One characteristic that I look for in a company prior to purchasing shares is how that company responds to a difficult environment or a “black swan event.” Companies that are able to not only withstand, but also grow during such a time are the ones I am interested in owning.
The Covid-19 pandemic is an excellent example of an unexpected event causing havoc with the world as we know it. One company that has down extremely well despite the disruption to daily life is Intercontinental Exchange Inc ICE
ICE operates the New York Stock Exchange. The company closed its trading floor for the first time in nearly 230 years in response to the coronavirus outbreak and quickly shifted its entire workforce to an at-home business. Even with the challenges that this presented, ICE had a magnificent first quarter. Let’s take a look.
Company background and recent results
ICE is an owner and operator of leading financial exchanges, including the New York Stock Exchange. The company also provides an electronic marketplace for trading futures and over-the-counter (OTC) energy contracts. In addition, ICE produces market data, pricing, risk management and trading support. The company is composed of two businesses: Trading & Clearing (which provides marketplaces for listing, trading, futures and options across several asset classes) and Data & Listings (which provides data services for trading, investing, risk management and connectivity). Each segment contributed approximately half of revenues last year. ICE trades with a current market capitalization of more than $51 billion.
ICE reported strong first quarter earnings results on April 30. Revenue soared 23% to $1.6 billion, which beat Wall Street analysts’ expectations by $16 million. Adjusted earnings per share improved 39% to $1.28, which was 6 cents ahead of estimates. Both revenue and EPS results were a quarterly record for the company.
The Trading & Clearing segment was the real driver of growth during the quarter, as revenue improved 44% to $883 million. All areas of this segment had at least 11% growth for the first quarter. Energy revenues, which accounted for 40% of total revenues for the segment, grew 54% to $353 million. This business was buoyed by a massive increase in average daily volumes for futures and options. Financials, Fixed Income & Credit and Cash Equities & Equity Options all had 41% growth or higher. Each of these businesses saw spikes in average daily volumes and increases in rate per contract. In total, future and options average daily volumes were up 42% compared to the first quarter of 2019.
Revenues for Data & Listings improved 3% to $676 million. Pricing & Analytics led the way with 4% growth as this business produced $276 million of revenue on higher demand for services. Exchange Data & Feeds improved 2% on robust trading. Desktops & Connectivity was higher by 4% on the strength of global network offerings. Network capacity improved 12% in the quarter.
Wrapping up first quarter results, adjusted operating expenses increased 13% to $597 million, though ICE has guided for a sequential decline of expenses. The company has invested in its exchange trade funds hub and built out its Mortgage Solutions business. ICE believes that these are two areas the company can continue to grow. The company’s adjusted operating margin improved 4% to 62%. ICE returned $866 million of capital to shareholders during the first quarter, primarily through repurchasing nearly $700 million worth of shares.
Dividend and valuation analysis
ICE began paying a dividend in 2013. While the dividend growth streak is on the short side, the company’s growth rates have been generous. The company has increased its dividend by an average of 17.4% per year over the past three years and 16.2% per year over the past five years.
ICE raised its dividend 9.1% for the dividend payment made March 31. This increase is below the averages listed, but still at a solid rate. Shares yield 1.3% following Monday’s trading session. This matches the stock’s five-year average yield of 1.3%.
Wall Street analysts expect $4.49 of EPS for the current year. With an annualized dividend of $1.20, the earnings payout ratio is 27%. The current payout ratio is nearly in-line with the five-year average payout ratio of 26%. The company’s ability to hold its payout ratio at a consistent level is clear, showing that the dividend policy has been well managed, if not yet recession tested.
The free cash flow payout ratio is also in good shape. ICE distributed $166 million of dividends during the first quarter while generating free cash flow of $461 million for a free cash flow payout ratio of 36%. This is a healthy payout ratio, one that likely means that the company’s dividend can be considered relatively safe. ICE’s payout ratio over a longer period of time look even better.
Last year, shareholders received $621 million of dividends while ICE had free cash flow of $2.4 billion, giving the company a free cash flow payout ratio of 26%. Dividends paid totaled $1.4 billion for 2016 to 2018 while free cash flow was $5.8 billion for this period of time for an average free cash flow payout ratio of 24%
While shares of ICE may not offer much in the way of yield, the company has given shareholders sizable increases in its short history of dividend growth. The earnings and free cash flow payout ratios are well within a safe range.
Shares of ICE closed Monday’s session at $94.31. The company earned $3.88 per share, giving the stock a trailing price-earnings ratio of 24.3. Using expected EPS of $4.49, ICE has a forward price-earnings ratio of 21. The stock’s 10-year average annual price-earnings ratio is 20.1.
The company’s ability to manage a shock so well had led me to believe that shares deserve a slight premium to the historical average. I have a price-earnings ratio target range of 20 to 22 for ICE. Using expected EPS for the year, I believe the stock is worth between $90 and $99 per share. Trading within this range means downside of 4.5% to 5% of upside. The dividend will also add a bit to total returns.
Final thoughts
I am impressed with ICE’s ability to pivot so quickly in the face of the pandemic and produce the results that the company did. Its businesses performed well and produced record results on a number of metrics.
The company has a short dividend growth history, but has rewarded shareholders with double-digit growth for the majority of the last eight years.
That said, shares are already trading in the middle of target valuation range, which itself is above the long-term average. There isn’t enough upside or total return potential for me to buy the stock at this moment. Therefore, I would wait for a pullback before buying shares of Intercontinental Exchange.
Author disclosure: the author has no position in any stock mentioned in this article.
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