Moody's Beats on Both Lines

Moody’s Corp. ( MCO - Analyst Report ) reported second quarter 2012 earnings of 76 cents per share, beating the Zacks Consensus Estimate by a nickel. However, earnings decreased 7.0% year over year, primarily due to higher operating expenses.

Quarter Details

Revenue climbed 6.0% year over year to $640.8 million and exceeded the Zacks Consensus Estimate of $634.0 million. The better-than-expected result was driven by strong performance from the Moody's Analytics (MA) division. Domestic revenue increased 9.0% year over year to $343.8 million, while international revenues increased 2.0% to $297.0 million in the quarter.

Segment wise, Moody’s Investors Service (MIS) revenues remained flat year over year at $441.2 million. MIS revenues in the U.S. leaped 5.0%, while revenues outside the U.S. declined by the same magnitude from the year-ago quarter.

Within the MIS segment, Global Corporate Finance revenues decreased 4.0% year over year to $191.5 million, while Global Structured Finance revenues jumped 5.0% year over year to $90.7 million. Global Financial Institutions’ revenue declined 2.0% year over year to $77.8 million. Global public, project and infrastructure finance revenues jumped 12.0% year over year to $81.2 million.

Moody's Analytics (MA) revenues grew 19.0% year over year to $199.6 million, buoyed by an increase in Research, Data and Analytics revenues (up 9.0%), Professional services revenues (up 84%) and enterprise risk solutions revenues (up 24.0%). MA revenues increased 23.0% in the US, while outside the U.S, it rose 17.0% on a year-over-year basis in the reported quarter.

Operating income increased 3.1% year over year to $278.5 million in the second quarter. However, operating margin declined 90 basis points (bps) to 43.5%, primarily due to higher operating expenses (up 8.1%). Net income declined 8.7% year over year to $172.5 million in the reported quarter on higher tax rate.

Moody's exited the quarter with $839.5 million in cash and cash equivalents and short-term investments compared with $828.0 million in the previous quarter. At quarter end, Moody’s had $1.24 billion in outstanding debt and had additional debt capacity of $1.0 billion under its revolving credit facility.

Guidance

Moody’s continues to expect diluted earnings per share to remain at the higher end of management’s guided range of $2.62 to $2.72 for fiscal 2012. For fiscal 2012, Moody’s expects revenues to increase in the low-double-digit percent range. However, expenses are also projected to increase in the low-double-digit percent range. Operating margin is projected to be approximately 39%.

Segment wise, global MIS revenue is expected to increase in the mid to high-single digit percent range for fiscal 2012. Domestic MIS revenue is estimated to increase in the low-double-digit percent range, while overseas revenue is expected to increase in the low-single-digit range. MA revenue will likely increase in the high-teens percent range for fiscal 2012.

Recommendation

We believe that Moody’s remains a solid franchise in rating debt instruments based on its diversified credit research business model and international growth. However, increasing regulatory complications and cut-throat competition from Dun & Bradstreet Corp ( DNB - Analyst Report ) and privately-held Fitch Ratings Inc. and Standard & Poor’s Financial Services LLC may hurt its profitability going forward.

We remain Neutral on a long-term basis (6-12 months). Currently, Moody’s has a Zacks #3 Rank, which implies a Hold rating in the short term (1-3 months).