CME Group (NASDAQ:CME) reported a 11% year-on-year decline in revenues for the fourth quarter of 2012, as trading activity remained low through the three months ending December. The average daily volume or ADV for the quarter was down 13% from the prior year’s level, but the company has seen a revival in 2013 and is expected to gain from new regulations regarding clearing of over-the-counter (OTC) trades.
Our $59 price estimate for CME Group’s stock implies a premium of 10% to the current market price
Interest Rate Futures Remain Key
Transaction fees from interest rates account for one-fifth of CME’s revenues. The ADV for interest rates contracts in the fourth quarter was down 9% from the third quarter level, and 13% from the same period in 2011. The exchange saw a revival in January 2013, as the ADV reached 5.3 million, up 24% from the average for the second half of 2012. Treasury products ADV in January was up 30% from the level achieved in the prior year. Low interest rates have hindered activity, but with the OTC mandate expected to be passed in March, we expect higher swap clearing activity in 2013.
The CFTC mandate requires OTC trades to be cleared through a central exchange. CME currently clears seven interest rate swap currencies, which account for 95% of the market and is introducing portfolio margins to attract clients. The deliverable swap futures product launched in December, was well received, trading 65,000 contracts to date, but the exchange will face stiff competition from IntercontinentalExchange (ICE). ICE is planning takeover of NYSE Euronext’s (NYSE:NYX) Liffe business. Interest rate contracts account for 70% of Liffe’s revenues and the acquisition will provide ICE a platform to enter the market. Even with the increased competition, we expect the new regulations to lead to an increase in trade volumes. Please read our article: NYSE-ICE Deal Could Disrupt CME’s European Expansion for more details. You can modify the interactive chart below to gauge the effect a change in forecast would have on our price estimate.
Increased Production Leading To An Increase In Energy Trading
Energy contract trading is also an important business for CME, accounting for 20% of the exchange’s revenue. Trade volumes for the asset class were low in the fourth quarter, down 13% from the 2011 level and 6% from the third quarter level. However, with increased production activity in North America, the company saw an increase in crude oil options trading, and is expected to continue this positive trend in 2013, with further investments being made in the region leading to higher hedging activity.
From Kansas To Chicago
The recent acquisition of the Kansas City Board of Trade is expected to boost agricultural commodity contracts trading. CME has unveiled plans to shift the wheat futures trading floor to Chicago. The fourth quarter ADV for the asset class was in line with the level for the prior year. Agricultural commodity trading accounts for nearly 15% of CME’s transaction and clearing fees.