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On Jun 7, we downgraded stock exchange operator – Nasdaq OMX Group Inc. (NDAQ - Analyst Report) to Underperform based on its faltering financial leverage due to raised debt and acquisition costs.

Why the Downgrade?

Estimates for Nasdaq have witnessed a steady decline since its first-quarter 2013 results on Apr 24. The company’s first-quarter earnings per share of 64 cents comfortably surpassed the Zacks Consensus Estimate and the year-ago quarter’s earnings of 61 cents. Meanwhile, total revenue of $418 million missed the Zacks Consensus Estimate of $426 billion but inched up 1% on a year-over-year basis.

Following a tempered growth outlook, the Zacks Consensus Estimate for 2013 has gone down 3.3% to $2.65 per share in the last 60 days. The Zacks Consensus Estimate for 2014 also slid 2.3% to $3.04 per share. With the Zacks Consensus Estimates for both 2013 and 2014 going down, the company now has a Zacks Rank #3 (Hold).

Cause for Concern

Nasdaq’s top line is already being marred by weak trading volumes in both cash equity and derivatives along with poor clearing and listing revenues. Even non-transaction revenue base contributes little to the top line. Factors deterring growth include lower order intakes, decreasing trading activity in the industry across the U.S. and Europe, muted growth from annual renewals, unfavorable foreign currency fluctuations and market competition.

Amid an eroding market share, when margins are fraying, a higher debt burden raises caution, driving ratings agencies to lower their outlook on Nasdaq’s credibility to negative. Although S&P has removed its CreditWatch in Jun 2013, it continues to cast a negative outlook on Nasdaq, given the over 40% hike in debt followed by the acquisitions of Thomson Reuters and eSpeed.

While we believe that the latest acquisitions are expected to be accretive to Nasdaq’s financials, these are also projected to weigh on expenses and margins in the near term. Nevertheless, the company’s operational and financial limitations reflect the pressing need to respond to the changing industry dynamics and dig in prospects for gaining scale.

Other Financial Stocks That Warrant a Look

While Nasdaq shows no clear directional pressure in the near term, other outperformers of the financial sector including XL Group Plc (XL - Analyst Report), Regional Management Corp. (RM - Snapshot Report) and Investment Technology Group Inc. (ITG - Snapshot Report) appear impressive. All these stocks carry a Zacks Rank #1 (Strong Buy).

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