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On May 9, we upgraded derivative exchange – CME Group Inc. (CME - Analyst Report) to Neutral based on some improvement in volumes and strict expense control in the first-quarter of 2013. However, top line continued to remain weak.

Why the Upgrade?

Estimates for CME Group have witnessed a marginal decline since its first-quarter 2013 results on May 2. The company’s first-quarter earnings of 73 cents a share were at par with the Zacks Consensus Estimate, while total revenue of $718.6 million topped the Zacks Consensus Estimate of $714 million.

Nonetheless, both earnings and revenues lagged the year-ago results by 8.8% and 7.2%, respectively. Overall, CME Group delivered positive earnings surprises in all of the last 4 quarters with an average beat of 5%.

While average daily volume inched up 1% year over year, total operating expenses declined 3.2% and non-operating expenses were flat. However, clearing and transaction fees, accounting for about 83% of the total revenue, decreased 4.5% year over year, whereas market data and information services decelerated 29.2%. A higher tax rate also marred the bottom line.

Following the release of the first-quarter results, the Zacks Consensus Estimate for 2013 dipped 0.6% to $3.13 per share. The Zacks Consensus Estimate for 2014 also inched down 0.8% to $3.62 per share. With the Zacks Consensus Estimates for both 2013 and 2014 going only marginally down, the company now has a Zacks Rank #3 (Hold).

What is the cause for the strong positive bias on the company? While the top line is facing challenges from the macroeconomic volatility and intense competitiveness and will recover at its pace, CME Group is initiating a disciplined expense management. Total expenses are further projected to be below 5% for 2013.

However, low trading activity, currency and interest rate fluctuations as well as lack of any growth catalyst further raise a wary outlook on the operating leverage in the upcoming quarters. Amid a frail operating environment, CME Group also remains exposed to intense competition.

Though the current scenario appears bleak, CME Group’s efforts to promote, expand and cross-sell its core exchange-traded business through strategic alliances, meaningful acquisitions and newer product initiatives along with its global presence should generate decent growth in the long run

Other Financial Stocks That Warrant a Look

While CME Group shows no clear directional pressure in the near term, other outperformers of the financial sector including Axis Capital Holders Ltd. (AXS - Analyst Report), Fleetcor Tech Inc. (FLT - Snapshot Report) and Piper Jaffray Cos. (PJC - Snapshot Report) carrying a Zacks Rank #1 (Strong Buy) appear impressive.

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