Moody’s Corp. (MCO, Financial) is part of the global oligopoly of ratings agencies and has a highly stable business model. Apart from its standard credit rating offering, the company also offers data, analytical solutions and insights to help decision-makers recognize opportunities and manage the risks of doing business with others.
Its importance has grown as a result of the Covid-19 pandemic as corporations across the globe have borrowed over $2.5 trillion from the bond market in the previous year, increasing the relevance of Moody’s offerings. Even with the recent developments of competitors in the ratings industry, including the merger of S&P Global (SPGI, Financial) and IHS Markit (INFO, Financial) and also the acquisition of Fitch Group by Hearst, Moody’s remains a strong company, in my opinion. Here's why.
Recent financial performance
Moody's recently reported a solid quarterly performance and an all-around beat. The company reported a top-line of $1.60 billion for the first quarter of 2021, which was a 24.03% increase as compared to the $1.29 billion in revenue reported in the corresponding quarter of the previous year. The company beat the analyst consensus estimate of $1.43 billion.
These revenues translated into a gross margin of 75.44% and an operating margin of 53.44%, which were higher than that in the same quarter of 2020.
The company reported net income of $736 million and adjusted earnings per share (EPS) of $4.06, which was well above the average Wall Street expectation of $2.82.
In terms of cash flows, the company generated $676 million in the form of operating cash flows and spent $194 million in investing activities during the previous quarter, resulting in a positive free cash flow that was higher than that in the same period of the previous year.
Resilient business model
Moody’s business is split into two main segments – the Investor Services business, which deals with credit ratings, and the Analytics business, which offers risk management solutions and other forms of research mainly to institutional investors.
Its credit rating offering forms the backbone of the company and provides a tangible benefit to corporate borrowers. According to the company’s investor presentation, its strong brand value and the popularity and acceptability of Moody’s ratings helps businesses to save about 0.3% of the value of the debt the management is willing to take on in terms of borrowing costs for a mere 0.07% charge for the ratings.
Its value proposition and brand are both strong, which is why the management has confidently increased the pricing of its ratings offering in order to combat the inflationary environment in the U.S. today. The increased borrowing as a result of the pandemic ensures a strong demand and companies might not mind paying the extra price of the ratings.
The rating business is highly resilient and is not affected significantly by the whims of the market. If we compare the recent price hike by Moody’s to the investment management industry, we see many funds being forced into fee cuts as a result of mediocre performances. The fact that the company is operating in a rock-solid oligopolistic industry with huge barriers to entry and a high-quality offering implies a strong competitive moat.
The Moody’s Analytics upside
Facing stagnancy in the Investor Services business, Moody’s is looking to scale rapidly through its Analytics offering.
Apart from software and analytical solutions related to risk management for institutional investors, this segment has expanded to include subscription-based research, credit research, economic research and forecasting, business intelligence and even online and classroom-based training services. This segment has contributed to a gradual increase in the operating margins of Moody’s and has given the management a lot of flexibility to grow its addressable market.
Its Enterprise Risk Solutions offering, which looks to monetize Moody’s ratings by helping businesses with balance sheet management, accounting, credit decisions and regulatory reporting, is also another pillar for future growth.
In 2020, Enterprise Risk Solutions had 92% customer retention and accounted for 28% of Moody’s Analytics revenues. With the stagnancy in market share in the rating business, Analytics is expected to be a strong driver of the company’s future growth.
Final thoughts
As we can see in the above chart, Moody’s stock has followed a strong upward trajectory over the past six months, backed by increases in corporate debt and a strong performance of its Analytics offering.
The company is trading at a price-sales ratio of 12.55, which is very high, but given its huge net margin of around 35.66%, the company’s price-earnings ratio of 35.2 does not look too high for a company in a stable, oligopolistic setup. Moody’s controls about one-third of the credit rating market and is looking to expand its overall addressable market through its Analytics offerings. The company is also cash-rich and has close to $2.8 billion worth of cash and short-term investments on its balance sheet.
Despite the high valuation, Moody’s is fundamentally solid and has a strong competitive moat, and I believe that it continues to be a decent long-term blue-chip investment.
