The past quarter has been a minefield for the financials sector. While banks and real estate investment trusts (REITs) have credit exposure and therefore suffer when markets are volatile, the various market exchanges benefit through the increased amount of transactions being processed from day to day. If you are looking for portfolio exposure in financials but want to sidestep the worst effects of a likely recession, buying stock in exchanges might be worth a look.
Best quarter ever
The Intercontinental Exchange (NYSE:ICE), the parent company of the New York Stock Exchange as well as 11 other exchanges and marketplaces, just reported its best quarter ever. Earnings per share were up 38% year over year to $1.17. Revenue rose 23% to $1.6 billion. Trading and clearing revenue rose 44% to $883 million, driven largely by a 58% increase in energy trading. Revenues from financial products (interest rate futures and options), cash equities and options, and fixed income segments were all up over 40%. The data and listings segment was up about 3% to $676 million.
Intercontinental will benefit from the digital mortgage
Mortgage services are expected to be a significant growth area for the company. This segment consists of the mortgage electronic registration system (MERS), which tracks title and servicing for 75% of U.S. mortgages. The other arm of the mortgage sector is Simplifile, which is an electronic document-recording system that connects county governments with the important stakeholders in a mortgage transaction. We are still in the early stages of the digital mortgage, and this segment will continue to grow. The segment's annual revenue was $140 million when the Intercontinental Exchange (ICE) bought the remainder of MERS in late 2018 and early 2019 (it had held a partial stake in the company since 2016). The company expects mortgage services to contribute over $170 million this year.
Oil went negative. What happened?
On the earnings conference call, ICE did address the volatility in oil, especially when the West Texas Intermediate (WTI) contract for May traded at a negative price right before contract expiration. Management offered some explanation for what happened and said it is looking into how this very unusual event could have occurred. It noted the negative price was a result of a lack of storage for oil due to a collapse in demand from the economic fallout of COVID-19. While WTI is the most common U.S. contract, the rest of the world tends to use the North Sea Brent contract, which is more stable.
West Texas Intermediate is a local and landlocked contract, which means it is settled by physical delivery on a specific day via pipeline in Cushing, Oklahoma. It is therefore highly sensitive to supply and storage issues, which is why traders who really understand the ins and outs of the workings of the oil market prefer to trade it.
Brent, on the other hand, is a global contract based on future delivery of oil by seagoing vessel. It is a cash-settled contract based on an index constructed by ICE based on trades from big commercial users. Brent is the oil contract most used by commercial parties for hedging. ICE trades both contracts and has been gaining market share, commanding 64% of open interest versus 55% a couple of years ago.
A new competitor will open later this year
One potential risk for ICE is the new equities exchange called the Members Exchange (MEMX), created by a consortium of banks and large investors. MEMX will feature a stripped-down version of equities trading and plans to offer cheaper data. One member of the consortium is Virtu Financial (NASDAQ:VIRT), which is one of the biggest high-frequency trading firms and accounts for something like 40% of the cash equities volume on the exchanges. That loss of volume will certainly affect ICE. The Members Exchange was set to open July 24, but the COVID-19 crisis has pushed that back to some time in the third quarter. MEMX will have more of an impact on ICE's 2021 results.
A defensive financial, but on the pricey side
ICE is going to be one of those financial stocks that will be largely insulated from much of the economic shock that is affecting the other financials. Data fees may fall as money managers cut costs or go out of business, but ICE doesn't have the sort of credit exposure we see in the banks. It trades at 23 times 2019 earnings and has managed an impressive 17% annual growth in earnings per share since 2006. The New York Stock Exchange is one of the most venerable names in U.S. financial markets. That said, ICE's P/E ratio is at the higher end of its historical range, and there is an identifiable catalyst to depress future earnings in the form of MEMX. ICE is not terrible as a potential investment at these levels, but it isn't necessarily a screaming buy, either. Call it a hold.