Moody's Good Mood

The good times just keep on rolling at Moody's (NYSE: MCO), parent company of credit-rating agency Moody's Investor Services and risk-management provider Moody's KMV. First-quarter revenues released this morning rose to $0.68 per diluted share on a 19% increase in revenues to $331.2 million. Backing out a onetime gain of $13.6 million in the first quarter of 2003, net earnings jumped 24%, beating estimates by six cents.

Moody's provides an invaluable service to investors, greasing the wheels of the capital markets by evaluating the creditworthiness of more than 200,000 corporate and government entities worldwide. Moody's is part of the ratings triumvirate, along with McGraw-Hill's (NYSE: MHP) Standard & Poor's and the French-owned Fitch Rating Services. Canada's Dominion Bond Rating Service is the new kid on the block. Together, analytical work done by these firms determines whether a bond is deemed worthy of investment-grade status, or relegated to the lowly realms of junk.

As expected, Moody's saw across-the-board strength in the first quarter. Excluding 200 basis points from the impact of a rising euro, ratings revenues grew 15% to $261.9 million. Much of this was due to increased issuance of commercial and residential mortgage-backed bonds in the complex (but profitable) global structured finance segment.

Corporate finance revenues were up 24% to $76.3 million on increased activity in the high-yield arena. Research-related revenues were particularly robust, leaping 41% to $40.5 million. Finally, subscription revenues from Moody's KMV, which provides risk-assessment software to banks and institutional investors, rose 16% to $28.8 million.

Fans of free cash flow (and who isn't?) should love Moody's. Capital requirements in the credit rating agency are low, and operating margins sweetened over the first quarter to 55%. Management has historically utilized cash, which last year topped $400 million, to make strategic acquisitions, buy back stock, and boost dividend payments.

At 25 times forward earnings, Moody's is richly valued, and deservedly so. The company is in a fantastic strategic position. It's the market leader in a high-margin business that, thanks to stringent SEC requirements, is very difficult to enter. However, the threat of higher interest rates will likely curtail the issuance of new debt offerings, and remains a caveat. Still, management is expecting a reduced but respectable growth rate in the high single digits over the next year.

Need more proof of Moody's solid credentials? How about a ringing endorsement from Warren Buffett? His Berkshire Hathaway (NYSE: BRK.A), (NYSE: BRK.B) has a 15% stake in the company.

Not to bang our own gong, but Tom Gardner recommended Moody's as his first-ever pick in Motley Fool Stock Advisor. The stock is up nearly 65% since the April 2002 inaugural issue, versus the S&P 500's return of -3% over the same period.

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Fool contributor Nathan Slaughter owns none of the companies mentioned.