S&P Global: A market-leading company with a large moat
S&P Global holds a 50% market share in credit ratings, effectively creating a duopoly with Moody's, which holds a 32% market share. Some of the advantages of investing in duopolies are high barriers to entry and healthy competition that force the companies to innovate. Thus, it seems like S&P Global could be a good investment, but at what price? This is what I will examine in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of S&P Global. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in S&P Global's competitors either. Thus, I have no personal stake in S&P Global. If you want to purchase shares (or fractional shares) of S&P Global, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.
S&P Global was founded in New York, USA in 1917 under the name The McGraw-Hill Publishing Company. S&P Global offers credit ratings, benchmarks, analytics, and workflow solutions in the global capital, commodity, and automotive markets. It has a wide range of customers, including banks, investment firms, insurance companies, exchanges, and government organizations. S&P Global has five reportable segments. (They sold off Engineering Solutions in 2023.) The largest segment is Market Intelligence, accounting for 35% of the revenue. This segment provides investment professionals with data and analytics to track performance, identify investment ideas, perform valuations, and manage credit risks. Their second-largest segment is Ratings, which accounts for 28% of their revenue. This segment provides credit ratings. Commodity Insights (15% of revenue) provides essential price data, analytics, and industry insights in commodity and energy markets. Indices (12% of revenue), such as the S&P 500 and Dow Jones Industrial Average, are the most well-known. Finally, Mobility (10% of revenue) provides data solutions and insights to the entire automotive value chain, ranging from vehicle manufacturers to insurance companies. S&P Global generates the majority of its revenue through subscriptions, accounting for 55% of its total revenue. The remaining portion is derived from transactions, fees, and royalties. The credit rating industry has high barriers to entry due to regulations, which gives S&P Global its moat.
Their CEO is Douglas Peterson. He joined S&P Global in 2011 as the President of Credit Ratings and became CEO in 2013. Prior to joining S&P Global, he held various positions at Citigroup. He holds a bachelor's degree in Mathematics and History from Claremont McKenna College and an MBA from the Wharton School at the University of Pennsylvania. He is also a member of the Board of Directors of the National Bureau of Economic Research, as well as a member of the Council on Foreign Relations and the New York Stock Exchange Board Advisory Council. Under his leadership, S&P Global has expanded its presence in Asia, while also investing in technological innovation. He has also made some major changes in the company, such as acquiring IHS Markit in 2022 and disposing of Engineering Solutions in 2023. While Douglas Peterson has been CEO, S&P Global has achieved a revenue growth of 10% CAGR, and operating margins have increased significantly. He also seemed to be liked by employees, as he has an 82 employee rating at Comparably, which places him in the top 5% of similarly sized companies. I believe that Douglas Peterson has delivered great results, and I am very confident in his ability to lead S&P Global in the future.
I believe that S&P Global has a strong moat, and I also have a positive opinion of their management. Now, let us investigate the numbers to determine if S&P Global meets our criteria for having a strong competitive advantage. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will investigate is the return on invested capital, also known as ROIC. We require a 10-year history with all figures exceeding 10% for each year. These numbers are certainly encouraging, as S&P Global has managed to deliver a return on invested capital (ROIC) above 20% in eight out of the past ten years. We have two bad years: one in 2014, which doesn't worry me, and another in 2022. The decrease in numbers in 2022 is due to the acquisition of IHS Markit, which was the largest acquisition in the history of S&P Global. Thus, I don't want to give too much importance to 2022. I believe that these numbers indicate that S&P Global could be a compounding investment moving forward.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. The numbers are mixed, which isn't overly surprising, as S&P Global has made plenty of acquisitions (5) and divestitures (4) in the past decade. These actions will impact equity, which is why I won't give these numbers too much significance.
Finally, we will investigate the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use margins to enhance clarity and improve understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. It is not surprising to see that S&P Global has consistently generated positive free cash flow every year. It is encouraging to see that the levered free cash flow margin has been above 30% in all years from 2017 to 2021. The free cash flow yield is now at its second lowest point in the past decade, which indicates that the stock is not cheap. However, we will discuss this further in the analysis.
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After performing the calculation on S&P Global, I found that the company has 3,3 years of earnings in debt. It is a bit higher than I would like, but it is due to the IHS Markit acquisition. In the five years leading up to 2022, S&P Global had less than three years of earnings in debt. Thus, I'm not concerned about debt.
Based on my findings thus far, I believe that S&P Global is an intriguing company. However, no investment is without risk, and S&P Global also has its fair share of risks. One risk is regulatory risks. S&P Global sells data, and with the rapid changes in global privacy, data localization, and data protection legislation, it creates a complex regulatory compliance environment. S&P Global expects that the costs of complying with new data regulations will continue to be significant. Furthermore, with the growing public concern over the use of personal information and data transfer, there is a possibility of stricter regulations in the future. These regulations could have an impact on the business operations of S&P Global. Lower volume in the capital markets. Negative and/or uncertain economic and political conditions could reduce trading activity in capital markets. S&P Global generates a significant portion of its revenue from transactions, indicating its dependence on the volume of debt securities issued in the capital markets. Unfavorable financial and/or economic conditions will reduce investor demand for debt securities. Furthermore, it may also deter investors from investing in the stock market, which would have a negative impact on the indices segment. Increasing operating costs. In its annual report, S&P Global mentions that there are several factors that could increase operating costs. One factor is employee compensation, which is a significant expense for S&P Global. Employee compensation costs are influenced by general economic factors, which means that S&P Global is experiencing wage inflation. Furthermore, high inflation also increases the costs of health insurance and post-retirement benefits. S&P Global also mentions that they are facing increased costs from their third-party service providers due to inflation. These extra costs have led to a decrease in operating margins, which has hurt profitability.
There are also numerous reasons to invest in S&P Global. One reason is the growth in private markets and sustainability. In his letter to shareholders, Douglas Peterson mentioned that two of the most promising business opportunities for S&P Global are private markets and sustainability. He mentions that S&P Global has distinct advantages to grow these markets that nobody else possesses, while also having the technology, scale, and global sales force. S&P Global is currently generating $400 million in revenue from products serving private markets, and they expect it to grow to $600 million by 2026. S&P Global also expects significant growth in the sustainability sector, projecting a compound annual growth rate of 34% until 2026. The acquisition of IHS Markit. The acquisition of IHS Markit is the largest acquisition ever made by S&P Global. The reason behind the deal is to expand S&P Global's offerings in fixed income benchmarks and indices, bond pricing and reference data, and the automotive sector. Thus, it allows S&P Global to scale their business, and with scalability comes increased volume, which should attract a larger customer base. Furthermore, management sees a lot of synergies by incorporating IHS Market into S&P Global and expects to achieve $600 million in expense savings through synergies by the end of 2023. Additionally, revenue synergies are projected to reach $68 million by the end of 2023. A large moat. S&P Global has a significant competitive advantage in the credit rating market due to the high barriers to entry, including the substantial costs and compliance with various legal requirements. However, they also have a large moat in their brand. If a company wants to obtain a credit rating from one of the smaller competitors, it may face a higher interest rate on its debt. It means that a smaller competitor to S&P Global (or Moody's) could offer their credit rating for free, but the additional costs in interest rates would still make it more expensive than using S&P Global. Thus, it is highly unlikely that a company would choose a smaller competitor over S&P Global or Moody's.
Now it is time to calculate the price of S&P Global shares. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 10,20, which is from 2022. I have selected a projected future EPS growth rate of 14% (Management expects low to mid-teens EPS growth moving forward), a projected future PE ratio of 28 (which is twice the growth rate, considering that S&P Global has historically had a higher PE ratio), and we already have a minimum acceptable rate of return of 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $261,71. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy S&P Global at a price of $130,85 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The operating cash flow last year was 3.290 capital expenditures were 108. I attempted to review their annual report in order to ascertain the proportion of capital expenditures allocated for maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated for maintenance purposes. This means that we will use 76 in our calculations. The tax provision was 719. We have 320,8 outstanding shares. Hence, the calculation will be as follows: (3.290 – 76 + 719) / 320,8 x 10 = $122,60 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With S&P Global's Free Cash Flow Per Share at $7,72 and a growth rate of 14%, if you want to recoup your investment in 8 years, the Payback Time price is $116,46.
S&P Global is a very interesting company with great management. S&P Global is the market leader in what is essentially a duopoly with high barriers to entry. S&P Global is facing some short-term risks, including higher operating costs and the possibility of lower volume. Regulations pose long-term risks, but S&P Global has been in business for more than a century, and hopefully, they will continue to comply with new regulations. It may come with higher costs, but it will also raise the barriers to entry in the market. I really appreciate the robust moat of S&P Global, which is difficult to replicate. I also like the acquisition of IHS Markit because it will enable them to offer new products and expand their business. I believe that there will be an increasing demand for data, and I don't foresee credit ratings becoming obsolete anytime soon. It makes S&P Global a highly compelling business to invest in. I don't think that S&P Global will ever trade at a discount due to the nature of the business. Thus, I will initiate a position if it reaches the intrinsic value of the Margin of Safety price at $261,71.
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