We upgraded our recommendation on NYSE Euronext Inc. to Neutral from Underperform based on the current sustainability factors. The company’s second-quarter 2012 operating earnings per share of 51 cents were a penny higher than the Zacks Consensus Estimate of 50 cents, but were much lower than 61 cents recorded in the year-ago quarter.
Resulted reflected a weak top line driven by reduced volumes and revenues across segments, which was partially offset by decreased expenses and lower tax rate. Alongside, unfavorable currency fluctuations and lower average revenue per contract added to the woes, resulting in deteriorated operating margin.
As a result of higher capital expenditure and debt, NYSE’s debt-to-EBITDA ratio deteriorated to 2.1x at the end of June 2012 from 1.6x recorded at the end of 2011. Higher debt and lower working capital in the first half of 2012 also impelled ratings agency S&P to downgrade its outlook to negative from stable in August 2012. Conversely, the rating agency believes that the recent refinancing of an old credit facility of $1.2 billion with a new $1.0 billion unsecured three-year credit facility is expected to help the company improve the financial leverage and reduce borrowing costs, while access to this excess liquidity should also aid in achieving incremental operational leverage.
Given the weak trading volumes from the global economic volatility, NYSE is making persistent efforts to enhance operating efficiencies, which are evident from its long-term goals. Further, the launch of NYSE Euronext London, in addition to NYPC and interest rate swap (IRS) derivative contracts on NYSE Liffe, along with the upcoming repo futures market and clearinghouse in London in 2013, will likely be beneficial on competitive grounds and provide ample opportunities to drive the top line in the long term. In future, NYPC will also have the ability to provide clearing services for other exchanges and Derivatives Clearing Organizations.
Moreover, NYSE is ardently working to tap the $8 billion foreign exchange Contracts for Difference (CFD) retail derivative market by early 2013, which should attract clients given the tax-efficiency component retail derivatives and enhance long-term earnings potential. Even the company’s recent acquisitions, primarily in the information and technology space, bode well for long-term growth. Hence, despite the global economic volatility, the company continues to make significant strides in diversifying revenue streams and creating a world-class diversified multi-asset global exchange group.
Nevertheless, increased regulatory challenges and continued volatility of interest rates, foreign currency, inflation, changes in price levels of securities is expected to limit the trading activity and the desired upside in the stock at least in the near term. We do not expect any radical growth in the top line unless the current market recovery provides resonance to liquidity and credit quality.
Additionally, NYSE has been facing intense competition from strong players, such as CME Group Inc. (CME - Analyst Report) and IntercontinentalExchange Inc. (ICE - Analyst Report), which tends to reduce market share and leverage of its business. This includes both product and price competition and has continued to increase as a result of the creation of new execution and listing venues in both the U.S. and Europe. Increased competition has been severely hampering growth prospects in trading activities, reduction in transaction fees and margins, pricing adjustments, listings and the markets for the company’s products; thereby adversely affecting NYSE’s operating results.
Hence, based on the pros and cons, the Zacks Consensus Estimate pegs NYSE’s earnings for the third quarter of 2012 at 50 cents per share, which is about 30% lower than the year-ago quarter. For 2012, earnings are expected to dip about 18% over 2011 to $2.03 per share. However, the stock is expected to rebound in 2013.
NYSE currently retains a Zacks #3 Rank, which translates into a short-term Hold rating and indicates no clear directional pressure on the stock in the near term.