EUR 850.00 For Business Accounts Only

Morningstar | Though Weaker Issuance Is a Short-Term Concern, Moody's Wide Moat Should Win Out in the Long Run

We’re initiating coverage on bond rating agency Moody’s with a wide moat and a fair value estimate of $168 per share. In recent months, investors have been worried higher rates will put a damper on issuance. Even more recently, investors have been worried about the opposite that lower rates are a sign of anemic economic growth. In our opinion, investors’ fixation on quarter-to-quarter issuance are missing the bigger picture that Moody’s fortunes are more dependent upon pricing power and the company’s deeper penetration into global credit markets. Currently, shares in Moody’s stand at more than an 18% discount to our fair value estimate.

Though higher interest rates will weigh on bond issuance and revenue in the short term, Moody’s remains well positioned to take advantage of long-term trends such as banking disintermediation and continued development in global bond markets. Also, we believe Moody’s wide moat affords it considerable pricing power. In the past, management has estimated it can raise prices on bond ratings 3%-5% each year. In our research, we have found ample evidence to support this. Though Moody’s had its stumbles during the 2008 financial crisis, ultimately, if banks were going to deleverage it would mean that loans held on their balance sheets would have to migrate to public markets, giving Moody’s additional business opportunities. Though Moody’s may have been part of the problem in the past, it is very much a part of the solution going forward. Over the long run, we expect this trend to continue and Moody’s will be able to provide ratings on credits that were previously held by banks.

In our view, Moody’s will continue to benefit from operating leverage allowing the company to expand margins. Though we do not anticipate the company will return to the mid-50s operating margins seen before the crisis, we do believe Moody’s can reach operating margins in the upper 40s over the next five years. Furthermore, our model assumes one bad year of negative issuance resulting in negative growth for ratings revenue. Even in a recession, we believe Moody’s exceptional moat enables the company to offset most weakness through higher pricing.