offerings, enhancing revenue growth.
  
• Reliance on Google Cloud and geopolitical tensions, alongside competitive and regulatory challenges, could impact earnings and market competitiveness.

Catalysts

Operates contract markets for the trading of futures and options on futures contracts worldwide.

• The robust growth in average daily volume (ADV) across all asset classes indicates a continued upward trajectory for trading volumes, positively impacting revenue.
  
• Record revenues in the physical commodities segment, driven by significant year-over-year growth in energy and metals products, suggest a strong revenue outlook in these higher-margin businesses.
  
• The expansion into cloud services through the partnership with Google Cloud, including building a new private cloud region and a colocation facility, is expected to offer next-generation technology advantages. This could enhance product development speed and offer significant cost efficiencies, ultimately impacting net margins positively.
  
• The geopolitical uncertainties and the financial environment that necessitates risk management are expected to drive higher demand for CME's diversified product offerings, bolstering future revenue growth.
  
• Investment in state-of-the-art trading infrastructure and the unmatched capital efficiencies provided to customers, particularly through interest rate futures and options, could enhance client retention and attract new clients. This is expected to have a positive effect on revenue and net income margins.

Assumptions

• Analysts are assuming CME Group's revenue will grow by 4.5% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 56.4% today to 55.9% in 3 years time.
• Analysts expect earnings to reach $3.7 billion (and earnings per share of $10.21) by about September 2027, up from $3.3 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 25.8x on those 2027 earnings, up from 24.1x today. This future PE is greater than the current PE for the US Capital Markets industry at 21.6x.
• Analysts expect the number of shares outstanding to grow by 0.1% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.61%, as per the Simply Wall St company report.

Risks

• The reliance on the partnership with Google Cloud for next-generation cloud technology and ultra-low latency networking could introduce risks associated with technological adaptation, platform performance expectations, and integration complexities that could affect operational efficiency and market competitiveness.
  
• Political uncertainties in the U.S. and geopolitical tensions in regions like the Middle East and between Russia and Ukraine could influence market volatility and trading volumes, impacting revenue predictability and margins.
  
• The transition to a new private Google Cloud region and a colocation facility might incur unforeseen costs or delays, potentially affecting capital expenditures and the projected benefits, thereby impacting earnings expectations.
  
• The competitive landscape, including upcoming platforms like FMX and their unique offerings, poses a risk to CME Group’s market share and could pressure pricing strategies, thereby affecting clearing and transaction fees revenue.
  
• Regulatory hurdles and approvals required for initiatives like treasury clearing plans may introduce delays or constraints, affecting the timing and expected benefits of such services, potentially impacting future earnings growth and strategic positioning.

Valuation

• The analysts have a consensus price target of $217.81 for CME Group based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $250.0, and the most bearish reporting a price target of just $177.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $6.6 billion, earnings will come to $3.7 billion, and it would be trading on a PE ratio of 25.8x, assuming you use a discount rate of 6.6%.
• Given the current share price of $218.3, the analyst's price target of $217.81 is 0.2% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.