CME’s future earnings: it’s all about volatility

Ceres, the Roman goddess of agriculture, can be seen atop CME Group's headquarters in Chicago. (Photo courtesy of Daniel Schwen)
Ceres, the Roman goddess of agriculture, can be seen atop CME Group’s headquarters in Chicago. (Photo courtesy of Daniel Schwen)

The CME Group CME is looking to interest rate uncertainties to help fuel volume and growth in 2014, but some analysts say future volatility may prove disappointing.

The Chicago-based exchange operator reported a 16 percent rise in fourth-quarter earnings Tuesday on higher volumes, including a nearly 30 percent jump in interest rate contract volume, amid continued speculation over the U.S. Federal Reserve’s monetary policy.

Last week the Fed announced it would decrease its monthly bond-buying program by $10 billion per month, but interest rates would continue to remain at 0.0 – 0.25 percent until core inflation rises above 2 percent and the unemployment rate drops to 6.5 percent or below.

Total average daily trading volume for January rose 13 percent to 12.9 million contracts, with interest rate contracts up 18 percent.

CME said in its earnings call that it expects more market participants to jump into interest rate contracts to take advantage of uncertainty surrounding the Fed’s monetary policy. The exchange’s revenues rise when trading volume increases.

“I actually believe there’s a tremendous amount of participants that are still on the sidelines” waiting to see what the Fed’s next move is, Terrence A. Duffy, executive chairman and president of CME, told analysts. “And then we’ll see some fluctuation in rates and then we’ll see some proprietary trading shops that maybe have not been in there. And not the pure hedges, but a lot of high turnover guys.”

CME makes much of its profit from volatility in the market as well as its transactions fees from trades.

The exchange operator reported a profit of $193.1 million, or 58 cents per diluted share, in the quarter ended Dec. 31, compared with $166.8 million, or 50 cents per diluted share, in the year-ago period.

Excluding foreign exchange-related benefits and several tax exemptions, CME Group’s profit of 64 cents per share missed the analysts’ consensus estimate of 67 cents per share, according to Bloomberg LP. CME’s shares rose 0.6 percent Tuesday to $73.61.

Revenue for the fourth quarter increased 3.9 percent to $687 million compared with $660.9 million in the year-ago period, driven by a 6 percent increase in clearing and transaction fees.

Morningstar Inc. analyst Gaston Ceron agreed that the continuation of the Federal Reserve’s tapering efforts will keep inspiring interest-rate trading activity and benefit CME Group, as will higher transaction fees.

“We expect CME’s higher trading fees, which were announced last year and are now in effect, should help profits,” Ceron wrote in a research note.

Transaction fee increases, which went into effect Jan. 1, range from 1 cent to 15 cents for interest rate, equity, foreign exchange, agricultural, metals and energy products.

Average daily trade volume grew 11 percent from the year-ago quarter, but the rate CME earns per contract fell 7 percent, which resulted in trading revenues only up 6 percent.

Other analysts say investors may be betting too heavily on interest rate volatility as a driver of volume.

“The market’s current growth expectations for trade volumes are dependent on significant interest rate volatility,” Shannon Stemm wrote. “As interest rates eventually return to more normalized levels, we view this volatility as unsustainable, and therefore we believe the market is pricing in interest rate trade volumes that are unlikely to be achieved.”

In a research note, Stemm recommended investors sell CME, stating that, “we believe the market is currently overestimating CME’s ability to grow trade volume” despite the fact that the company has a “diversified and innovative business model, as well as a strong balance sheet.”

CME’s operating margins are near 60 percent and it currently trades at 24.65 times earnings, well below the industry average of 29.8 and futures exchange competitor, IntercontinentalExchange Group Inc. [[ICE]] at 25.78 times earnings.

Shareholders of CME, who have been members of the exchange since the 1970s, have sued the company. The shareholders state that changes to the future exchange’s trading technology have hurt the value of their memberships, which now includes no more free access to the Globex trading platform.

CME shares fell 7 cents to $73.54 in trading on the Nasdaq Stock Market. Year-to-date, CME shares are down 6.18 percent.

Leave a Reply