the Intercontinental exchange (NYSE: ICE) operates electronic platforms (exchanges, quotes and clearinghouses) for the commodities, derivatives, financials, fixed income and equity markets. Although the company has used mergers and acquisitions to diversify into recurring revenue businesses, it still derives about half of its total revenue from businesses. driven by average daily volume (“ADV”). With Putin’s invasion of Ukraine, global trade in commodities and energy derivatives is booming. Unfortunately, this positive catalyst (for ICE, certainly not for Ukraine…) could last for some time yet. As a result, I find ICE appealing here.
ICE has done a good job of diversifying its business into recurring revenue streams (mostly services and data offerings) at around 50% of revenue. Additionally, the 2020 acquisition of Ellie Mae has significantly strengthened ICE’s position in mortgage technology. While rising interest rates are obviously a headwind for the mortgage industry, I suspect that given ICE’s large-scale presence, the company should continue to gain market share this year.
However, given Putin’s invasion of Ukraine and the resulting disruption of global energy and commodity markets, the most positive growth catalyst going forward may well be the ICE’s more traditional energy and derivatives business.
As Seeking Alpha recently reported, ICE’s ADV was up 9% year-over-year in March. The higher interest rate environment boosted financial ADV by 15% while commodity ADV increased by 8% – driven by cocoa market ADV growth of 20% in year-on-year. ICE CEO Ben Jackson said:
In the first quarter of 2022, the war in Ukraine brought both geopolitical risk and supply uncertainty to commodity markets, as inflationary pressures supported activity in interest rate markets. Our benchmark futures contracts help price the commodities that millions of people rely on, providing our clients with the risk management tools they need in the midst of a crisis.
The big jump in the cocoa market highlights another positive catalyst for the ICE: global warming. With the growing impact of drought (and flooding) on global agricultural markets, investors are likely to turn to derivatives to protect their positions. ICE also has a significant presence in European asset complexes, which should also strongly benefit from the macro-geopolitical environment.
Earlier this month, BofA raised its first-quarter EPS estimate for ICE to $1.48/share. I think ICE could earn over $6/share this year. Given Friday’s close of $129.89, I estimate that ICE is currently trading with a forward P/E of around 21.6x. That said, I expect as the war in Ukraine drags on, EPS estimates for ICE will likely continue to rise throughout the year.
As the chart below shows, ICE’s traditional energy business was already growing by leaps and bounds in Q4 due to the massive down cycle of Covid-19 followed by the resulting recovery rebound and a shortage of natural gas in key markets like the EU:
At the same time, recurring revenue increased by 8% year-on-year at constant exchange rates. Overall, total revenue in the fourth quarter increased 17% year-on-year.
For the full year 2021, total revenue of $7.15 billion increased 7% year-over-year. However, as the company continues to digest and optimize the effectiveness of various recent acquisitions, EPS for FY21 was $5.15/share, up 17% year-over-year (i.e. i.e. much higher than revenue growth). Free cash flow of $2.82 billion was also up 17% year-on-year. Based on the 565 million fully diluted shares at the end of 2021, this equates to approximately $5/share in FCF, which obviously bodes well for shareholders given the current annual dividend of $1.52/ stock.
As you can see, ICE was pounding on all cylinders in the fourth quarter – even before Putin invaded Ukraine – and I suspect the development will mean the company continues on a similar trajectory this year. Indeed, ICE has a 15-year track record of adjusted EPS growth at a CAGR of 17%. All things considered, this means the stock is expected to double every ~5 years.
Returns to shareholders
During the fourth quarter conference call, ICE Chief Financial Officer Warren Gardiner commented on the company’s capital allocation strategy:
…consistent with our track record of growing our dividend as we grow, we expect to increase our quarterly dividend by 15% year over year, from $0.33 per share to $0.38 per share. Additionally, and now that we are within our target leverage range, we expect to deploy approximately $475 million for share buybacks in Q1, which represents an increase of nearly 20% from Q2. of 2020, the last full quarter of buybacks before our acquisition of Ellie Mae.
ICE’s balance sheet is relatively strong (although it could be better in my opinion). ICE ended 2021 with $607 million in cash and $13.6 billion in net debt. Which, while a bit high in my opinion, is quite manageable and reasonable given ICE’s $73 billion market capitalization, strong FCF generation, and recurring revenue base. At the end of the year, gross leverage was 3 times EBITDA.
Increased competition in ICE’s electronic marketplaces is always a possibility. That said, the size and scale of the business is a competitive advantage. In the meantime, SEC scrutiny and regulation is still a risk for market makers and exchanges.
The normal headwinds of the macroeconomic environment that you all know by now (higher inflation, higher interest rates, massive geopolitical risks from Putin’s invasion of Ukraine and the resulting economic sanctions imposed on the Russia by the United States and its Democratic NATO allies, etc.) could lead to a significant contraction in global economic growth and, especially for ICE, a decline in ADV across its various platforms and verticals.
Finally, ICE has a long history of growing through mergers and acquisitions. A large and reckless acquisition announcement could hurt shareholders in the short term.
Summary and conclusion
Overall, ICE’s risk/reward proposition seems to be relatively positive here. Energy and commodity derivatives should remain strong throughout the year. In my view, EPS estimates have yet to catch up with the improving outlook for the business. Indeed, Seeking Alpha (which I believe uses an automated service to report consensus EPS estimates), still has ICE’s forward EPS estimate at $5.40/share. As we saw in BofA’s recent upgrade, I think this is significantly lower than what ICE could achieve this year given the generally bullish backdrop. I think ICE could easily generate more than $6/share EPS in FY21.
I’ll end with a 5-year chart of ICE’s rather impressive stock price: