Is Intercontinental Exchange Stock Undervalued?

Intercontinental Exchange (NYSE: ICE), one of the largest exchange operators and clearing houses in the world, gained a meager 3% – increasing from about $115 at the beginning of 2021 to around $119 currently, underperforming the S&P500, which grew 14% over the same period. While the stock has benefited from higher cash equities and equity options trading volumes in 2021, the positive impact was offset by the lower contract volume in other categories. Overall, the stock has seen high volatility this year.

There were two main reasons behind the jump in equity trading volumes: First, the approval of the $1.9 trillion stimulus package. Second, the higher level of engagement of retail investors.

But is this all there is to the story? 

Not quite, despite the recent gains, Trefis estimates  Intercontinental Exchange’s valuation to be around $132 per share – 11% above the current market price – based on a key opportunity and one risk factor.

The opportunity we see is an improved trajectory for  Intercontinental Exchange’s revenues over the subsequent quarters. ICE’s total revenues of $8.2 billion for the full year 2020 were 26% ahead of the 2019 figure. This translated into net revenues (revenue minus transaction-based expenses) of $6 billion – up 16% y-o-y. It was driven by growth in clearing & transaction fees due to higher U.S trading volumes, coupled with a 2.28x jump in mortgage technology revenues due to the acquisition of mortgage tech firm ‘Ellie Mae’ last year.

The company posted better than expected results in the first quarter of FY2021. It reported total revenues of $2.4 billion – up 15% y-o-y, which translated into net revenues of $1.8 billion. While the clearing and transaction revenues were marginally down as compared to the year-ago period, the growth was solely driven by a 6.72x increase in mortgage technology revenues. That said, clearing and transaction revenues contributed close to 65% of the net revenues in 2019, which increased to 76% in 2020 due to higher trading volumes. We expect the higher trading volumes to continue to dominate the quarterly results in the coming months as well, before normalizing with the recovery in the economy. Further, its non-trading revenues are likely to continue their positive growth trajectory in FY2021. Overall, we expect the ICE revenues to touch $9.2 billion in the current year.

The operating expenses are likely to see a slight increase in FY2021, which is likely to partially offset the benefit of higher revenues. The company is likely to report a net income of $1.7 billion, around 18% lower than the previous year. This will result in an EPS of $3.15, which coupled with the P/E multiple of 42x will lead to a valuation of around $132.

Finally, how much should the market pay per dollar of Intercontinental Exchange earnings? Well, to earn close to $3.15 per year from a bank, you’d have to deposit about $315 in a savings account today, so about 100x the desired earnings. At Intercontinental Exchange’s current share price of roughly $119, we are talking about a P/E multiple of just below 38x. And we think a figure around 42x will be appropriate.

That said, despite reporting growth in the last year, a financial exchange is still a risky proposition. While growth is likely, change in current market sentiment can harm the near-term outlook. What’s behind that?

Intercontinental Exchange drives the majority of its revenues from clearing and transaction fees. This, in turn, means that it is heavily dependent on trading volumes. The recent jump in trading volumes was due to the higher engagement of retail investors. While the participation of the retail investors has significantly increased over the last year, it is to be noted that they don’t have much loss-taking capacity. Any sudden market course correction can result in considerable losses for them, pushing them out of business, and hurting the trading volumes. To sum things up, we believe that Intercontinental Exchange stock is undervalued and offers some upside. 

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