ICE Initiated as Neutral - Analyst Blog

We have recently initiated coverage on IntercontinentalExchange Inc. (ICE) with a Neutral recommendation. The company’s third quarter earnings per share of $1.18 modestly surpassed the Zacks Consensus Estimate of $1.04. Results benefited from position limitations on speculators, sweeping regulatory reforms, lower expenses and record futures trading. The upside was also attributable to growth in the company’s core businesses, significant progress from new initiatives and stronger margins. However, this was partially offset by higher operating and amortization expenses.
 
IntercontinentalExchange has demonstrated immense growth potential in its futures and over-the-counter (OTC) markets. Organic growth has also been significantly driven by strong growth in contract volumes, average daily commission for the company's OTC energy business and transaction fees.
 
Despite the global downturn, IntercontinentalExchange’s markets have shown resilience due to the consistent client demand for the company’s products and risk management services. Going ahead, these unswerving initiatives will continue to drive both top- and bottom-line growth along with volume expansion that will benefit as more futures and OTC contracts are now exchange-traded and cleared. As well, the financial market restoration will provide greater certainty to market participants, as well as additional opportunities for the company to leverage the valuable exchange, technology and clearing infrastructure that it has developed over the past decade.
 
IntercontinentalExchange’s intermittent restructuring programs through acquisitions and spin-offs have driven robust inorganic growth as well, which are reflected in increased assets and global expansion. Besides, the company poses a sturdy balance sheet with strong cash, receivables and capital position. While the treasury cash vigorously exceeds the total debt position, total interest coverage also remains healthy, reflecting a minimal capital expending. Given the economic turmoil, such a healthy and minimal risk based balance sheet will continue to provide stability and buoyancy to the company in the medium to long term.
 
However, in the current volatile market, IntercontinentalExchange could be marred by new regulations or laws that impact market operations. The imposition of new commodity market conditions leading to failure in prohibiting prop trading by the U.S. regulators is one such instance. Further, the company has also recently objected to the U.S. Commodity Futures Trading Commission’s (CFTC) proposal to approve Exchange of Futures for Futures (EFFs) transactions. While EFF transactions appear to have a limited appeal in the market, they could serve as a prototype to trading interchangeability, allowing a trader to buy a contract on one exchange and sell on another, thereby challenging the futures exchanges’ established liquidity and monopolistic position. This can also adversely hamper the volume growth and capital position of the company.
 
Additionally, IntercontinentalExchange’s operating performance has been rather slack due to the financial downturn in 2008. While share of revenue from exchange, commission, clearing fees and exchange fees earned from trading in the ICE Brent Crude futures contract showcase a declining trend, the company’s expenses are also increasing, thereby reducing the operating and competitive leverage. Going forward, compensation and benefits expenses are expected to increase from current levels, primarily due to additional employees, variable performance bonuses and non-cash compensation expenses.
 
IntercontinentalExchange has a history of developing innovative products and services, including electronic trade confirmation, affirmation and replacement for the bilateral OTC markets, independent price validation services, portfolio compression, credit event auctions and OTC clearing. Although higher core operating expenses, stringent regulations and a tapered volume growth especially in the OTC derivatives market and energy futures market are some of the near-term challenges that the company has to cope with, once the markets restores its buoyancy and clarity regarding legislation improves, it is expected to beat its peer group in the long term.
 
On Friday, the shares of IntercontinentalExchange closed at $95.48, down 0.2%, on the New York Stock Exchange.
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