Moody's Corporation (MCO) Earnings Call Transcript & Summary

All right. We will go ahead and get started. Thank you, everybody, for joining us this morning. I'm Patrick O'Shaughnessy, the Capital Markets Technology Analyst at Raymond James. And with you for this session, we have Moody's. On Moody's behalf, we have Mike West, who's the Head of Moody's Investor Services; and Shivani Kak, who is the Head of Investor Relations.

So maybe, Shivani, to first, have you kick it off. For those in the room who are a little bit less familiar with the company, can you maybe just provide an overview of what Moody's is today? And maybe even layer in kind of how that has changed a little bit over the last several years.

Sure. So I think most people think of Moody's as the rating agency. And then in '22, for the full Moody's Corporation, we had revenue of around $5.5 billion. And that was made up just around nearly half-half, MA and MIS, and MA was actually 51%, so broke the 50% barrier for the first time. I won't touch too much on MIS because we've got Mike West here. But we rate over $73 trillion of debt, globally. And so we've been around for 100-plus years and are very well established in the debt capital markets. MA, on the other hand, has really grown since its foundation in 2008. And the CAGR of growth has been approximately 12%, 60% of which is organic. So as we think about MA, it's kind of its USP is that it takes data, it takes analytics and software, combines all of that together and deliver some really phenomenal either raw data that you can imbibe through a data lake or some very sophisticated workflow tools and software solutions. And as we think about the growth of MA, it -- its revenue growth last year was 15%, and that was with a 5% FX headwind. We had ARR of 10%. And when we think about recurring revenue element of MA, that's approximately 94% with retention rates in the mid-90s. So it's a very -- and we call it an acyclical juggernaut because it's just really delivering those critical solutions to our customers that are embedded in their workflows. And is very exciting as we think about the growth opportunities, both in the KYC and private kind of data, where we have data on over 450 million public and private companies. In the insurance space, especially with our RMS acquisition, as we think about some of the climate data models that we have for RMS. We're in the banking lending solutions. We have best-in-class and stress test models. We are -- the ratings research that is the output of MIS. We have a very, very broad range of solutions that we're delivering and that are driving us to guide for that at least 10% revenue growth for 2023 in MA and low double-digit ARR for the year.

Perfect. Well, thank you for the introduction, and I will circle back to some more questions on Moody's Analytics later. But let's take advantage of having Mike in the room. So turning the focus on MIS, the ratings business. What's Moody's outlook for issuance in 2023 as you think about the key components?

Yes. Well, it's a very good question because many of the elements of impact on our issuance in 2022 have flowed through in 2023. And when you think about some key components of GDP, the interest rate environment and the longer-term picture around this intermediation, a number of those components have been impacted in the first half. And what we recently announced on our earnings call is that many of the factors that were influencing '22 have flowed through into '23. We have an expectation of that inflation to continue, and the impact of that on issuance is that rates have continued to rise. There's an expectation they will continue to rise and the expectation around the spread making the all-in cost of debt being at a higher level than it has been in the prior 10 years. So that's very, very impactful for us. We expect as the second half gives some clarity that, that will start to ease. And what we have said is that issuance will start to pick up in the second half of the year.

When you think about the various macroeconomic risks as it pertains to issuance this year, whether that's a debt ceiling crisis, a hard landing or reaccelerated inflation, how do you incorporate that in your outlook?

Yes, in terms of the macro, when you think about some key components, debt is often driven by GDP. This year, we are lowering our expectation around GDP with an expectation of a pickup for the G20 going into '24 inflation somewhere around the 5% to 9% depending on where you're looking across the globe and rates hovering around about 5%. And we are looking at policymakers who are trying to balance addressing and arresting that inflation with a soft landing. It's very important with regards to that soft landing because one of our other indicators is around the spread. Our expectation around spreads for high yield is around the 500. And when you think about the all-in cost of debt of 5% base, 500 basis point spread, but 10% in the high-yield space is significantly more than has been experienced in the last decade. And then you've got default rates. Our expectation around those default rates, again, rising above a 10-year historical average towards about 5% causes support for investors and the selection of instruments that they want to go in. So it's quite a challenging period, and then you get an overhang of certain elements in politics and in this case, the debt ceiling. And at best, that's probably something that will get resolved as it has done in the past at the 11th hour with various negotiations and concessions because nobody wants a default scenario with the U.S. AAA.

Was there anything about the weak issuance environment in 2022 that you would view as a structural change in issuance? Or was it just the manifestation of a significant cyclical and temporary market shock?

Yes. I'd classify issuance shift in '22 coming off a very high '20 and '21. As a cyclical move, I wouldn't necessarily talk to a structural move where if you define structural shift in debt markets as a persistent deleveraging in a particular asset class or sector. We're not seeing that. What you saw was a very strong stimulus build generating issuance in '20 and '21. That reversed as policies tightened in '22. And we can also see that the buildup of debt has continued during this period. In fact, we have our highest level of debt that needs refinancing in the next 4 years than we've ever seen before at approximately $4 trillion, and that's just for nonfinancial corporates. We're also seeing that debt continues to be a cheaper source of funding than others for corporate treasurers and therefore, will be an important part of the mix. And then just that long-term glacial trend of disintermediation is continuing, both in the developed as well as emerging markets. So you will see this cyclical movement over decades, and I've been actually observing debt markets for 30 years, and this is just another element of those swings.

When you meet with corporate treasurers and CFOs and kind of discuss the macro, is there a level of interest rates where they say, "Hey, this is going to change how I think about how I utilize corporate debt organization?" Or is it all dependent on a variety of other factors?

Yes. I mean, when -- I mean, the great advantage of working at Moody's is that you actually get to speak to a significant number of CFOs and treasurers and hear what their financing strategies are. There's one thing that all financial planning departments have to get used to is a new normal where in the last 10 years, there's been very low rates. Spreads have been relatively modest when you think about the all-in cost of debt. The treasurers have had to get used to this new normal of -- as a 5% at the moment base before you even start to look at spreads. And that's why when they think about what is important to them, which is probably interest cover and cash flow to debt metrics that you have to now start working into your planning your debt structure and the cost of that debt to remain within those benchmarks. So there's many things that go into it, including the spread of their debt. But there's a continuous expectation that debt will be a part of it, but they have to accommodate the overall cost of that going forward.

One of the big trends over the last couple of years has been the emergence of private credit. Do you foresee leveraged loans winning back market share from private credit in 2023 or beyond as market conditions normalize?

Yes. If you think about private credit and those that may not be familiar, it's direct lending from private funds as opposed to going through a public market that could be the high-yield market or the broadly syndicated market. So it's a third option if you think about it in that context to fund leverage buyouts. And again, if you are an observer in these markets, dislocation often allows for an alternative form of funding. And last year, with both the high-yield market and the broadly syndicated market being dislocated, there was an opportunity for private lenders to come in and fund some of those buyouts. I just got a few numbers around that in context of 2021 where the public markets were approximately about $1.6 trillion, of which we rated approximately $50 billion of that above what we would classify around about $350 million of total debt, and our instrument came from private credit. That during '22 went to about $80 million to $100 million.

Billion.

$80 billion to $100 billion. And it provides an opportunity for around that execution to get those deals away. As markets start to settle, as markets start to come back, then the opportunity to come back and refi in some of those public markets is there. There is also the factors that face the markets that do not differ between the private credit companies and the public is that as economies get stressed, as conditions get tighter, that those conditions apply to credits, both in the private and public. So we'll see how the private credit companies that have been funded performed during this period. But I do expect that the reemergence of the public markets will start to pick up some of that funding opportunity.

And then I think you touched on this a little bit, but how does Moody's monetize private credit? What sort of role can you play in helping those private credit general partners manage their portfolios in providing useful information to the limited partners?

Yes. Just try and keep this pretty simple. There is that generation of that primary asset. And then there are buyers of those assets, whether those are the broadly syndicated, the high-yield bond or the private credit. And what we are seeing is the emergence of funds like business development companies or BDCs. We rate BDCs. We rate the funding that is generated to purchase the primary asset. Some of those private credit also go into CLOs, whether mid-market or whether larger syndicated loan CLOs, of which we rate. We also rate through our funds group, the funds that are put together, the general partner funds to purchase credit and any instruments they use or other funds like sovereign wealth that we also rate a number of those. So when you think about where does Moody's play? There is the primary, there is this asset purchase, and which I will classify in this case, a secondary. And then Moody's Analytics has the opportunity to provide tools and data sources to allow the private credit funds to monitor and surveil those particular funds. So we can come at different ends of the spectrum. And obviously, we have a variety of relationships through that space with the players in private credit.

If I can just add for Moody's Analytics, for example, our Orbis database has data and firmographics on over 450 million public and private companies. And we also have a product called RiskCalc, which helps portfolio managers kind of predict probability of default on their portfolios, and that includes investments in private companies. So there are tools and solutions that we can help people operating in the private credit markets from that side.

The medium-term outlook for MIS segment revenue growth is for low to mid-single-digit growth. Can you discuss the underlying assumptions behind that and whether events since your Investor Day last year had impacted your outlook in any way?

Yes. Just a few comments around our outlook. First of all, we had a low to mid-single digit based off the '22 -- the '21 issuance. In the latest earnings call, we moved that to a mid-single digit of the '22 year-end. That appeared to a number of observers that, that was relatively conservative. But what we did say on the earnings was that, given the uncertainty in the first half of this year for many of the reasons I've spoken about in terms of the inflation, the rates, that growth, the geopolitical circumstances, that we would go back and revisit our medium-term outlook later this year as a number of those factors became clearer. In terms of the longer-term fundamentals, we feel very good about the longer-term fundamentals of the debt market and our role in the debt market. But we will revisit that medium term later this year.

And then your medium-term adjusted operating margin outlook for MIS is low 60s, which compares to your 2023 outlook for the mid-50s. What are some of the cost initiatives underway to help you deliver your 2023 target? And then how do you get from there back to low 60s?

Yes. So there was a really good report that was written recently about Moody's is controlling what's controllable. And if you are in MIS, the one thing you cannot control is the volume of debt that we would be rating and evaluating. But what you can control is running the business and the costs. And the back end of 2022, we did a fulsome review across the whole corporation, not just in the Moody's Investor Service, about our cost base. A large chunk of our cost base is people. We had programs to reevaluate the number of staff we needed across the company. Coming out of the pandemic we were also reevaluating real estate. And we're also reevaluating what projects we wanted to bring on. What we did say on our call was that we would be very comfortable outlining that our adjusted operating margin would move up to the mid-50s. And then as markets started to pick back and operating leverage started to come through and we continue to be disciplined in the way that we operate that, that margin would start to rise into the low 60s. And again, that's about controlling across as we start to see that leverage and flow coming back and positioning the company accordingly for greater volumes going through the company.

I think a lot of people who are familiar with your business, the ratings business in particular, know it is a really high-quality, high barrier-to-entry business where you have a very strong competitive position. So in that context, what does aspiring to be the agency of choice mean?

Yes. I mean, I think that when people think about the rating agency business, they see it as a few players and high barriers to entry, but you cannot rest. You cannot rest on your laurels. This is a business with competition. And we are dealing with a market that's continuously evolving, and the demands on our business are continuously evolving. So we have to make sure that we are always prepared. We can always turn down a rating because of credit quality, but we always need to be prepared to participate. And when you think about that, it's about preparation for the digitalization of bond transactions. We need to be ready that when people want to bring a digital bond that they want to come to us and make that choice. So Agency of Choice is we recognize people have a choice. When you think about a company in a sector like cement that need to be able to articulate what regulation and carbon decarbonization means for their credit, they are looking to us to be able to articulate that very clearly in the context of cash flows and servicing debt. So adding ESG factors in the context of credit, adding cyber factors in the context of credit, being able to operate in every market locally where there's a meaningful debt market is something that we do. And therefore, we are availing ourselves to people making a choice to come and use us. We rate extensively across industries, but we also write research that then investors want to come and use our research and our data. And that is monetized through Moody's Analytics. But it's about making ourselves available and be the Agency of Choice for whether it's a debt issuer or whether it's an investor with a portfolio of debt instruments.

A broader question that can probably bring Shivani back in the conversation, and you mentioned ESG as part of your answer just now. What are Moody's key initiatives right now in ESG across both Moody's Analytics as well as MIS?

Well, it's a nice blend because when you think about Moody's Investor Service, you think about credit. And ESG in the rating agency is about the focus on credit. Come back to that cement company. If that cement company has regulation on decarbonization to meet by 2040, it will either have to invest some of its own cash, borrow some cash to make that retooling. And if they don't, there is a risk of stranded assets. And the debt repayment profile, therefore, gets impaired. So focusing ESG on credit and be able to talk about the impact of various factors on cash flow profiles is where we are operating. And that's been very, very well received. We have over 10,000 scores out across the portfolios, and those are being used by investors to think about those credit consequences. And this differs a little bit from where MA are focused. And Shivani, do you want to just talk a little bit about...

Yes, I think from MA and its -- and Rob made the -- Rob Fauber, our CEO, made this comment when we acquired RMS that we were going long on climate. And if you think about what RMS brings to the business is just world-class climate data and models around climate risk. And as you think about asset owners, asset originators, factoring in climate, I mean, Mike just mentioned cement factories, but if you are going to be building a plant, you want to know what is the climate risk. Is it in the flood plain, hurricane, all of these things that you start integrating into your lending tools. And we have our CreditLens, which is a bank lending tool is, kind of that's incredibly valuable and useful to banks. You also then have in stress tests when climate is becoming a consideration in this scenario that we're able to integrate that. And we have ESG tools that we can score using AI and algorithms, kind of what is the implied kind of ESG score on hundreds of millions of companies using the data that we have in our database. And so that is something that as we kind of integrate ESG more and more into our product offerings, we see it as incredibly exciting. But we're very focused on making sure that we are really setting standards and that we are being as transparent as possible.

During the company's 2022 Investor Day, you spoke to a medium-term revenue growth outlook for Moody's Analytics of a low to mid-teens. Can you delineate the key contributors to that growth outlook, including future acquisitions?

So we said at the time that the low teens, we saw a very clear path to achieving that organically, and the mid-teens would be through most likely investments. And as we think about the building blocks behind MA's revenue growth, we have this 10% ARR, and we're guiding to low double-digit ARR for '23. One of the things that we have that we're incredibly proud of is just a phenomenal sales force. We have, I think, really, really great salespeople. And we talked about the fact in '22 when we were adding to that sales force, the productivity level didn't dip even though the numbers of salespeople was increasing. And you put that behind the RMS kind of platform, that's incredibly exciting. You then also have the kind of the SaaS journey. And we've been -- we made a strategic decision back in 2015 to kind of shift a lot of our MA products onto the SaaS-style platform. And that is something that we're not fully there yet in the journey. But as you transition to SaaS, you see greater operational efficiency and the ability to greater usage and the ability to get more price yield on your products because they're being used more. We also have new product development, and that's something that is very exciting that we're constantly innovating and enhancing. And again, going back to the USP that I mentioned at the beginning, that integration of data, analytics and software, just really positioning ourselves as somebody who can't -- no one else can provide that kind of holistic overview that we can to our customers. And then being embedded in their workflows, that stickiness that we deliver with the mid-90s retention rate is incredibly exciting that we continue to be delivering more and more products. So a lot of exciting opportunities that are driving growth. We're not reliant. We talk a lot about KYC and compliance because that has north of 20% growth, but that is not the only revenue growth stream for the business.

Terrific, and then maybe to wrap up the conversation this morning, we spoke about your conversations with other CFOs and other corporate treasurers. How is Moody's thinking internally about its own balance sheet and its own leverage and uses of cash flow in this environment?

So our capital allocation philosophy hasn't changed. We will always look to invest first organically in the business, then look at inorganic opportunities before then looking to return capital to our stakeholders firstly, in the form of dividends and then in the form of share repo. And our guidance, as we said on the year, as we're looking to return approximately $800 million this year to our shareholders in the form of either dividends or share repo. So as we think about our free cash flow, which at the midpoint is around $1.5 billion, we have -- we ended '22 just around the 3x the gross leverage for our debt coverage. And that is pushing the threshold for the BBB anchor that we have for our business. So as Mark Kaye said on the last earnings call, we will look to use a portion of our free cash flow to partially deleverage and get us back within that range.

All right. Terrific. Well, on that note, we can wrap it up. But thank you, everybody, for attending this morning.