CME’s Transaction-Based Revenues Could Decline Due To Tumbling Volumes
CME Group (NASDAQ:CME) is scheduled to announce its Q2 earnings on Thursday, July 31. The exchange operator registered solid growth in its transaction-based revenues in the March quarter, mainly due to a 20% year-on-year (y-o-y) rise in interest rate derivatives trading volumes. [1] However, the trend reversed in Q2, with trading volumes of interest rate products declining by nearly 4% y-o-y to 6.7 million average daily trades during the quarter.
Trading volumes of all derivative classes, including energy, equities, metals and foreign exchange combined, declined sequentially (-7%) and annually (-12%), leading to a company-wide average of 12.6 million contracts traded per day. The subsequent decline in average revenue per contract (RPC) to $0.76 per contract earned by CME could lead to low transaction-based revenues for the company. On the other hand, the market data division is likely to continue to do well on the back of a 20% fee hike, which the company introduced at the beginning of the year. Below we take a look at how the decline in trading volumes impacts the company’s margins and profitability.
Our $66 price estimate for CME’s stock is slightly lower than the current market price.
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Interest Rate Volumes Not As Bad As They Look
CME’s total interest rate derivatives traded in Q1 were up by 20% y-o-y to 411 million contracts, and the revenue realized for derivatives trading was up by more than 24% to $200 million. Total average daily volume (ADV) for Q2 remained flat over the March quarter at 6.7 million trades per day. This translated to just over 420 million trades through the quarter – a 2% sequential increase. However, average daily volume declined on a y-o-y basis from over 6.8 million contracts per day in the prior year quarter.
During the June quarter last year, CME’s total interest rate derivatives traded rose by nearly 30% sequentially to 436 million contracts (or over 6.8 million contracts per day) as there was volatility in the global markets. Trading volumes of interest rate products rose, especially during the months of May and June last year, on the back of speculation about the Fed’s future monetary policy, primarily those concerning tapering initiatives of the QE program. As a result of the spike in trading volumes in May and June last year, total contracts traded during Q2 2014 are lower than the prior year quarter. However, the rate per contract (RPC) earned by CME during the first two months of Q2 2014 was higher than the year-ago period, due to which revenues generated by interest rate products trading could be nearly the same as the prior year period. [2]
Decline In Trading Volumes Of Other Derivative Classes
Interest rate products constitute nearly half of CME’s trading volumes. The slight y-o-y decline in interest rate derivatives should not be a major concern for the exchange operator for two main reasons. Firstly, the slight decline was nearly offset by a higher RPC during the quarter. Secondly, if interest rate volumes could stay at similar levels to that in the first half of the year (6.7 million contracts per day) through 2014, it would be 15% higher than the 2013 average of 5.8 million contracts per day.
Comparatively, CME’s trading volumes across most other derivative classes have declined in the first half of 2014. Equity contract volumes declined both sequentially (-12%) and y-o-y (-22%) in the June quarter to 156 million trades or 2.5 million contracts per day. Energy contracts faced a similar sequential (-12%) and annual (-20%) decline in volumes to 91 million contracts for the quarter or less than 1.5 million contracts per day. [2]
Interest rate products have a significantly lower RPC (about $0.50 per contract), compared to other derivatives such as energy (around $1.30), equities ($0.70), agricultural commodities ($1.30) and foreign exchange ($0.80). A significant decline in volumes of most derivative classes has led to a growing mix of interest rate derivatives. Consequently, the average RPC across the trading division for the first two months of the June quarter was 3% lower than the year-ago period at about $0.76 per contract. This could take a toll on the company’s margins, since most costs incurred by exchanges are fixed in nature. A higher mix of interest rate products was partially responsible for a nearly 3% y-o-y decline in EBITDA margins to 65.7% in 2013. Margins could remain compressed in Q2 as the trading volumes of non-interest rate products declined over the prior year period.
Market Data Revenue To Sustain Growth
Revenues generated by CME’s Market Data segment declined from about $390 million in 2012 to $315 million 2013. However, most of the decline was due to the sale of CME’s Credit Market Analysis business to McGraw Hill. The company announced a hike in its annual subscription fee from $70 to $85 starting 2014 and management doesn’t expect its subscriber base to fall as a result of the changes. [3] Consequently, we expect the revenues generated by CME’s market data division to reach 2012 levels of around $380 million owing to the 20% price hike. However, we have a more conservative growth forecast for the long run.
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Notes:- CME Group Q4 2013 Earnings Call Transcript, Seeking Alpha, February 2014 [↩]
- CME Monthly Reports, CME Investor Relations, July 2014 [↩] [↩]
- CME Q3 2012 Earnings Call Transcript, Seeking Alpha, November 2013 [↩]