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

Okay. Let's go ahead and get started. I'm George Tong. I cover business and information services here at Goldman. I'm really pleased to be joined by Noemie Heuland, CFO of Moody's. Noemie, thank you for being here with us today.

Thank you for having me.

So Noemie, as Moody's new CFO, can you describe your top financial priorities for the company and perhaps how you expect to run the company differently than your predecessor?

Yes. So as you said, I joined in April, so just completing 8 months. And it's been a great year to join. I'm sure you've all seen our results for the past quarter, 41% Ratings revenue growth, adjusted diluted EPS growth of 32%. So it's been a very great year so far, and I'm very pleased to be here. I think my priorities as the CFO, and I think they'd be very consistent with Rob's and the rest of the leadership team's priorities is really to make sure we allocate resources and capital to fuel and capture -- to fuel the growth of our business and capture the demand drivers that we see across our 2 businesses. We have a tremendous issuance environment, as I just mentioned. We have opportunities in private credit. I'm sure we'll talk about this in transition finance. And we're working with our analysts to really make sure they can capture those opportunities on the rating side. On the MA side of our business, we also have pretty significant long-term demand drivers for our businesses with the digitalization of bank workflows, insurance workflows. Our research business is one of the largest fixed income research in the world, very, very powerful, and I'm sure a lot of you here in the room are using it. And we have our data estates that we've built across the past 115 years. And we not only have $74 trillion of rated debt, but we also have economy time series, data around corporate hierarchies, properties, people, et cetera, that we then can feed into our algorithm and workflows to help people make decisions about risks that they're undertaking. So there's a lot of opportunities to not only continue to build that with our existing customers, but also expand or land new customers in the corporate sector. And so that's what my team and I have been really focused on is understand where to put investments to really capture -- not only continue to do what we do very well, which is maintaining our agency of choice in the ratings business and giving tools to our analyst population to do what they do best and spend maybe less time on noncore activities, but also equip our MA salespeople, our product group and work with our corporate development team to really allocate dollars to serve the needs of the corporate and expand our presence with financial institutions.

Right. Makes sense. Moody's is guiding to approximately $1 billion in buybacks this year, which is the highest level it's been since really 2015. Where would you say share buybacks fit on the overall spectrum of capital allocation? And what are your overall capital allocation priorities?

Yes. We've increased our guidance for share buyback, by the way, earlier this year. So our capital allocation has been pretty balanced over the years, and I think it's my intent and the intent of the rest of the leadership team to continue in the same mindset. We first allocate capital to fuel growth. I talked about a lot of the demand drivers across our 2 businesses. And so that's really where we are focused on in investing for growth. And then we have a pretty steady dividend increase policy each year, and then the rest is share buybacks such that we overall return a large amount to our shareholders. But if I go back to the growth, you've seen us this year. To illustrate what I said, we've made some investments in our business. We talked about $60 million of investments earlier this year across -- mostly in our MA business, but also in our ratings and technology. And we've acquired a few -- we've done a few bolt-on M&As in MA to increase the breadth of our capabilities to serve different workflows. We've acquired the remaining stake in the leading Africa rating agencies, GCR to help us continue to increase our presence in domestic markets. So those are recent examples of where we've made some investments to fuel our growth.

Yes. At Moody's last Investor Day in 2022, the company established some medium-term targets that included 10% plus revenue growth, low 50s operating margins and low double-digit EPS growth. What are your thoughts on those targets?

Yes. If you think of stepping back on where we are 3 or so years after publishing those targets, I'd say we've kind of checked the mark on a lot of those. If you think about the MCO revenue growth, we're probably there now. If you think about MIS adjusted operating margin is close to 60% this year. We're guiding a little bit shy of that. Adjusted EPS growth has been way within the guidance that we've set for the medium-term target. So we've accomplished a lot, and I think it's very well balanced between growth and profitability story between the 2 businesses. Now if I think about MA specifically, we still have some -- obviously, some room to grow and to get to what we've outlined in the medium term. The way I like to think about the Moody's Analytics business is really if you think about Decision Solutions, about $1.4 billion of ARR. It's already growing at the medium-term target level. So this is where we have workflows for banks and insurance. We have KYP that's growing north of that, and we have opportunities to expand that into the corporate. So that's really where a lot of our investments are going, not only in the workflows themselves, but in our data estates as well to fuel -- to feed those workflows. Then we have the largest fixed income research business that's about $800 million in ARR. That's growing at mid- to high single digit. That's a very mature business. I think that's kind of probably a good proxy for the growth rate of that business. And then you have the data and information somewhere in between in the high single to 10%-ish level. So that's how I like to think about it for MA. And again, we've seen a pretty sizable growth in our workflow and data solutions business.

Makes sense. Let's dive a little bit further into the MIS business. So recently, with 3Q results, Moody's increased its MIS revenue growth outlook from high teens to high 20s, reflecting not only the strong performance in the third quarter, but also an improved outlook for 4Q. Where do you see the most positive momentum as you look at the debt issuance landscape? And are there any areas of concern that really pop out for you?

Yes. And -- we can talk about 2024, but I think we all know where we've published our guidance in the third quarter. We all know how the issuance environment has been since then. So maybe I'll zoom out a bit and talk about how we're framing our thinking for the year to come and beyond. There are a few pretty strong demand drivers for ratings. So we're pretty constructive about the growth prospect of that business. Obviously, economic growth is the most important. We expect around 3% GDP growth for the U.S. next year. So that should bode well for the issuance environment. Spreads are at all-time low. We have recently published our default rate study. We expect the Fed grade default rate to come down in 2025 to about 2.8%-ish midyear. So that should, again, be a good indicator for the trends in spreads that should remain tight. So all of those factors are constructive for issuance. M&A has been still -- the volume of M&A -- financing related to M&A has been still subdued versus historical levels. There's a lot of dry powder at private equity firms. Corporates are sitting on a significant amount of cash. We'll have to see what the antitrust environment looks like under the new administration, but we think there's a constructive environment for M&A. As a matter of fact, we have what we call a rating assessment services business, which is a pre-analysis around a potential M&A transaction and how those transactions would affect the credit profile of a given issuer. That business is usually a good proxy for what the M&A finance volume is going to be going forward, and that business has been going very well. So those are overall constructive environment. And then the last thing I haven't touched on, on the maturity wall. We've published our study in September. We see a significant growth in maturity wall, especially spec grade, around 19% of the 4-year maturity wall in spec grade. So there's been some pull forward this year of spec-grade issuance. People have gone ahead of the potential election volatility. The spreads have been tight. But the volume of spec-grade maturity has been going up such that you think about the forward -- the 1-year forward maturity in spec grade, it's actually the same amount in absolute dollar value than what it was last year. So yes, there's been some refi, but the underlying volume of debt is going up. So obviously, again, very conducive to issuance environment for next year and beyond.

Maybe sticking on the topic of issuance for next year. How do you think about the impact of a Trump administration on the debt capital markets? What could it mean for the, I guess, the broader macro and issuance environment? And how do you think about ratings performance in that backdrop?

Yes. I think we've -- so the first thing I'd say we've been around for 115 years. We've been working through the different cycles, and we've been kind of performing we've been administration agnostic, so to speak. I think what matters really for our business, as I said earlier, is the underlying economic growth. Again, as long as you have GDP growth, that's usually our business is following the trends of GDP growth. So as long as there's economic growth, that should continue to be constructive for us. I talked about M&A. I think what's yet to be seen is whether there's going to be any change in the stance against towards antitrust and whether that's more conducive to larger M&A, which obviously would be a positive for our business. And then regulations, I think we talked a lot about regulations. We're a regulated business. I don't think there's anything around the regulated -- regulation for ratings agencies in the U.S. So that shouldn't have any effect on our business.

Right. And then let's switch gears and talk a little bit about the refi pipeline. You touched on this earlier. There has been a pull forward in both investment grade and high-yield issuance, a little bit more in spec grade, a little bit less in investment grade. So you sort of see the 2 balance out. And I think previously, you had mentioned that if you look at the 1-year forward issuance pipeline, refinancing pipeline, it's up something like mid-teens. So how much visibility does the refi pipeline give you for 2025? How much debt issuance would you say is in the bag because of the refi pipeline?

Yes. So we look at the maturity wall pretty extensively. There's a lot of sophistication that goes within my team and the ratings business to look at the rating -- the maturity walls and the trends. If you think about investment grade, there's maybe more opportunistic issuance. If you think about a CFO, they're usually typically planning 18 -- 12 to 18 months ahead, and you always have capital market access. So there's maybe less pull forward there, as you pointed out. Now in spec grade, as I said, we've seen a lot of pull forward this year, but we also have a significant increase in the maturity walls for the spec grade, 19% spec grade maturity wall over the next 4 years. So that's obviously positive for our business. And if you think about the 1-year forward maturity, they're at the same level as they were last year. And then the other thing I would say is if you look at those maturity walls, the highest year is 2028 for both Europe and the U.S. And I think about 1/3 -- 25% to 1/3 of that debt was issued in 2023 at the time where rates were elevated. So there's obviously opportunity for that to be pulled forward if the rate environment continues to decline.

Right. Now the refinancing pipeline is not only strong for 2025, but also quite strong for 2026. To what extent could there be a pull forward from '26 into '25 that would lift '25 debt issuance? And what would be the circumstances that would cause that to happen?

Yes. We typically have in year -- if you think about any given year, there's always pull forward from the subsequent years. And I've talked a bit about the dynamic between spec grade and investment grade, and I don't think there's going to be any difference next year versus what we've historically seen, especially if spreads remain tight.

Got it. Private credit, big topic for many investors and for Moody's. It's been gaining momentum in recent years. How do you expect private credit to impact ratings revenue at Moody's and MA revenue to the extent that there's impact there as well?

Yes. It's -- so we definitely think it's view private credit overall as a tailwind for our business that might be a bit different from what we thought 18 months to 2 years ago, where we maybe were a bit more on the defensive side. I think there's 2 parts to that market. And one is what people know very well as the leveraged direct financing, which is about $1.3 trillion, expected to go up to $3 trillion. So that's what people kind of know about private credit. And the other part that's very interesting, if you listen to the Apollo and Blackstone and the other large players is all the asset-backed finance and everything that's sitting on the bank balance sheet. And that market, if you listen to Rowan and those guys, they view it as $20 trillion to $30 trillion. And we're already servicing the players in that market already today. And we've actually nominated -- we've created a private equity -- a private credit specific team, and that's co-head -- the head is the co-head of the FIC franchise as well. So she has visibility across all the different asset class of our ratings franchise to understand where the flow is coming from. And because today, as I said, we already rate some portfolio companies of those funded by those big private equity players. We also have a fund finance franchise that mostly falls under our FIG ratings group with subscription lines, NAV, rated feeders, et cetera. We rate portfolio companies. As I said, we have the largest leading -- what we think is the leading franchise in BDCs. And so we already serve the market today. For us, what's important is to make sure we continue to evolve our methodology. We have the staff that's trained and skilled to address the needs of that market. And then we also understand where the flow is coming across the different asset class, which is why we've established that practice.

Makes sense. We talked about some of the puts and takes with 2025 debt issuance. If you look longer term, what would you say is a reasonable medium-term growth rate for MIS revenues? And what megatrends do you think will serve as key growth drivers?

Yes. We've published our medium-term targets for MIS. And I think -- if you think -- as I said earlier, we have the different components. Obviously, economic growth is really the main driver. We have some pricing increase as well. And we -- the way we look at pricing is really on the value base from an issuer standpoint. So we have different pricing mechanics depending on the asset class, depending on the frequency that an issuer is coming to market. I'm sitting on the pricing committee. We have monthly pricing reviews and quarterly reviews where Rob is involved as well. So that's a component of our growth algorithm. And then the rest to get our medium-term target is really the incremental revenue coming from the areas I talked about, which is private credit, transition finance, domestic financing. So all those combined really get us to our medium-term target for ratings.

Makes sense. Now MIS operating margins are currently running in the high 50s. To what extent do you think margins can expand further from current levels? And what are the drivers?

Yes, it's a great operating leverage. We're guiding shy of 60% for this year. We're not far from our medium-term target already. What we're really working on with Mike West, who's leading our Ratings business and the rest of the team is to try to become volume agnostic within a certain issuance band. And what I mean by that is if you think about a year like this year, we've made some investments in the past such that we didn't have to increase our staffing, our ratings and analyst staffing dramatically to face and we're able to absorb and face the demand of such an environment as we saw this year. So those are -- the reason we were able to do that is because we've invested heavily in our technology. As you can imagine, we are a 115-year-old company. We have a lot of different tech systems that required to be upgraded or enhanced such that analysts can really spend time on ratings, research, talking to the market participants as opposed to pulling -- going through the workflows or spending time in putting the same data entry into different spreadsheets. So those are -- there's been a lot of investments in tech that have been going on in MIS to really help us be what we like to call volume agnostic and really help analysts increase their portfolio load. Within obviously, the parameters that are set by a regulator, we're heavily regulated. So as you can imagine in the U.S., but also ESMA in Europe is really looking at how we staff and how we respond to the demand with our skill sets.

Let's switch gears and talk a little bit more about Moody's Analytics. Most recently, if you look at the data and information subsegment of MA, ARR decelerated a little bit from low double digits to high single digits. I think the impact cited were the election cycle affecting government spending. You also had the impact of the MSCI partnership. So how long lasting do you expect these headwinds to be -- and is there a path for data and information ARR to get back to that low double-digit range?

Yes. You mentioned -- so data and information is all the revenue under subscription that comes from our data feeds, our data estates. We've had, as you pointed out, a few government contracts that renewed at a lower rate in the third quarter. We have -- the universe of those contracts is known. We've accounted for those aspects in our third quarter and the full year guidance. So there's no more to be expected there. We also signed a very exciting partnership with MSCI earlier this year, whereby we embed the -- we use their ESG content and sourcing and scores in our product as opposed to customers sourcing them with Moody's directly. And so customers who may have bought -- been having contracts for both are now sourcing those data needs into -- with MSCI. And so that's why you saw a little bit of erosion in pipeline. But again, that's contained. I think we have a good grasp of what that looks like. What we're really focusing on in the data and information part of our business is keeping our edge versus competitors in the depth and breadth of our data. We're investing in curating those data estates, cleaning it, standardizing it so that it can be used across different use cases beyond what they're being used today. If you think about KYC, now we -- we have the ability to expand into the corporate sector where we have a very low penetration today because we've done a lot of work around our data to serve those specific use cases, trade credit as well. So there's a lot of exciting opportunities to continue to feed our data into existing workflows or our own workflows within Decision Solutions.

Right. And then within MA Research and Insights, you're also seeing a little bit of headwinds there from both the buy side and the sell side, asset managers and banks expecting some budget difficulties. Similar question, when would you expect the environment there to improve? What are the catalysts? What's the time frame?

So for Research and Insight, we've talked about the attrition that we've seen late '23, early '24. That really is what drove a bit of a deceleration of growth in that. I think, again, we're past that. We've accounted for all those attrition events earlier in the year. We're pretty excited about our Research Assistant product that was launched last year. We've made some significant strides with the lower player in the market like smaller asset management firms. We have a lot of pipeline with large financial institutions. We've been working with them also to help them build and establish their own framework around the use of Gen AI. As you can imagine, similar to us, we're regulated. Our customers are regulated. So they have to make sure they have the right framework and governance around Gen AI, which is one of the reasons why it's maybe it's taken a little bit more longer time than we expected before we started to get traction on those large transactions. But we're making good progress, and we have a lot of exciting things happening right now and that we expect also we have a strong pipeline for next year there. So again, I think we've seen some tight purchasing pattern on bank and asset managers. I would say, though, if you look at our banking ARR in our Decision Solution workflow, it's been growing at 9% to 10% since early 2023. There's a lot of demand drivers around -- for banks in the -- as they're going through their digitalization journey, not only to be more efficient, but also effective. I mean you've heard some of the fines around the KYC for some of the large banks. So we help customers, and we have a lot of attention and traction and pipeline as a result of those types of events. So we have a lot of good discussions now with banks around growth and maybe less so around risk and resiliency and expense control as we had about a year ago. So that's encouraging signs.

Yes. Let's talk a little bit more about Gen AI. You touched on Research Assistant. That certainly sounds like it's gaining a lot of good traction. Can you talk about the pipeline for Gen AI, what additional products they have in development? And what has overall customer receptivity been broadly to Gen AI?

Yes. If I -- maybe just on Research Assistant, again, which we launched about a year ago, the -- a few interesting stats around that. We've seen our NPS score for customers using Research Assistant to be about 20 points above customers using just CreditView without their Gen AI capability. We've seen a sizable increase in research consumption, which at the end of the day, is a good tailwind for subscription research business. We've also seen the average deal size for Research Assistant to be higher than the regular CreditView deal size by a factor of 3x or 3.5x. So those are encouraging signs. Obviously, still moderate contribution to revenue growth for the reasons I talked about in terms of timing of implementation of the Gen AI framework. But what is -- I think what those products do is it elevates the narrative and the dialogue with our C-suite, whereby before we may have been focused on selling one specific product to address one specific use case for one specific persona at a financial institution, whereas now Rob is having more comprehensive dialogue around efficiencies, effectiveness, controls and resiliencies with large banks, and Gen AI is a strong driver for value generation there. If you think about labor, the share of labor versus agentic AI. So there's a lot of interesting dialogue going on there. Now to your question about what else is in the pipeline, we've launched automated credit memo also in the same vein. And we have early warning systems, which take any piece of information, for example, a news event around a retailer exiting a specific location or state and having the ability to immediately model what that means in terms of lease portfolio exposure and potential losses as a result of reduction in occupancy rates, and you can do that in a span of seconds. So that's one of the examples that now we're not only selling initially to our insurance customers, but also now to banks for them to assess their potential losses on their portfolio. So we think about this in kind of being pretty consistent across all of our solution sets.

Right. It seems most of the Gen AI products are sitting in the MA segment. What kind of role do you see Gen AI playing in the MIS business? Is it really just a productivity enhancer? Or are there some potential revenue benefits there as well?

So most of our -- so we're -- the Gen AI capabilities that we commercialize are all in Moody's Analytics. But we're also looking at -- were pretty exciting outcomes of our AI-generated ratings in our ratings space. We're obviously using that in parallel to our traditional ratings, but we're getting in front of it. We're building an understanding of how those algorithms are predicting and projecting credit score or credit ratings so that when and if the customers at one point in time want an AI-generated ratings, we're ready and we have the skill sets and capabilities to do it. Obviously, we're regulated, as I said. So we're working with our regulators, and we have very frequent dialogue. Mike West is there talking to them frequently to understand and for them to understand what we're doing with Gen AI in our ratings. And I think in terms of -- so that's just for the kind of the ratings part of our -- and the use of Gen AI with respect to ratings. I think, as I said earlier, a big opportunity for us, which we've been investing in over the course of the past 3 years, 4 years is around the underlying workflow technology, to -- from the time a research document is pulled to inform a ratings to the time it gets published on moodys.com. There's a lot of different systems and interfaces as we're working to streamline that, automate it and then potentially use Gen AI as well to facilitate the work that's done by our analysts so that they can spend more time with the market participants and in credit ratings committee and so on and so forth.

Makes a lot of sense. I'm going to pause there and see if there are any questions from the audience before I continue. We have one there. Let's wait for the mic.

You mentioned [indiscernible]. Can you talk just generally about how your [indiscernible]?

You mean it's for the research assistant specifically or in general?

In general. [indiscernible] is there a fairly significant opportunity inside the cross penetration of the current client base?

Yes. We -- so that's a very interesting theme, and I'm very excited about that actually, that's coming from a software space where in SaaS, where you have actually build it once and sell it multiple times or -- so yes, the answer is absolutely yes. There's a lot of opportunity to cross-sell not only to our existing banking customers, but also selling some of the -- each solutions and workflows initially built for the insurance customers into banks now. Think about understanding of the impact of weather -- significant weather events or climate change into the portfolio of property or commercial real estate as an example. So that also has very strong interest for banks. So that's an example of a cross-selling opportunity for -- to cross-sell across different customer segments. We've done a lot of investments in our infrastructure and our platform to make it easier for customers to access our workflows and having the same single sign-on, the same point of entry. So that's part of a -- I've talked about the $60 million of investments we've made in February. Some of it went into our platform so that we can actually enable cross-selling across different customer segments.

Great. Any other questions? Okay. Let's return to our conversation on Gen AI. We touched a little bit on monetization, but can we dive a little bit more into potential ways you might look to monetize Gen AI? Is this a cost plus? Is this an add-on? Is this an upsell consumption-based pricing? What are your thoughts there? And then how much impact or lift to revenue do you think Gen AI can provide over the near term and over the medium term?

Yes. I think we've -- as we -- with Research Assistant, we initially took the stance of an increase -- an uplift to our existing pricing. We're obviously piloting that, see how that resonates, and we'll continue to evaluate that. I think what I've noted in my conversations with CFOs and customers is really about value-based pricing, and it's not so much about the price of the product itself, but it's also what is the business case around the investment? And how much labor efficiency or efficiency am I going to get in the execution of my own workflows by implementing the tool? And that's where the pricing discussions comes in in terms of how much ROI. So it can vary depending on the different customers. So that's how we're approaching it. Now in terms of the road map or how we're thinking about the framework longer term and maybe I've talked about Research Assistant, which is what we call the Navigator. So it helps customers accessing and using our existing tools in a more efficient way. Then you have a bit more sophisticated, what we call skills, which are models that embed Gen AI capabilities. So think about some of the models within RMS as an example, or some of the things that I talked about in the early warning system. And then the end of it is the Navigator, which are really going to replace workforce in the execution of workflows. I think we're still some time away from that, but that's really where we're investing to really build workflows, [ agentic ] workflows that can replace significant labor costs. And that's what our customers are really excited, and those are kind of where the discussions are leading today.

At this point, would you say it's still too early to measure the materiality in revenue impact? It's less than 1%.

It's -- yes, we haven't quantified how much -- and the other thing I would say is we've always had some sort of AI, artificial intelligence embedded in our products. So I think we're taking that to the next level. We already -- as part of our existing revenue base, we already have some pretty sophisticated AI capabilities in our credit default model, our climate-related risk management tools, et cetera. So it's not new. We're just taking it to the next level. And I think you'll see us provide more color on that over the next few quarters.

Makes sense. And then last question on MA margins. This year, you're guiding to segment margins in the low 30s, which is relatively stable and unchanged from 2023. How do you think about the puts and takes with balancing reinvestments in MA with driving more margin flow-through?

Yes. For this year, we've made a conscious decision to invest in Gen AI capability, platforming as well as product capabilities. So that's why the margin has been relatively flat versus last year. We've guided to mid-30s for our MA margin. And I think there's potential to go beyond that in the outer years. I mean it's a great business model. You sell it, you build it once, you sell it to multiple times, you have cross-sell opportunities and then you have additional expansion or landing new customers in the corporate, which will largely leverage the existing workflows and infrastructure with a bit of more tweaks on the data state, et cetera. So there's opportunity to take that forward, and we're committed to that. We're already leveraging a lot of tools internally around our customer support, where sales prep, go-to-market, we're using Gen AI and automation to really increase productivity across the board, and you'll see us continue to do that.

Wonderful. Well, really appreciate the time and the insights. Please join me in thanking Noemie.

Thank you.