We reiterate our Neutral recommendation on IntercontinentalExchange Inc. (ICE) to reflect the lack of significant momentum in earnings estimate revisions. Although the company remains strong due to new initiatives, acquisition and alliances, yet market volatility has been adversely affecting trading volumes.
IntercontinentalExchange’s first-quarter 2012 operating earnings of $2.02 per share were in line with the Zacks Consensus Estimate, but surpassed the year-ago quarter’s earnings of $1.74 per share. Accordingly, net income attributable to shareholders increased 14.7% to $147.9 million when compared with $128.9 million in the year-ago quarter.
IntercontinentalExchange continues to be cost-effective given its disciplined expense management. This is reflected by its controlled mid-single-digit total expense growth in the past couple of years and is further validated by management’s projection of flat growth in 2012. While the treasury cash and new credit facilities vigorously exceed the total debt-funding position, total interest coverage also remains healthy, reflecting minimal capital expenditure and solid operating cash flow growth, which accelerated 34% year over year in 2011, followed by 19.4% in the first quarter of 2012. These factors also pave way for efficient capital deployment.
IntercontinentalExchangehas demonstrated immense growth potential in its futures and OTC markets, thereby gaining competitive leverage. The company offers more than 730 cleared OTC energy contracts, including more than 640 new cleared OTC contracts since the launch of ICE Clear Europe in November 2008.Additionally, the U.S. Commodity Futures Trading Commission’s (CFTC) provisional approval on launching ICE Trade Vault as a swap data repository (SDR) not only opens new long-term growth opportunities but also conforms to new regulations. Further, IntercontinentalExchange continues to drive organic growth and even its intermittent restructuring programs through acquisitions and spin offs have driven robust inorganic growth, which are reflected in increased assets and global expansion.
Despite the global downturn, IntercontinentalExchange’s markets have shown resilience due to the consistent client demand for the company’s products and risk management services. Going ahead, these unswerving initiatives will continue to drive both top- and bottom-line growth along with volumes and margin expansion that will benefit as more futures and OTC contracts are now exchange-traded and cleared.
Risks to Operations
However, low interest rates and demand for low-priced products have been hampering the trading volumes growth of the futures contracts, as witnessed in the first quarter of 2012. Declining volumes also pose ample risk on transaction and clearing revenues that account for majority of the top line. We expect the futures volumes’ growth to remain sluggish until the markets gain stability.
Over the past few quarters, IntercontinentalExchangehas been facing a challenging global operating environment as most of the arch-rivals are rapidly evolving through new and innovative product and service launches in order to gain market share and stay ahead in the competition. This has also relatively slowed down the growth momentum of IntercontinentalExchange.The recent outlay of growth plans by dominant players such as NYSE Euronext Inc. (NYX) and CME Group Inc. (CME) through acquisitions, setting up of clearinghouses along with new product and service initiations in the derivatives market have already pointed out the swiftly changing dynamics of the exchange industry.
Such aggressive industry efforts are not only keeping the company’s management on its toes but are also directly threateningits operating and competitive leverage. In future, the company may even have to resort to price reductions and margin contractions amid intense competition. Hence, we believe that management should make productive endeavours as well as manage cash and liquidity position proactively, in order to retain and grow its industry position.
Moreover, amid the current volatile market, IntercontinentalExchangeis liable to be marred by new laws that impact market operations such as the Financial Reform Act of 2010 that puts regulatory constraints on block trading and margin requirements on derivative securities, primarily the OTC swaps market in the U.S.Conforming to these ruleswould also adversely hamper the volumes growth and capital position of the company. The regulations could result in substantial additional costs for infrastructural modifications and will intensify the competitive pressure.
Overall, based on the pros and cons, the Zacks Consensus Estimate pegs earnings for the second quarter of 2012 at $1.92 per share, which is about 14% higher than the year-ago quarter. IntercontinentalExchangeis scheduled to release its second quarter financials before the bell on August 1, 2012.
Currently, IntercontinentalExchangecarries a Zacks Rank #3, implying a short-term Hold rating, at par with its long-term Neutral recommendation.
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