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Updated Research Report on CME Group

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On Apr 2, we issued an updated research report on CME Group Inc. (CME - Free Report) . While we remain bullish on the company’s organic growth initiatives, headwinds related to economic and interest rate volatility, immense competition and regulations continue to mar the desired upside in the stock.

Meanwhile, this Zacks Rank #3 (Hold) stock delivered positive earnings surprises in 2 of the last 4 quarters with an average beat of 0.5%. The company’s fourth-quarter earnings also missed the Zacks Consensus Estimate by 4.5%, although it beat the year-ago quarter number by a penny.

CME Group’s diversified product portfolio is significantly exposed to extreme interest rate volatility, firm government regulations and limited credit availability. These factors not only hamper steady growth in volumes of the derivative market but also implicate higher expenses, as reflected by deteriorated operating margins in 2013, well below the historical average of higher than 60%. Poor renewals in co-location services also dampened the top line in 2013. In addition, CME Group is facing steep competition from the changing industry dynamics that affect pricing, volumes and market share.

Light at the end of tunnel

Although 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, newer product initiatives along with its global presence should generate decent growth in the long run. Going ahead, the upcoming launch of derivatives exchange in London along with the launch of Euro-denominated deliverable IRS Futures (Euro DSF) contracts in Apr 2014 should help boost momentum.

Improved fundamentals and prudent capital management also supported operating cash flow growth of 5% in 2013 after a decline of 9% in 2012. Additionally, modest liquidity supports healthy capital deployment via dividend pay-outs. Along with the recent 4% dividend hike, the company’s annual variable dividend was worth more than $872 million in 2013, significantly higher than about $199 million that was paid for the first time in 2012. Including the regular dividends, a total of about $2.7 billion was paid in dividends since the beginning of 2012, thereby adding to the company’s financial flexibility and investor confidence.

Overall, a balanced risk-reward relationship in the near term has led to very insignificant estimate revisions for 2014 and 2015. As a result, the Zacks Consensus Estimate for 2014 and 2015 are pegged at $3.59 and $4.11 per share, down a penny each, respectively, in the last 30 days.

However, the Most Accurate estimate for CME Group’s 2014 and 2015 earnings stands at $3.65 and $4.15 a share, resulting in an Earnings ESP of +1.7% and +1.0%, respectively.

Key Picks in the Sector

Some better-ranked stocks in the financial sector include MarketAxess Holdings Inc. (MKTX - Free Report) , Portfolio Recovery Associates Inc. (PRAA - Free Report) and General Finance Corp. (GFN - Free Report) . All the stocks bear a Zacks Rank #2 (Buy).

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