CME Group’s (NASDAQ:CME) earnings for the third fiscal quarter of 2012 were hit by weak trading volumes in a trend that we have seen with other exchanges.  A 26% year-on-year decline in average daily volume of trades led to a 22% fall in revenues, which totaled $683 million. Net income was affected by a one-time $16 million increase in tax provision due to deferred income tax liabilities related to S&P Dow Jones Indices and the acquisition of market information provider, Pivot, Inc., and was down 30% from the prior year.
Our $60 price estimate on CME Group’s stock is in line with the current market price despite the disappointing third quarter results as we believe that the company is set for future growth particularly from over-the-counter (OTC) clearing that is set to be mandatory from next year.
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Although the average rate per contract was up 6% from the third quarter of last year, it was not able to mitigate the effect of the decline in trade volume. Clearing and transaction revenues, which account for more than 80% of the exchange’s revenues were 23% lower than 2011.
Clearing and transaction revenues are divided into six asset classes: interest rates, equity, foreign exchange, energy, agricultural and metal. Of these asset classes, interest rate and energy contracts and are the biggest bread-winners for CME, accounting for a quarter of the total revenues each.
Interest rate trading has been adversely effected by the Fed’s zero-interest rate policy. The average daily volume fell 25% from January through July, but has since recovered, increasing 21% in August. CME has recently announced the launch of deliverable interest rate swap contracts offering pricing transparency and margin savings. The interest rate business will also be boosted by reforms in OTC derivative trading which will require swap trades to be cleared via regulated clearinghouses. Analysts at UBS (NYSE:UBS) estimate a 25% increase in revenues from OTC interest rates swaps clearing. 
We forecast a steady increase in average daily volume in the next few years driven by regulatory reforms and improving macro-economic conditions.
OTC energy trades are currently cleared through CME’s ClearPort platform. Energy trades cleared through ClearPort followed a trend similar to interest rates contracts falling 45% from January through July, with a slight revival in August and September. CME is expanding its OTC energy offering and the decline in volume might be due to uncertainty due to the regulatory transition. Like interest rates, we believe that energy contracts ADV will rise steadily through the next few years.
Market data is an important division for CME, helping the company abate the effect of declining trade volumes. Revenues from the division account for 13% of the company’s total revenues. The company recently acquired Pivot and will offer its instant messaging service under the name “CME Direct Messenger”. CME is also applying to qualify as a swaps data repository to provide customers market data. Market data accounts for 15% of our price estimate for CME and the number of market data subscribers to increase of the next few years, as illustrated by the interactive chart below.Notes:
- CME Group Inc. Reports Third-Quarter 2012 Financial Results, CME Group Press Release, 25th October, 2012 [↩]
- CME Group third-quarter profit drops, but beats Wall Street view, Reuters, 25th October, 2012 [↩]