Moody's Moving Forward

Imagine you could provide a service that millions of people (corporations and governments, too, for that matter) would be clamoring to receive on an ongoing basis. Next, assume that your business model is not very capital-intensive, and you would enjoy excellent margins and healthy free cash flows. Finally, picture such stringent government oversight and regulation that few firms will be inclined to enter the market, limiting competition to a small handful of other companies. It sounds intriguing, doesn't it?

Fortunately, this exercise hasn't been completely hypothetical, as investors interested in the above scenario need only read to the next sentence to find a company that fits the description. Ratings agency Moody's (NYSE: MCO  ) evaluates the credit risk of more than 200,000 global entities, churns out hundreds of millions in annual free cash flow, maintains operating margins in excess of 55%, and -- thanks to the rigorous entrance requirements imposed by the Securities and Exchange Commission -- has few peers besides McGraw-Hill's (NYSE: MHP  ) Standard & Poor's and the French-owned Fitch Rating Services. There have been recent complaints by some politicians who would like to see a larger playing field, but Congress isn't exactly known for implementing changes quickly.

Moody's shares are gaining this morning, after the company posted third-quarter earnings of $0.78 (excluding one-time charges), shattering estimates by $0.14. The bottom-line results marked a solid 39% improvement over the $0.56 earned a year ago, on revenues that jumped 17.3% to $357.9 million. Domestic revenues shot up 19% to $228 million, while international operations (aided by a strong euro) rose 15% over last year, contributing another $129.9 million.

The bulk of the gains came from the core ratings business at Moody's Investor Services, which reported a $40 million increase in revenues to $285.1 million. Much of this was the result of a 30% rise in global structured finance revenues, driven by commercial mortgage-backed bonds and credit derivatives. Corporate finance, though, was slowed by decreased activity in both the investment-grade and high-yield bond markets and registered more subdued growth of only 4% to $72.2 million.

Aside from determining the creditworthiness of current and prospective borrowers, Moody's also generates substantial revenues by offering credit research and related analytical software. Research revenues jumped 36% to $43 million, and Moody's KMV -- a subsidiary that provides risk assessment software to banks and institutional investors -- added nearly $30 million in sales, with a double-digit gain in subscription revenues.

Moody's stock, which is nearing a 52-week high, will not entice value investors at 28 times this year's earnings, but it is worth the premium price tag. People, corporations, and governments alike all need debt to function, and the firm is among the few equipped to assign a credit rating, issue quality research, and provide the tools to help financial institutions manage their loan portfolios. Aside from the sensational fundamentals (attractive growth rates, oversized margins, clean balance sheet, etc.), the company is shareholder-friendly and has bought back 26.4 million shares ($1.1 billion worth) since becoming a publicly traded company four years ago.

Of course, Moody's credentials have not escaped the attention of Warren Buffett, whose Berkshire Hathaway (NYSE: BRK.A  ) (NYSE: BRK.B  ) owns a sizeable stake, nor Tom Gardner, who selected the company as his first pick in the inaugural issue of Motley Fool Stock Advisor.

Looking for more on Moody's? Start with these two:

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Fool contributor Nathan Slaughter owns none of the companies mentioned.


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