CME Group Inc. (CME) Earnings Call Transcript & Summary

All right, everyone, let's get started. Good afternoon, everyone, and welcome to the 21st Annual Crédit Suisse Financial Services Forum. My name is Ari Ghosh, and I cover the U.S. exchanges here at Crédit Suisse. It's my pleasure to introduce CME's management team this afternoon. With us on stage, we have Chief Financial Officer, John Pietrowicz; and we also have the company's Chief Accounting officer, Jack Tobin in the audience with us. The structure of our discussion today is a hybrid fireside format, where John will run through a few slides. I'll hit on some key themes and then we'll open up for audience Q&A. So 2019 was a productive year for CME as the company hit integration milestones with NEX, exceeded synergy targets and maintained healthy volume trends supported by a growing client network and premium product launches. 2020 has got off to a volatile start with sharp equity market corrections, elevated activity levels from clients and a huge manage risk, and all this is driving some really strong volumes at CME. John? Great to have you here. Thanks so much. And why don't you kick things off with a quick update?

Great. Well, thank you very much, Ari, and good afternoon, everybody, and appreciate you spending some time with us here, and appreciate your interest in CME Group. So first off, CME has a tremendous business model. We're vertically integrated with our clearing house, which provides risk management expertise and offers our customers substantial capital efficiencies. We've got Globex, which is our trading platform, which is used in 150 countries. It provides access to our markets, which operate nearly 24 hours a day. And we've got our deep liquidity pools of globally relevant benchmark products, which allow customers to move large positions in and out of the market without moving the market. As you can see from the pie chart, about 1/2 of our revenue comes from financial products, about 1/3 of our revenue comes from commodity products, and the balance comes from market data and other products and services that we provide our customers. So this is a very defensible business model and a great platform for growth. The main driver of CME's financial results are transaction volumes. We charge a fee for transactions cleared or traded across our platform. With our diverse product set and continuous innovation, we've been able to grow our volumes on average 13% per year over the last nearly 50 years through a myriad of financial and economic conditions. As you can see from the far right-hand side of the chart, we're averaging -- this is a little dated. This is 20.8 million. We're up to around 22.5 million contracts a day based on the volume we've had this last few days here. So we're off to a very strong 2020. So let's drill into kind of recent activity at the exchange. We're up about 18% year-to-date. More recent numbers gets you there around 23%, but about 18% year-to-date versus same period last year. Every single product area is up. Four out of our 6 product lines are up double digits. We're seeing particular strength in the commodity products. You see those circles on the chart, so the energy, ags and metals, and those tend to be our higher-priced products, that we're seeing extreme strength in our equities business, which right now is averaging -- is about up 57% compared to the same period last year. The chart was done a couple of days ago. So that's showing around 45%. So a very strong start to 2020. One of the key growth drivers for CME Group is bringing in global customers or expanding our global customer base. And we've been focused also on developing liquidity 24 hours a day, and it's really paid off. We're generating about 4.1 million contracts a day from Europe and about 1.2 million contracts a day from Asia. When you look at more recent results, it's up about 25% year-to-date in Europe and up about 35% year-to-date in Asia. So all totaled, we generate over 25% of our electronic trading volume and about 1/3 of our electronic trading revenue from customers outside the United States. One of the characteristics of CME Group is that we have tremendous leverage in our business model. And you see from the chart on the left, we -- this is our financials for the last decade, and it includes NEX, which we closed on in the fourth quarter of 2018. So in 2019, we generated about $4.9 billion in revenue. We had 62% operating margins. We exceeded our first year synergies related to the NEX transaction. And we guided to flat expenses in 2020. So with these financial characteristics, CME Group produces a tremendous amount of cash. And we get that cash back to our shareholders through our innovative capital return policy. So in addition to our regular quarterly dividend, which we increased from $0.85 from $0.75, so about a 13% increase in our regular quarterly dividend, we have what we call the annual variable dividend. So at the end of each year, we target average -- we target a cash balance of about $700 million. We will get the amount of cash we need for the following year, and we sweep that cash back to our shareholders through the annual variable dividend. In 2019, I'm sorry, it was about $2.50. That's up from $1.25 the year before, as we're paying down debt for NEX. And we're targeting a debt-to-EBITDA of about 1x debt-to-EBITDA by the end of this year. So since we implemented the annual variable dividend policy in 2012, we've dividended back more than $13 billion to our shareholders through the regular and annual variable dividend. Oh, sorry. And then, all right, to summarize, CME has a tremendous business model and is a great platform for growth. We're very much a networks business. We're very focused on bringing on the end customer and innovating new products and delivering to our customers capital efficiencies and returning -- and rewarding shareholders through growth and through our innovative capital return policy. So with that, I'll turn it over to Ari for some questions.

Great. Thanks for that update, really thorough over there and nice volume trends as well.

Yes, hard not to be happy with the way things are performing.

You got to update it every day to get the right number on that slide.

I do.

But let's look at some of the underlying trends, just starting with equities. Now clearly, volatility is helping volumes there, keeping strong growth year-over-year in the franchise. Maybe you'd dig into some of the products that's driving the volumes early this year and then also sort of the interplay with the retail client base as well in terms of what innovation looks like.

Sure, absolutely. The way we look at the business is we're looking to grow the business regardless of the volatility environment. Certainly, volatility helps, but really focused on growing the business regardless of what's happening in the environment. And we're very much a networks business. So we're very focused on bringing in the customer because that customer improves the overall offering to all customers on the platform because it narrows the bid-ask spread and it makes -- and that tends to be the most costly part of the trade. So we want to bring in as many customers as we can and innovate as much as we can. So in terms of equities, in particular, we've had a tremendous start to the year. In fact, we're up over 70% in the month of February in our equities complex and we generated about -- in the month of February, we're up to around 4.5 million contracts a day in our E-mini product, which is our main product in the equities complex. So just tremendous activity. It really -- it's -- what's really important is that we have all of the major indices on our platform, and it's exclusive to CME Group. So that includes the S&P, that includes the Russell, and that includes the NASDAQ along with the -- we also trade the Nikkei as well. So all the major indices are traded on our platform, and it allows a lot of capital efficiencies for our customers, and it also allows a lot of spreading opportunity in and amongst those indices. In terms of the retail, we've innovated in that area as well. So not only do we have the E-mini contract, but working with our intermediaries, we determined that we could generate more activity and more customers by offering the Micro contract. And what the Micro is 1/10 the size of the E-mini. And it is in -- our most successful product launch in our history. In fact, in the month of February, we're generating about 750,000 contracts a day in our Micro contract. In a Monday, we traded about 1.8 million contracts in the Micros on Monday. So that's been a huge success. So we've been able to attract new customers to the platform by really innovating around the equities products.

Maybe then moving to energy next. Well, I think if I look at the volumes the last couple of years, maybe there's been a little bit of range-bound ex of volatility events so that you see a nice little uptake in 2020 when you think about the overall complex. Maybe you could just start with thoughts around the structural tailwinds from the globalization of WTI. Like has that mostly played out? Do you see more of that yet to come? And then more broadly, if you could talk about the diversification of the energy franchise and the outlook for 2020.

Sure. I think the -- when you take a look at our energy complex, I'm really excited about it. We are the leader in terms of the energy markets. With our 2 main contracts, which is the WTI, and we have got the Henry Hub natural gas contract. And of -- we also have refined products as well. What we've experienced recently is kind of a range-bound in terms of prices and no discernible trends around prices. So that has somewhat limited the amount of -- or dampened the amount of trading, but what we're seeing now is really -- it's starting to take off. I mean we're up around 20% in terms of year-to-date in our energy complex. And when you take a look at the -- our global growth in energy, it's up double digits, both in Europe and Asia in the month of February. So in terms of the tailwinds playing out, I don't think they've played out. I think there's a lot more room to go there because the structural changes that happened in the energy marketplace a couple of years ago still has more room to play out. There's a lifting of the crude oil ban, which tied the WTI to the global markets and also the fracking revolution, which really has made the U.S. largest producer of oil in the world. So we are now the swing producer. And that's where the risk is, and that's where people will need to come and hedge. So I feel very good about where we sit in our energy business. When you look out several years, I think there's really some exciting trends that are happening, really -- especially in natural gas. When you look at the investments that are being made in the Gulf Coast with the liquification of natural gas, I think that will be really helpful and really increase the importance of our Henry Hub contract because once you liquefy natural gas, you put it on a boat, that ties the regional natural gas markets into a global market. And that's where we think our Henry Hub contract is going to be -- become even more important as a hedging mechanism in the future. Also, we do have liquefied natural gas contract that we've launched. We've also launched a Houston-based oil contract which are, again, small, but it will tie the markets together as we kind of move forward. So I think we got a lot more room to go when it comes to our energy business. I really like where it sits globally. And I think when you take a look several years out, as much as we talk about the energy markets changing, there's still an important role to play for CME Group and the energy markets going forward.

Got it. And then you touched on higher RPC as [indiscernible]. And also we've seen really good volume trends of [shear] metals, ags. Part of that is driven by some of the concerns, the metal concerns from some of the buyers, maybe trade wars and things like that. But can you parse out maybe how much of this is more related to some of these concerns versus the new products, new customer bases that you're penetrating. And if you think about their -- either ags or metals off of a smaller base, how do you see that over the next few years? How does that play out in terms of more sustained growth?

Yes. You know what? Well, first off, it's -- the latest changes or the latest impacts to the market, it's certainly a tragedy around the coronavirus and hopefully, we can find a solution there. I think what's important is when you take a look at our marketplace, whatever the risks may be in the world, we're the place that you could come to, to manage that risk. So what we've been really focused on is making sure that we have the tools for our customers to manage that risk 24 hours a day. And so we've been doing things like innovating around our product set across all of our asset classes. So when you look at things like metals, for example, our gold contract has been a tremendous success. We have -- it has grown tenfold since year 2000. If you look at the CAGR from 2015 to 2019, it's grown 20% during that period of time on average. So it's been a tremendous success. And that's all while the OTC markets from the year 2000 to now has been relatively flat. So I think the world is turning to our products to manage that risk. And it's because we're open almost 24 hours a day. And also, it's something that's easily -- easy to do business with, easy to transact on. So really pleased with our metals business. That's been a tremendous success. Also, we've launched our copper contract, which has done very well. So that's a new contract we launched, and it's taken a significant share in the overall metals marketplace. So that's been very good. In terms of agriculture, that's been very much a quiet success story. It is -- we have all the major products for the global food chain or -- I'm sorry, global food supply. And that is -- that's very important, especially when we deal with things like trade -- global trade or the weather, which can impact prices. You have to come to CME to manage that risk. And that's up in the mid-single digits in terms of growth this year. So I think what's really important, you kind of touched on it, is that, unlike our peers, we have all the major asset classes, and our peers don't really have that to offer their customers. So we have all the major asset classes. We're available almost 24 hours a day to manage the risk. And whether it's in metals, whether it's in ags, whether it's in energy, we've got you covered.

Last, but not least, fairly on rate, you sort of touched on that as well. Following 2 record years, when I think about volumes starting this year and also open interest trends, maybe the slightly lighter than expectations in January, when you look at it year-over-year, might pick up now year-to-date. So could you talk about, maybe heading into the year, what were some of the dynamics at play there, both in terms of volume trends over the year and maybe the underlying trends in open interest as well on the rate side?