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S&P Global: A market-leading company with a large moat

Opdateret: 28. mar.

S&P Global holds a 50% market share in credit ratings, effectively creating a duopoly with Moody's, which holds a 32% market share. Investing in duopolies offers several advantages, including high barriers to entry and healthy competition that drive 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, conduct valuations, and manage credit risks. Their second-largest segment is Ratings, which accounts for 27% of their revenue. This segment provides credit ratings. Commodity Insights (16% of revenue) provides essential price data, analytics, and industry insights in commodity and energy markets. Indices, such as the S&P 500 and Dow Jones Industrial Average, account for 11% of revenue and are the most well-known. Finally, Mobility (11% of revenue) provides data solutions and insights to the entire automotive value chain, spanning from vehicle manufacturers to insurance companies. S&P Global generates the majority of its revenue through subscriptions, which account for 56% 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.

The 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. During Douglas Peterson's tenure as CEO, S&P Global has achieved a revenue growth of 10% CAGR, and operating margins have increased significantly. Douglas Peterson has been recognized as a great leader. Institutional Investor named S&P Global to its 2023-24 All-America Executive Team, while the Drucker Institute has selected S&P Global as one of the 250 best-managed companies multiple times. He also seemed to be liked by employees, as he has an 82/100 employee rating at Comparably, which places him in the top 5% of similarly sized companies. I believe that Douglas Peterson has delivered excellent 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 possessing a strong competitive advantage. In case you want an explanation about what the numbers represent, you can refer to "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 had three bad years: one in 2014, which doesn't worry me as it is a long time ago, and the others in 2022 and 2023. The decrease in numbers in 2022 and 2023 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 the numbers in these years as S&P Global is integrating IHS Markit into its business. I believe that S&P Global will eventually return to delivering a high Return on Invested Capital (ROIC) once it has fully integrated IHS Markit into its business.

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, as evidenced by the numbers from 2022 and 2023 when S&P Global acquired IHS Markit. Hence, I won't give these numbers too much significance.

Finally, we will analyze 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. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected 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 in the past decade. It is encouraging to see that the levered free cash flow margin has been above 30% in all years from 2017 to 2021. The levered free cash flow margin has decreased in 2022 and 2023 due to the acquisition of IHS Markit, which is currently being integrated into the company. The free cash flow yield is now at its third lowest point in the past decade and significantly below the ten-year average. This suggests that the shares are trading at a high valuation. However, I will delve into 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 4,35 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, when S&P Global acquired IHS Markit, the company had less than three years of earnings in debt. Therefore, I'm not overly concerned about debt.

Based on my findings so 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 increasing public concern regarding the use of personal information and data transfer, there is a possibility of stricter regulations in the future. These regulations could impact 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 could have a negative impact on the indices segment. The increasing availability of free or inexpensive information sources. In its annual report, S&P Global mentions that in recent years, more public sources of free or relatively inexpensive information have become available, particularly through the Internet. Advances in public cloud computing and open-source software are expected to continue. Moreover, generative artificial intelligence may be used to significantly enhance access to publicly available free or relatively inexpensive information. Public sources of free or relatively inexpensive information can reduce the demand for S&P Global's products and services. If a large number of smaller customers or a critical number of larger customers choose to use public sources as a substitute for S&P Global's products or services, it could have a significant adverse effect on its business, financial condition, or results of operations.

There are also numerous reasons to invest in S&P Global. One reason is the growth in its private markets and sustainability businesses. 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 for expanding these markets that no one else possesses, along with the technology, scale, and global sales force. S&P Global is currently generating $430 million in revenue from products serving private markets, and they expect it to grow to $600 million by 2026. S&P Global also anticipates substantial growth in the sustainability sector, forecasting a compound annual growth rate of 34% until 2026. Management has recently stated that they are optimistic about the long-term potential of the sustainability sector. 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, as well as the automotive sector. Thus, it allows S&P Global to scale their business. 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. Management expected cost synergies of $600 in 2023, but exceeded that target by delivering cost synergies of $630. Management also expects revenue synergies from the acquisition. Revenue synergies refer to the ability of two merged companies to generate higher sales than the total of their individual sales. S&P Global managed to reach $152 million in revenue synergies by the end of 2023, and management expects revenue synergies to reach $350 million by 2026. A large moat. S&P Global has a significant competitive advantage in the credit rating market due to the high barriers to entry, which include substantial costs and compliance with various legal requirements. However, they also have a large moat in their brand. If a company seeks to acquire a credit rating from one of the smaller competitors, it may encounter 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 share price of S&P Global. 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 8,23, which is from the year 2023. I have selected a projected future EPS growth rate of 15%. Finbox expects EPS to grow by 21,6% in the next five years, but I only use up to 15% in my calculations. Additionally, I have selected a projected future P/E ratio of 15, which is twice the growth rate. This decision is based on S&P Global's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $246,90. 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 $123,45 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 3.710, and capital expenditures were 143. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 100 in our calculations. The tax provision was 778. We have 322 outstanding shares. Hence, the calculation will be as follows: (3.710 – 100 + 778) / 322 x 10 = $136,27 in Ten Cap price.

The final calculation is referred to as 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 $11,26 and a growth rate of 15%, if you want to recoup your investment in 8 years, the Payback Time price is $177,75.

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, such as the potential for decreased 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. While it may come with higher costs, it will also increase the barriers to entry in the market. The increasing availability of free or inexpensive information sources poses a risk, especially with AI developing so rapidly. S&P Global's products are enhanced by its analysis, tools, delivery mechanisms, and applications, which should protect S&P Global from this risk. However, currently, there is a lot of uncertainty regarding the boundaries of AI, and I believe it is something that needs to be monitored. I truly appreciate the strong competitive advantage of S&P Global, which is hard to replicate. I also like the acquisition of IHS Markit because it will enable the company to introduce new products, expand its business, and boost revenue by leveraging revenue synergies. Finally, both its sustainability and energy transition business and its private market solutions business are growing steadily each year, with management forecasting further growth in the future. While AI and freely available information may pose risks in the long term, I believe that there will be a growing demand for high-quality data, and I do not anticipate credit ratings becoming obsolete in the near future. Investing in S&P Global is highly compelling due to its business model. 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 shares reach $300, which will give me a discount of around 18% on the intrinsic value of the Payback Time price.

My personal goal with investing is financial freedom. It also means that to obtain that, I do different things to build my wealth. If you have some extra hours to spare each month, you can turn a few hours a week into a substantial amount of money in a few years. If you are interested to know how I do it, you can read this post.

I hope that you enjoyed my analysis. Unfortunately, I cannot do a post of all the companies I analyze. I am available to copy but if you do your own trades, you can follow me on Twitter instead, as I tweet when I buy or sell anything.

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