We have upgraded our recommendation of IntercontinentalExchange Inc. (ICE - Analyst Report) to Outperform from Neutral based on its high earnings visibility, strong product portfolio, consistent cash generation, disciplined investment and limited balance sheet risk, which enables it to be one of the most dynamic companies in the industry.
The company’s fourth-quarter 2011 operating earnings of $1.76 per share topped the Zacks Consensus Estimate of $1.68 per share and were also ahead of $1.35 per share reported in the year-ago period. Results benefited from favourable over-the-counter (OTC) execution and record futures trading that in turn led to strong top-line growth.
The upside was also buoyed by lower tax rate, growth in the company’s core businesses, significant progress triggered on new initiatives and increasing demand for commodities. However, this was partially offset by higher-than-expected operating expenses.
ICE has demonstrated immense growth potential in its futures and OTC markets, thereby gaining competitive leverage against arch-rivals such as CME Group Inc. (CME - Analyst Report) and NYSE Euronext Inc. . The company offers more than 650 cleared OTC energy contracts, including more than 580 new cleared OTC contracts since the launch of ICE Clear Europe in November 2008. The company’s ICE Clear Credit is also a globally leading clearinghouse for credit default swaps (CDS).
Over the past several quarters, ICE has launched multiple new coal, natural gas, gas oil and crude oil futures contracts, in order to extensively penetrate the rapidly expanding energy sphere. Organic growth is also significantly driven by strong escalation in contract volumes, average daily commission for ICE's OTC energy business and transaction fees, reflected by the strong performance of ICE Brent Crude and ICE Gas Oil futures markets, among others.
ICE has also driven robust inorganic growth through intermittent restructuring programs, acquisitions and spin offs. The company’s initiatives such as the TradeCapture OTC acquisition and expansion in Brazil through Cetip’s part-acquisition, the BRIX alliance and the launch of CDS clearing in Latin America also reflect the company’s aspirations of diversifying into the rapidly growing emerging markets and products. Besides, the company also plans to launch Brazilian coffee futures, Brazil Arabica, by 2013.
Going ahead, these unswerving initiatives will continue to drive both top- and bottom-line growth along with volumes and margin expansion that will benefit as more futures and OTC contracts are now exchange-traded and cleared.
Additionally, ICE continues to be cost-effective given its disciplined expense management, which is reflected by its controlled mid-single-digit total expense growth in the past couple of years and further validated by management’s projection of flat growth in 2012.
Further, ICE poses a sturdy balance sheet with strong cash, receivables and capital position, reflecting minimal capital expending and solid operating cash flow growth that accelerated 34% in 2011. These factors also pave way for efficient capital deployment, primarily through share repurchases.
On the flip side, ICE’s Creditex business continues to pose a weak trend based on reduced demand for portfolio hedging, fewer credit default events and significant regulatory uncertainty. Moreover, the company has been consistently marred by new legislations in both the US and Europe related to financial transaction tax, block trading and margin requirements on OTC derivatives and other laws related to clearing houses and trade repositories. Conforming to these rules would also adversely hamper the volumes growth and capital position of the company.
Although these risks are immensely detrimental to ICE’s growth, they also reflect the company’s potential to generate higher growth once the market volatility and regulatory challenges recede. This enhances our optimism for long term growth.
Hence, the Zacks Consensus Estimate for the first quarter of 2012 is currently pegged at $2.04 per share, up about 15% from the prior-year quarter, while s for 2012 is projected to increase about 14% over 2011 to $8.07 per share. Three of the 16 analyst firms revised their estimates upwards in the last 30 days, while no downward revision was witnessed. ICE carries a Zacks Rank #1, which translates into a short-term Strong Buy rating, while the long-term stance is perked at Outperform.