IntercontinentalExchange Group’s Margins Improve Despite Slump In Trading Volumes

IntercontinentalExchange Group (NYSE:ICE) reported its Q2 earnings on August 7, with a net revenue growth of over 100% year-on-year to $750 million. Much of the growth in revenues came from the NYSE acquisition in November last year. ICE faced a year-on-year decline in trading volumes in its core derivatives trading business in the June quarter, which the company attributed to low volatility levels in global markets. However, low trading volumes were offset by a corresponding increase in the rate per contract (RPC) earned by the company. ^[1]

In the month of June, ICE announced the spin-off of Euronext NV, its European equity trading business. Euronext’s cash equity trading business generated about $60 million in revenues in the March quarter. ^[2] The move to spin off Euronext should help ICE improve its margins in the coming years, since equity trading is typically a low-margin business. Additionally, the company acquired the Singapore Mercantile Exchange (SMX) and clearing house earlier in the year, making it the only operator in the world with exchanges across the U.S., Europe, Latin America (Brazil) and Asia (Singapore). SMX has now been renamed ICE Futures Singapore and the clearing house is now called ICE Clear Singapore. The company expects strong growth in Asia in the long run, which it intends to capitalize on with its Singapore-based exchange and clearing house. Our $225 price estimate for IntercontinentalExchange Group is nearly 20% ahead of the current market price.

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Trends in Interest Rate and Energy Markets

Total commodities futures and options traded on ICE, which include energy, agricultural commodities and metals, declined by over 25% y-o-y to 146 million during the quarter. Additionally, trading volumes of financial derivatives including interest rate, equity and foreign exchange products also declined by over 20% to 337 million contracts during the June quarter. Low volatility levels across oil prices and low interest rates across Europe and the U.S. kept trading volumes lower than the prior year quarter. Management pointed out that in spite of geopolitical unrest in certain geographies, including the Middle East and Russia, there was limited volatility in natural gas prices as the market seems to be “getting used to the unrest”. Despite the slump in volumes, the company earned a higher rate per contract (RPC) for energy and interest rate futures and options, which partially offset the revenue decline.

Interest rate trading volumes were low in Europe due to the prevailing low interest rate environment across Eurozone, which impacted Euribor futures volumes. However, this was offset by fluctuating expectations from interest rates in the U.K., leading to strong trading numbers for Pound Sterling futures and options, which were up by 27% and 67% respectively, over the prior year quarter. Moreover, European natural gas futures witnessed strong growth during the quarter, with trade volumes rising by nearly 100% year-on-year.

Although trading volumes were low for most asset classes in the U.S., management has a positive outlook for volumes in the coming quarters due to growth in open interest volumes. Exchange-traded derivatives open interest stood at 79 million contracts at the end of the June quarter – 5% higher than the December levels. Open interest, excluding natural gas products, was 17% higher than 2013 year-end levels at 58 million contracts at the end of the quarter. Brent, other oil and interest rate open interest were up 25%,  17% and 17%, respectively, at the end of June compared to year-end. Open interest for European interest rate futures was also up by 17% from the beginning of this year. The company expects healthy open interest levels to translate into volume growth, and also expects higher seasonal activity in the latter half of the year.

At the beginning of 2013, the combined operating margins of NYSE Euronext and ICE were estimated to be around 42%. During the year, the company realized $95 million in synergies, bringing the margins up to around 45%. Comparatively, Euronext’s operating margins stood at around 41% last year, due to which the company initially expected its full year margins to be around 49% through 2014. ^[3] However, the company reported operating margins of 50% for both the March and June quarters, with $108 million in expense synergies in the first half of the year. The company attributed the improvement in margins to “disciplined expense management”  and believes that it can achieve expense synergies of almost $240 million for the full year. Going forward, the company expects margins to stay at 50-51% for the full year. Given that the company is successfully maintaining its targeted synergies on a run rate basis, we expect the company to meet its target of generating margins of over 55% in 2015.

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1. ICE Q2 2014 Earnings Call Transcript, Seeking Alpha, August 2014 [↩]
2. IntercontinentalExchange Group 10-Q, SEC, May 2014 [↩]
3. ICE Earnings Call Presentation Q1 2014, ICE Investor Relations, May 2014 [↩]