CME CME Group Inc

IntercontinentalExchange Inc.’s (ICE) second quarter operating earnings of $1.69 per share were substantially ahead of the Zacks Consensus Estimate of $1.60 per share and $1.51 per share reported in the year-ago period.

Excluding certain acquisition-related costs, net operating income of $125.1 million jumped 10.6% year over year in the reported quarter. Net income attributable to shareholders was $121.4 million or $1.65 per share, compared with $101.7 million or $1.36 per share in the year-ago quarter.

The quarterly results of ICE benefited from favorable 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 9.8% year over year to $325.2 million, modestly up from the Zacks Consensus Estimate of $316 million. The growth was mainly attributable to 8.9% increase in consolidated transaction and clearing fee revenues to $288.5 million in the quarter, primarily driven by strong trading volumes in ICE's crude oil and energy futures and OTC markets, new product introduction along with increase in credit default swap (CDS) clearing revenues.

Additionally, consolidated market data revenues grew 12.9% year over year to $30.7 million while consolidated other revenues increased dramatically by 45.5% to $6.0 million as compared to $4.1 million in the year-ago quarter.

Average daily futures volume increased 5% year over year while average daily commissions in ICE's OTC energy business grew 7% year over year for the quarter, resulting in 3% year over year ascent for the total global OTC segment. Besides, revenue from ICE’s credit derivative business totalled $41 million against $39 million in the prior quarter.

Total operating expenses surged 13.9% year over year to $134.3 million, primarily due to increase in compensation and benefit expenses, higher selling and administrative coupled with increased depreciation and acquisition-related expenses. Consequently, operating margin slipped down to 59% from 60% in the year-ago period. The effective tax rate was 32% compared to 34% in the prior-year quarter.

Financial Update

Consolidated cash flow from operations, at the end of the first half of 2011, grew to $321 million, soaring 24% on year-over-year basis. Capital expenditures totaled $9 million in the reported quarter, while $8 million were recorded as capitalized software development costs.

As of June 30, 2011, the company recorded unrestricted cash and investments of $757 million (up from $622 million as of December 31, 2010) while total outstanding debt decreased to $457 million from $579 million as of December 31, 2010.

Share Repurchase Update

At the end of the reported quarter, ICE had $185 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 $25 million of common stock during the reported quarter. While $90 million of common stock was repurchased during the fourth quarter, no repurchases were made during the first quarter of 2011.

Guidance for 2H11

Concurrently, management provided an extensive outlook for the second half of 2011. CDS clearing revenues are expected to be between $35 million and $37 million. ICE expects transaction costs related to the Cetip investment in the range of $5–$8 million for the third quarter of 2011.

Capital expenditures, including capitalized software development costs, are projected in the range of $25–$28 million, driven by continued investments in trading and clearing technology and data centers.

ICE's diluted weighted average outstanding share count for the third quarter of 2011 is expected to be in the range of 73.8–74.8 million shares outstanding and for 2011 is expected to be in the range of 74.0–75.0 million shares.

Besides, CDS clearing revenues are expected to be between $35 million and $37 million in the second half of 2011.

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 and boost ICE’s competitive leverage in the industry, where presence of arch rivals CME Group Inc. (CME) and CBOE Holdings Inc. (CBOE) pose a challenging operating environment.

 
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