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Moody’s long bond provides attractive pick-up vs S&P

| August 2, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Both Moody’s Corporation (MCO – BBB+/BBB+) and its closest peer, S&P Global Inc. (SPGI – A3/A-), posted better than expected fiscal 2Q results this week. MCO’s strong quarterly performance reflected robust growth at Moody’s analytics, while SPGI chalked up its performance to new product initiatives. Both credits upped full year EPS guidance reflecting strong 1H results. There is incremental value in MCO long bonds as they provide an attractive spread pick up relative to SPGI. Currently, investors can swap out of SPGI 4.5% 5/15/48 and into MCO 4.875% 12/17/48 for a spread pick up of 30 bp.  In the intermediate part of the curve, the trading differential is roughly 20 bp.

Exhibit 1: MCO versus SPGI curve

Source: Bloomberg, Amherst Pierpont Securities

Moody’s analytics (MA) firing on all cylinders 

The MA division posted its second consecutive quarter of double-digit growth as revenues were up 12% year-over-year, 10% on an organic basis.  All business units within MA witnessed strong organic growth.  MA remains a good source of recurring revenue for MCO, with 84% of MA revenues classified as recurring on a LTM basis (up from 78% on a LTM basis in 1Q). MCO management has been emphasizing 12 month subscription sales, which have been outpacing one time product sales, thereby fueling recurring revenue growth.  MA saw strong operating margin growth of 350 bp year-over-year to 28.2%, reflecting the solid revenue growth and good cost controls.

Moody’s investors service (MIS) proves resilient

Despite 2Q19 issuance down 14% year-over-year, MIS only saw revenues decline 2% in the quarter (revenues flat year-over-year ex fx).  While the lower rate environment brought infrequent issuers to market, overall M&A issuance was down given the lack of jumbo deals relative to last year. MCO noted that issuance was skewed towards more fixed rate debt which helped to offset weakness in global floating rate bank debt. Global bank debt issuance was down for the fourth consecutive quarter. Structured finance revenue was down 15% year-over-year, reflecting lower U.S. and EMEA CLO refinancing activity. MIS’ operating margin declined 100 bp year-over-year to 60.2%, given the revenue contraction and relatively flat expenses.

Market conditions/comps support 2H19 and FY guidance

As MCO moves into the back half of the year, issuance comparisons get easier supporting management’s confidence in reaffirming FY guidance.  MCO estimates that issuance for the year will be flat to down 5% with the second half supported by debt funded M&A.  MCO remains on track to achieve approximately 900 first time mandates in 2019. Debt issuance could potentially exceed estimates in the back half of the year if issuers pull forward issuance by utilizing special mandatory redemption (SMR) language associated with large debt funded acquisitions.  As such, management reaffirmed its FY revenue guidance of low single digit growth for the MIS division and adjusted operating margins of approximately 58%, roughly flat to 2018. For the MA unit, MCO continues to expect low double digit revenue growth reflecting strong sales across all business lines.  Adjusted operating margins are expected to be in the 28%-29% range (up from 26.4% in 2018). Overall adjusted EPS was increased from the $7.85-$8.10 range to the $7.95-$8.15 range.

S&P affirms ratings

S&P recently affirmed MCO’s BBB+ rating reflecting its solid market position, good profitability and strong growth expectations particularly from the MA division. S&P highlighted management’s prudent financial policy and track record of deleveraging quickly post acquisitions. Pro forma leverage is currently about 2.2x and is expected to fall below 2.0x by year end.  S&P expects leverage to remain within the 1.5x-2.0x range in subsequent years. Liquidity is solid with $1.3 billion of cash on hand, an untapped $1.0 billion revolver and no debt maturing until 9/1/20 (when $500 million comes due).  EBITDA to free cash flow conversion remains strong at roughly 60%.

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