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Morningstar | Moody's Resilient Business Model Has Led Us to Increase Our FVE to $196 From $168

After incorporating full-year results and decreasing our model’s cost of equity, we’re increasing our fair value estimate to $196 per share from $168. This is mostly attributable to our updated cost of equity, which we lowered to 7.5% from 9%. We felt that it was prudent to do this because of the resilience Moody’s has demonstrated in its business model. Though revenue tied to bond issuance will always be cyclical, we think Moody’s wide moat allows it to offset lower issuance through higher pricing, as it did in 2018, when issuance declined more than 7%, yet ratings revenue fell only 1.7%. In addition, we anticipate Moody’s revenue base will be increasingly balanced toward recurring fees from Moody’s analytics. Our model still includes one bad year of a recession, where ratings revenue falls more than 5%, with total revenue declining only 2%. In addition, Moody’s impressive margins give it more than enough room to cover debt obligations, giving us no worry about the company’s debt load. We feel shares are modestly undervalued, trading at a 10% discount to our fair value, but should the company revisit its December lows based on short-term worries, we would view Moody’s as materially undervalued.

In addition, we’ve made a few changes to our model. Over the next five years, we anticipate margins to expand only modestly from 2018 levels. Though we believe the company has a sizable opportunity from operating leverage, our forecast for one bad year of a recession limits those gains' profitability. If it weren’t for our model including one bad year, it seems totally reasonable that Moody’s operating margins could expand by 500 basis points or more.

Finally, investors worried that higher interest rates would hurt bond issuance didn’t have to wait long to realize lower interest rates. That said, a slower economy could weigh on debt issuance as well. Even in these scenarios, it’s hard to see these issues detracting too much from revenue and earnings. For 2019, we anticipate issuance climbs around 3%, leading the company to consolidated revenue growth of 6%. Given we expect a modest rebound in bond issuance, management’s 2019 guidance of mid-single-digit revenue growth and diluted EPS in the range of $7.30 per share seems reasonable to us and could surprise if bond issuance beats our 3% growth estimate.