Morningstar had a 2% increase in its operating expenses despite the relatively flat overall business growth. As a result, Morningstar shares fell 4.95% the following day while the broader Standard & Poor's 500 index remained flat at -0.008% change.
"We saw a slight uptick in revenue growth in the third quarter this year, driven by modest improvements in revenue for license-based products such as Morningstar Data and Morningstar Direct. As a group, products with a subscription or license-based revenue model – which make up roughly three-fourths of our business – showed a revenue increase of 3.9% for the quarter. Products and services that mainly generate revenue from asset-based fees, meanwhile, showed a 5.0% revenue increase, driven by strong growth in Workplace Solutions and Morningstar Managed Portfolios.
"On the negative side, our transaction-based business lines continued to suffer. Because of lower industrywide issuance volume for commercial mortgage-backed securities, revenue for Morningstar Credit Ratings was down about $5 million, or 50%, year over year. Internet advertising sales also showed continued weakness as many advertisers have been shifting to programmatic buying platforms that target users on other sites.
"While we've continued to face headwinds this year, there have been bright spots. Many financial advisers and asset managers have reached out to us to find out more about the solutions we can provide to help them meet the Department of Labor's new fiduciary standard, which goes into effect in April 2017 and will require financial advisers to determine, demonstrate and document that their advice is in the best interest of the investor. We also continue to invest in our core data and research capabilities. We added close to 400 employees year over year, mainly reflecting new positions for our offshore data centers in Shenzhen, China and Mumbai, India as well as seasonal hires for the Morningstar Development Program, an entry-level program for recent college graduates. Finally, we recently announced an agreement to acquire PitchBook Data, which provides the industry's most comprehensive information on venture capital, private equity and mergers and acquisitions." – Joe Mansueto, chairman and CEO of Morningstar
According to Morningstar data, the company had -7.4% total return in 2016 and a five-year return of 5.25%. The broader S&P 500 index had 11.96% and 14.66%.
According to GuruFocus data, Morningstar had a trailing price-earnings (P/E) ratio of 24.9 times (industry median 20), price-book (P/B) ratio of 4.8 times (industry median 2.2) and price-sales (P/S) ratio of 4 times (industry median 1.25). The company also had a dividend yield of 1.2%, a 30% payout ratio and 2.3% share buyback ratio.
Morningstar is a leading provider of independent investment research in North America, Europe, Australia and Asia (1).
It offers an extensive line of data, software, research and investment management offerings adapted to one’s region and accordingly for financial advisers, asset managers, retirement plan providers and sponsors and individual investors located in the U.S., Asia, Australia, Canada, Europe, Latin America and South Africa. In 2015, Morningstar derived 74.2%, or $585.1 million, of its total sales from the U.S.
Morningstar has several data and proprietary analytical tools that help various individuals and professional investors achieve certain financial goals. For example, the company has been providing independent analyst research on mutual funds and other investment vehicles since the mid-1980s.
Morningstar focuses on four primary customer groups: investment advisers, asset management, workplace/retirement and individual investors (2). Morningstar reports one segment, but several key products contribute a good share of total Morningstar revenue.
Among its several key products, Morningstar Data contributed the most at 18.3%, or $144.4 million, to Morningstar’s total sales in fiscal 2015. Morningstar Data gives institutions access to a full range of investment data spanning numerous investment databases including real-time pricing and market data. According to the company, Morningstar Data’s equity database includes more than 43,000 companies globally covering 98% of the world's market capitalization.
Morningstar Advisor Workstation
Morningstar Advisor Workstation is a web-based investment planning system that provides financial advisers with a comprehensive set of tools for conducting their core businesses – including investment research, planning and presentations.
Morningstar Advisor Workstation has Morningstar Office for independent financial advisers and enterprise version for larger firms. As of Dec. 31, 2015, approximately 4,300 financial advisers in the U.S. were licensed to use Morningstar Office.
In 2015, the Workstation product grew by 4.6% and contributed 13.5%, or $106.5 million, to total Morningstar sales.
Morningstar Direct is an institutional investment research platform that includes data and advanced analytical tools on the complete range of securities in Morningstar's global database, as well as privately held investments and data from third-party providers – as of Dec. 31, 2015, 11,400 licensed users worldwide.
In 2015, Morningstar Direct grew 10.6% and contributed 12.9%, or $101.8 million, to Morningstar sales.
Morningstar.com is the company’s largest Web site for individual investors. In addition to its U.S.-based site, Morningstar offers more than 30 regional investing Web sites customized to the needs of investors worldwide.
In 2015, Morningstar had 136,000 paid Premium subscribers for Morningstar.com in the U.S. and in other global markets. The Web site generated 7.6%, or $59.9 million, of total Morningstar sales compared to $57.8 million in 2014.
(Morningstar logo, trademarks and service marks; 10-K)
Meanwhile, Morningstar had five-year sales, profit and operating margin averages of 7.27%, 8.95% and 21.5%.
Cash, debt and book value
As of Sept. 30, 2016, Morningstar had $265 million in cash and $60 million in debt with a 0.09 debt-equity ratio. Morningstar also had 41.2% of its $1 billion assets in goodwill and intangibles with a book value of $662 million compared to $680 million year on year.
Nine months into fiscal 2016, Morningstar had a 24% drop in its cash flow from operations to $143.2 million. Morningstar had more cash outflow in relation to its accounts payable and liabilities and accrued compensations year on year.
Capital expenditures were $47.5 million leaving Morningstar with $95.7 million in free cash flow compared to $148.7 million year on year.
(10-K and 10-Q)
Shareholder payouts, dividends and share repurchases combined as a percentage of its free cash flow was 70% in its recent nine months of operations. Morningstar had allocated 109.6% of its free cash flow in shareholder payouts in the past three fiscal years.
Morningstar exhibited a strong balance sheet and a steady flow of cash flow in recent years. In addition, the investment research company has several products that have consistently been growing in recent years. In contrast to its peer Value Line (VALU, Financial), Morningstar does not rely on one service or product to operate its business. Value Line has a more complex arrangement for earning business through fund management.
Read Value Line: Value Found in Value Line?
Good margins, steady business growth and minimal debt have rewarded premium to Morningstar’s shares compared to its peers. Historical earnings multiple, profit growth and an 20% margin indicate a value of $83 per share for Morningstar (3).
Ignoring traditional valuations, Morningstar is a buy with about $80 per share target price.
(1) All information moving forward sourced from Morningstar’s 10-K and 10-K unless specified.
Adviser products are Morningstar Advisor Workstation (including Morningstar Office) and Morningstar Managed Portfolios.
Asset Management key products are Morningstar Direct, Morningstar Data, and Morningstar Indexes, Morningstar Research and Morningstar Credit Ratings.
Workplace/retirement products are Workplace Solutions (formerly Retirement Solutions), Investment Advisory services and Investment Profiles.
Individual investor key products are found in the Morningstar.com website.
Five-year earnings multiple averages: 31.9 times.
Five-year profit growth: 8.95%.
Disclosure: I do not have shares in Morningstar or any of the companies mentioned.
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