CME CME Group Inc

IntercontinentalExchange Inc.’s (ICE) first quarter operating earnings of $1.77 per share were modestly ahead of the Zacks Consensus Estimate of $1.68 per share but grew 30.1% year over year from $1.36 per share reported in the year-ago period.

Excluding certain acquisition-related costs, net operating income of $131.0 million surged 29.1% year over year in the reported quarter. Net income attributable to shareholders was $128.9 million or $1.74 per share, compared with $101.2 million or $1.36 per share in the year-ago quarter.

The quarterly results of ICE benefited from favourable over-the-counter (OTC) execution, sweeping regulatory reforms and record futures trading that led to strong top line growth. The upside was also attributable to growth in the company’s core businesses, significant progress triggered on new initiatives and increasing demand for commodities. However, this was partially offset by higher operating and tax expenses.

ICE’s total revenue increased 18.7% year over year to $334.3 million, modestly up from the Zacks Consensus Estimate of $326 million. The growth was mainly attributable to 19.1% increase in consolidated transaction and clearing fee revenues to $299.0 million in the quarter, primarily driven by strong trading volumes in ICE's energy futures and OTC markets, new product introduction along with increase in credit default swap (CDS) clearing revenues.

Additionally, consolidated market data revenues grew 9.3% year over year to $29.4 million while consolidated other revenues increased dramatically by 59.5% to $5.9 million as compared to $3.7 million in the year-ago quarter.

Average daily futures volume increased 24% year over year while average daily commissions in ICE's OTC energy business grew 18% year over year for the quarter, resulting in 10.0% year over year ascent for the total global OTC segment. Besides, revenue from ICE’s credit derivative business totalled $39 million against $38 million in the prior quarter.

Total operating expenses surged 11.0% year over year to $130.7 million, primarily due to increase in compensation and benefit expenses, higher selling and administrative coupled with increased depreciation and acquisition-related expenses, which were partially offset by lower professional services.

However, operating margin jumped to 61% from 58% in the year-ago period. The effective tax rate was 34% compared to 32% in the prior quarter.

Financial Update

Consolidated cash flow from operations, at the end of the reported quarter, grew to $155 million, soaring 53% on year-over-year basis. Capital expenditures totaled $5 million, while $8 million were recorded as capitalized software development costs.

As of March 31, 2011, the company recorded unrestricted cash and investments of $694 million (up from $622 million as of December 31, 2010) while total outstanding debt decreased to $523 million from $579 million as of December 31, 2010.

Share Repurchase Update

At the end of the reported quarter, ICE had $210 million of share repurchase capacity still in store according to the share repurchase program that was approved during the fourth quarter of 2009. The company bought back 90 million of common stock during the fourth quarter while no repurchases were made during the first quarter of 2011.

Guidance for 2011

Management revised non-cash compensation expense expectation to the range of $52–$56 million in 2011. Besides, tax rate is now projected to be between 31% and 34% in 2011.

ICE's diluted weighted average outstanding share count for the second quarter of 2011 is expected to be in the range of 74.2–75.2 million shares outstanding and for 2011 is expected to be in the range of 74.1–75.1 million shares.

Previously, ICE projected an interest expense of $6–$8 million per quarter in 2011. As of December 31, 2010, ICE had 933 employees, which it expects to increase by 6%-10% in 2011 on the back of mergers and acquisitions activity.

For 2011, CDS clearing revenues are expected to range within 15%–20% over 2010. Besides, ICE estimated its depreciation and amortization expenses in the range of $132–$138 million.

Capital expenditures, including capitalized software development costs, are projected in the range of $50–$55 million, driven by continued investments in trading and clearing technology and data centers.

Business Update

Last month, ICE had scheduled to launch 19 new natural gas OTC futures contracts, on May 16. The launch of these energy contracts by ICE in the rapidly expanding energy sphere further boosts the company’s competitive leverage in the derivatives and OTC areas, where presence of arch rivals CME Group Inc. (CME) and CBOE Holdings Inc. (CBOE) pose a challenging operating environment.

Our Take

Growing through product novelty and expansion into the global emerging markets is also crucial for ICE, given the ongoing regulatory turmoil that set limits for speculative market participants and disappointing financial yield for operationally successful CDS clearing initiative.

 

Overall, we believe that based on the current volatile macro environment, ICE has a strong revenue-generating product portfolio, high earnings visibility, consistent cash generation, disciplined investment and limited balance-sheet risk. In the long run, these factors are expected to generate strong earnings potential.

 
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