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Despite Slowing Growth, Moody's Is Still a Buy

By Matthew Cochrane – Apr 30, 2019 at 9:31AM

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Growth is slowing and margins are compressing, so why does this credit ratings agency still make for a good investment?

Since the beginning of the year, the stock price for Moody's Corporation (MCO 1.89%) has appreciated almost 40%, an incredible rise for the credit ratings agency. When the company reported its first-quarter earnings last month, the results did little to slow Moody's momentum, even as revenue growth dropped.

In Q1, Moody's revenue rose to $1.14 billion, a tepid 1% increase year over year. Adjusted earnings per share (EPS) grew to $2.07, a 2% boost from last year's first-quarter results, helped slightly by a lower tax rate and a reduced share count. Moody's adjusted operating margin, one of its most important metrics, slightly decreased to 45.4%.

Moody's Metrics 2019 Q1 2018 Q1 Change (loss)
Revenue $1.14 billion $1.13 billion 1%
Adjusted EPS $2.07 $2.02 2%
Investor services division revenue $670 million $720 million (7%)
Analytics division revenue $472 million $407 million 16%

Data source: Moody's Corporation.

Despite the slowing growth and slimming margins, this boring company still enjoys a wide economic moat due to its well-known brand and strict regulations that keep would-be competitors at bay. Let's take a closer look at the company's two divisions, Moody's Investor Services (MIS) and Moody's Analytics (MA), to see why this company can continue to reward investors with market-beating returns.

Three capital letter "A"s made of dollar bills spelled out in a row.

Moody's rates corporate and government bonds, an industry that is highly regulated. Image source: Getty Images.

The debt ratings agency

MIS is the larger of Moody's two business segments, contributing $670 million, or about 59% of the total, to Moody's top line. This segment is responsible for providing credit ratings and research for debt investments and securities, such as corporate and government bonds. In Q1, revenue declined in this segment by 7%, driven by a 14% decrease in global debt issuance. Unfortunately, much of this segment's revenue depends on macroeconomic trends far outside of Moody's control.

The good news is that while revenue growth from this segment will always be lumpy and a bit unpredictable, it's extremely profitable. The operating margin for this segment was 54.9% this quarter, a margin nearly any company would be absolutely thrilled with and few industries can afford.

Beyond the profitability of this segment, it also enjoys a wide economic moat, or competitive advantage. Strict regulations at home and abroad limit the number of companies that can provide credit ratings by providing high hurdles companies in the sector must clear. Moody's reputation -- deserved or not -- also carries clout with clients, as it is one of the credit ratings agencies in the "Big Three," which combined hold a huge market share in North America and Europe.

A growing secondary business

The MA business segment provides economic and financial software, research, and advisory services. In Q1, revenue from this segment grew 16% to $472 million, representing about 41% of the company's total. The operating margin from this segment, while not nearly as high as the MIS segment, still clocks in at a respectable 28.1%. Better yet, the MA segment is much more predictable and less dependent on external factors.

The high margin from MIS allows Moody's to heavily invest in the MA side of the business, bolstering the offerings and services it can provide its clients. This includes the recent acquisitions of:

  • Reis, a leading provider of commercial real estate data;
  • Team8 Partners, a cybersecurity think tank; and
  • Vigeo Eiris, a global provider of environmental, social, and governance (ESG) data analysis.

These investments help MA appeal to a broader set of clients and give MA a deep set of data that other financial research providers find hard to match. For instance, consider Moody's plans for Vigeo Eiris, which CEO Raymond McDaniel provided during the company's conference call:

Vigeo Eiris is a leading global provider of ESG research, data and assessments and is a foundational asset for our broader efforts in this space. ... Vigeo Eiris brings Moody's an extensive database, a long established presence in the ESG space and a wide product offering, which will help Moody's and its goal to become a global standard setter in ESG. Vigeo Eiris, will be an affiliate of MIS and continue to operate from its headquarters in Paris. This investment is consistent with Moody's strategy of serving the evolving needs of financial market participants beyond the credit risk.

A proven investment

Based on the midpoint of its full-year 2019 EPS guidance, Moody's shares are currently trading at a forward P/E ratio of about 24.5. While that might seem high for a company growing its top and bottom lines by so little, I think that might be shortchanging the large competitive advantages that lead to Moody's sky-high margins. Because of these advantages, investors might want to ignore short-term noise surrounding global debt issuance and macroeconomic concerns that sometimes weigh on Moody's shares and, instead, focus on the long term and its competitive advantages to lead the stock to become what I suspect will be one of the top financial stocks in 2019.

Matthew Cochrane owns shares of Moody's. The Motley Fool owns shares of and recommends Moody's. The Motley Fool has a disclosure policy.

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