How would you rate Moody's Corp. (MCO, Financial), the company that rates the debt of other companies?
Fortunately, GuruFocus provides us with a long list of metrics and calculators that allow us to assess its worth as a stock--but not its debt.
And debt evaluation is the meat and potatoes of Moody's business. It described its traditional operations in its 10-K for 2019 this way: "MIS publishes credit ratings and provides assessment services on a wide range of debt obligations and the entities that issue such obligations in markets worldwide, including various corporate and governmental obligations, structured finance securities and commercial paper programs."
The company has two reporting segments, MIS and MA. The former is the business described above, while MA refers to Moody's Analytics, which "provides financial intelligence and analytical tools to assist businesses in making decisions. MA's portfolio of solutions consists of specialized research, data, software, and professional services, which are assembled to support the financial analysis and risk management activities of institutional customers worldwide."
In the U.S., the biggest competitors for MIS are S&P Global Ratings (S&P), a division of S&P Global (SPGI), Fitch Ratings, A.M. Best Company, Kroll Bond Rating Agency Inc., Morningstar Inc. (MORN) and financial entities with their own in-house research capabilities.
For MA, its main competition comes from Refinitiv, Bloomberg, S&P Global Market Intelligence, Fitch Solutions, D&B, SS&C Technologies (SNCC), Wolters Kluwer (WKL), Fidelity National Information Services, SAS (SAS), Fiserv (FISV), MSCI (MSCI) and IHS Markit (INFO), among others.
As for growth, MIS sees its key drivers as debt market issuance driven by global GDP growth and the continuing disintermediation in fixed-income markets. For MA, growth is expected to be the result of deeper and broader penetration of its customer base because of data demands, regulatory compliance and analytical requirements.
All that sounds promising, but is that promise backed up by its performance over the past 10 years? We will examine that performance to do our initial rating of Moody's.
Financial strength
As always, debt issues take up the first few lines, reflecting the importance of leverage in financial health. At first glance, we see a glaring red bar indicating its cash-to-debt ratio has gone up. Yet, as we make our way down the table, the metrics are more encouraging.
The interest coverage ratio is more than 10; Benjamin Graham was satisfied with stocks that had a ratio of 5. In Moody's case, it is generating enough operating income to pay its interest expenses 10 times over.
The Piotroski F-Score is high at 8.
Finally from this table, the return on ROIC vs. WACC ratio is very good, with return on invested capital about three times as much as the weighted average cost of capital.
For financial strength, I would argue that Moody's should be rated more highly than the 5 out of 10 given by the GuruFocus system.
Profitability
The Moody's rating for profitability is as high as it gets at 10 out of 10.
Its margins, both operating and net, are high, suggesting the company has a competitive advantage or economic moat protecting its pricing.
Its return on equity is exceptionally strong, while its return on assets is OK for a company that does not have to invest much in capital expenditures.
Having very strong margins means the company can grow much more quickly than most, and we see that at the bottom of the table:
- Three-year revenue growth rate: 11%
- Three-year Ebitda growth rate: 38.8%
- Three-year earnings per share without non-recurring items growth rate: 76%.
These sorts of numbers show management is doing a good job at making money for shareholders.
Valuation
If there is a thistle in the Moody's bouquet, it is the price of the stock. We begin by following the share price over the past decade:
The share price has increased from about $21 a decade ago to more than $275 today (Aug. 11). According to my calculator, that's roughly a 13-fold price increase over 10 years. While the current price may be a barrier for today's investors, for those who bought and held 10 years ago, it is a bonanza.
The price-earnings ratio, at 29.73, looks high, and when compared to its 10-year median at 21.5, it is high, roughly a third higher. Based on its history, this figure has been higher in the past, most recently around 40 in February and in the high 80's in 2017.
The discounted cash flow calculator also indicates a stock that is overvalued:
After looking at the price chart, the price-earnings ratio and the DCF calculator, we would have to rate Moody's share price as overvalued. Its the kind of price that would chase away value investors, but might be of interest to growth investors who expect the price to keep climbing.
Dividends
At 0.78%, this dividend yield is not the stuff of instant riches. However, it is a small reward to shareholders for owning a stock that generates big capital gains, about 13-fold over the past decade.
If you had bought the stock during its spring dip, the yield would have been considerably higher, which is another argument for buying low. That's why we see the red bar in the History column. The smaller red bar suggests that if you're shopping for income, there are more attractive candidates in the capital markets sector.
The dividend payout ratio, at 23%, underlines the idea that Moody's is still a growth company. The low payout ratio means 77% of its free cash flow is available for expansion. And for the last couple of years, it has been growing that rapidly:
The three-year dividend growth rate, at 10.6%, is good and if it keeps growing at that rate the dividend will double in about seven years.
The forward dividend yield is slightly higher than the trailing 12-month rate, suggesting an increase in the dividend payment in the past year. That turns out to have been the case; in February of this year, the company's annual dividend increased from $2 annually to $2.24.
The five-year yield on cost is also quite low at 1.33%, but demonstrates what happens when compounding starts from a current dividend yield of less than 1%.
This modest dividend won't be boosted much by share repurchases. The current buyback ratio is just 0.5, well below the median repurchase ratio of 2.5 over the past decade. Hence the red bar in the History column. In its second-quarter earnings release, the company announced it was suspending its buyback program until further notice.
I would rate Moody's dividend as low, and since it is building from such a low base, will take quite some time to reach the S&P 500 average.
Gurus
Fifteen of the investment gurus, led by Warren Buffett (Trades, Portfolio) of Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial), had positions in Moody's on March 31.
Buffet had 24,669,778 shares, enough for a 13.16% stake in Moody's. That stake represented 2.97% of Berkshire's portfolio.
Chuck Akre (Trades, Portfolio) of Akre Capital Management had 5,638,341 shares, representing 3.01% of Moody's outstanding shares and 11.58% of his fund.
Bill Nygren (Trades, Portfolio) of the Oakmark Fund held 1,085,000 shares, representing 0.58% of Moody's shares and 2.39% of his fund.
Conclusion
As noted, Moody's is in the debt ratings business, and we found it rated quite well as a publicly traded stock. In particular, it is exceptionally strong in profitability, and that is ultimately the test for all investments.
Different types of investors would have quite different assessments. Value investors would find the price too high and the leverage too much for comfort; it would only make sense if the price were to fall dramatically, perhaps by half or more.
Income investors will likely want to look elsewhere. The dividend yield is low and unlikely to grow quickly as the company reserves its free cash flow for more growth. Like value investors, income investors might jump in, though, if the share price were to come tumbling down.
Growth investors will like Moody's stock. It is at the same time a large-cap and a well-established company, while also a strong growth company generating notable capital gains.
Disclosure: I do not own shares in any companies named in this article.
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