The Chicago Merc (Chicago Mercantile Exchange) (CME), Chicago’s great institutional testament to free-market capitalism, reports its second-quarter 2020 financial results before the opening bell on Wednesday morning, July 29, 2020.

Street consensus per IBES data by Refinitiv is expecting $1.196 billion in revenue to generate $1.62 in earnings per share for y/y declines of 6% and 8%, respectively.

The worse news is that – exiting the April ’20 quarter – the Street was looking for $1.82 per share on $1.3 billion in revenue, so the cuts to the forward estimates haven’t been kind.

For full-year 2020, the Street is currently expecting $7.33 per share in EPS and $5.2 billion in revenue for expected y/y growth of 8% and 7%, respectively.

Here is the trend in CME’s EPS and revenue estimates:

Q2 ’20 (pre-EPS) Q1 ’20 Q4 ’19 Q3 ’19
2022 EPS est $7.73 $7.91 $8.31 $8.23
2021 EPS est $7.30 $7.45 $7.83 $7.90
2020 EPS est $7.33 $7.62 $7.33 $7.38
2022 est EPS gro rt 6% 6% 6% 4%
2021 est EPS gro rt 0% -2% 7% 7%
2020 est EPS gro rt 8% 12% 8% 7%
2022 PE 22x 21x 26x 24x
2021 PE 23x 23x 27x 25x
2020 PE 23x 22x 29x 27x
2022 rev est ($’s bl’s) $5.3 $5.4 $5.4 $5.6
2021 rev est $5.13 $5.2 $5.35 $5.4
2020 rev est $5.2 $5.3 $5.2 $5.2
2022 est rev gro rt 3% 4% 1% 5%
2021 est rev gro rt -1% -2% 5% 4%
2020 est rev gro rt 7% 10% 5% 5%
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Source: Consensus estimates from IBES data by Refinitiv

It worries me a little bit that 2021 EPS and revenue estimates the last two quarters have turned negative, which makes some sense since interest rates are back to close to zero (Fed funds through the 10-year Treasury yield, anyway) which is CME’s largest contract by volume.

Here is CME’s product distribution by contract and y/y growth looks:

Source: CME earnings reports, 10-Q

It’s geeky stuff but readers can see the exchange volume by contract, the percentage of revenue each contract represents and then y/y growth.

Bitcoin and micro S&P 500 futures are new contracts that generated some nice public relations for the exchange when they launched, but don’t seem to be moving the needle yet.

Readers can see the influence on the interest rate contracts on the exchange, and you’d expect them (interest rate volatility) to be dead money until at least the Presidential election.

In early June, CME announced ADV (average daily volume of 17.6 million contracts and in early July that had slipped to 17.2 million contracts.

CME’s performance relative to the S&P 500:

10-year:

CME vs SP 500 since 1/1/2010

5-year performance

CME vs SP 500 since 1/1/2015

YTD performance

Chart source: YCharts

Summary/Conclusion: Sometimes a stock’s “story” is pretty simple and investors are stuck until the capital markets change, and with 50% of CME’s volume being interest rate (Treasury contracts) and the Fed and monetary policy screwing Fed Funds and the rest of the Treasury curve down to zero once again (just like from 2008 to 2016), it makes for little volatility across the Treasury curve and hence little need to hedge that risk.

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Commodities, maybe equities, maybe even forex, might see some increases in volume, particularly with the strength in the euro and the euro bailout package, but all that still pales in comparison to Treasury volume.

The one surprising aspect to Covid-19 and the last 4 months is that ‘core inflation is actually starting to tick up despite the Q2 ’20 GDP looking at 20% decline and an unemployment rate closer to 15%, but so far the 10-year Treasury yield at 60 basis points tells us that no one owning Treasuries is worried about inflation.

CME is a 2-2.5% position in client accounts and has been owned for years, since it went public in late 2002, and a technician friend of mine who had a seat at the CME asked me to take a look at the stock fundamentally.

A trade below $160-161 or the June lows would not be a good sign, and that might trigger more selling/liquidation.

CME was a 30% ROE (return on equity) generator from 2002 through 2007 and then it fell apart after 2008, thanks primarily to flat interest rates. The CME bought the NYMEX and its global oil complex but it sank the ROE and really didn’t do much for the exchange overall.

Volume really is the key to CME. Readers can see when volume exploded in Q1 ’20, the operating income margin expanded from 60% to 70% but the market interpreted it correctly that the volume surge was temporary, and the stock didn’t bounce very much.

Over the years, management has shown decent expense and margin control but the key to CME is interest-rate volatility, and I’d expect very little will happen with that until at least the Presidential election, November 3, 2020.

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As the capital markets stand today, the stock is fairly valued in the $160s, low $170s.

Disclosure: I am/we are long CME. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Reports Wed 7/29 before open



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