Trading the Exchanges: Buying CME Group (NYX, rated BUY)
Trading the Exchanges: Buying CME Group CME Group (CME) has lost more than half of its market value over the past three months and the stock price has cratered by nearly three-quarters in the past year. As illustrated in the accompanying three-month chart and table of valuation parameters [click to enlarge] for the major U.S.-listed exchanges, CME is extremely oversold and trades at less than two-thirds of book value (0.66) despite its position as the world's largest futures exchange with a major new source of revenue in the form of central counterparty clearing for credit default swaps [CDS] – which represents an estimated $45-$60 trillion market. I have initiated a long position in CME around 183 bucks, although there is no way to predict the exact bottom as shares are down more than 40 bucks in the past five days alone. Nasdaq OMX Group (NDAQ) is omitted from the accompanying three-month chart, but posted similar performance to the S&P 500 Index with a loss of 28% in the past quarter while Intercontinental Exchange (ICE) has outperformed both its peer group and the overall market with a 3% loss. NYSE Euronext (NYX) trades at the deepest value parameters of the group for every category except price/book ratio and has lost over two-thirds of its market value in the past year, resulting in a fat dividend yield of 4.9%. ICE has taken over the top spot in terms of trading at a premium to the group and posted the strongest stock price performance in the past quarter. With earnings power of $16-$17 per share for 2008 despite an expected decline of 10%-12% in trading volumes (with current valuations discounting a 20%-25% decline in trading volumes), CME has gone from trading at a premium to its peer group to posting the largest stock price decline in the past quarter and year. While NYX has gotten the early jump with SEC approval this past week as a central clearinghouse for CDS trading, the market is large enough for the entire group to benefit. The Wall Street Journal reported last week that CME is in talks with six dealers to take equity stakes in the Company's new CDS platform while it awaits SEC approval to begin trading. Meanwhile, ICE is also awaiting regulatory approvals and has decided to create a separate CDS clearinghouse to avoid the systemic risk of combining CDS with futures trading and to reflect the different collateral and liquidation requirements for each. For 3Q08, CME posted a 25% decline in interest rate trading volumes, which was offset by an 18% increase in equity products – reflecting credit market turmoil and tremendous volatility in the equity market for the quarter. CME posted average daily volume of 13.2M contracts during 3Q08, generating $665M in clearing and transaction revenue – which represented a 4% increase from the year-ago period despite challenging credit and equity market conditions. CME posted record quarterly trading volumes for E-mini (stock index futures in smaller sizes for greater liquidity and affordability, allowing individual investors to participate) and FX (foreign exchange currency trading) products and the Company's NYMEX acquisition (energy + metals futures products and the ClearPort electronic OTC trading + clearing system) further strengthens its role as the leading innovator for new products and technologies on a global basis despite challenges such as global de-leveraging.