Lou Simpson Is Betting Big on This Rating Agency

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Lou Simpson is one of the best investment managers that Warren Buffett likes. When he managed investments for GEICO Insurance, he had delivered a 20% compounded annualized return for more than 30 years. He now runs a quite concentrated portfolio with his own investment advisory firm, SQ Advisory LLC. In the fourth quarter 2012, he bought more than 1.16 million shares of Moody’s Corporation (NYSE: MCO). As of December 2012, Moody’s accounted for 4.9% of his portfolio. Let’s dig deeper to see whether or not investors should follow Lou Simpson into Moody’s now. 

A Fast Growing Business

Moody’s is one of the top global providers of credit ratings, credit and economic research, risk management software and credit portfolio management solutions with two main reportable segments: Moody’s Investors Service (MIS) and Moody’s Analytics (MA). The MIS segment generated revenue from fees for the ongoing credit ratings monitoring while MA comprises all non-rating commercial activities with three main business lines including RD&A, Risk Management Software and Professional Service. The majority of its revenue, $1.96 billion, or 72% of the total revenue, was generated from the MIS segment while the MA segment contributed around $855 million in revenue in 2012. The operating margin of the MIS segment, 48.4%, was much higher than the MA’s operating margin of only 15.3%. Moody’s experienced a double-digit growth in both top line and bottom line in full year 2012. Its revenue increased 20% to $2.7 billion whereas the operating income grew by 21% to $1.1 billion. The EPS came in at $3.05, 22% higher than 2011 EPS.

A Cash Cow With Comfortable Debt Position

I was quite impressed with the positive, but somehow fluctuating cash flow that Moody’s generated within the past 10 years. Its operating cash flow increased from $335 million in 2002 to $803 million in 2011 while the free cash flow rose from $317 million to $736 million during the same period. At first look, investors might be scared of Moody’s thin equity. However, Moody’s balance sheet in 2012 looked much stronger than in 2011. The total stockholders’ equity has turned positive, from -$158.4 million in 2011 to $400 million in 2012. The cash balance has increased significantly, from $760 million to $1.75 billion. As of December 2012, total debt was more than $1.67 billion. Although the amount of debt seems to be a lot, investors should not be worried because of three factors: (1) Moody’s had more cash than the total debt on its balance sheet, (2) the majority of the debt is due in a long time, around 8-10 years, and (3) the principal would be covered by its operating cash flow quite comfortably. 

<img src="/media/images/user_14219/screen-shot-2013-02-20-at-125833-pm_large.png" />

Source: Company’s fourth quarter results 

A Market Leading and the Most Profitable Company

Moody’s and McGraw-Hill Companies’ (NYSE: MHFI) S&P are the two dominating rating agencies globally. Each of the two agencies has around a 40% market share in the global credit rating market. With the current trading price of $48.60 per share, Moody’s is worth $10.85 billion in the market. McGraw-Hill is a bit bigger at nearly $12.8 billion in total market cap. While Moody’s is valued at 8.75x EV/EBITDA, McGraw-Hill is valued at around 8.23x EV/EBITDA. Dun & Bradstreet (NYSE: DNB), another peer of Moody’s, is the smallest company with only a $3.7 billion in market cap. At the current trading price of $83 per share, Dun & Bradstreet is valued similarly at 8.37x EV/EBITDA. Among the three, McGraw-Hill is paying the highest dividend yield at 2.5% whereas the dividend yields of Dun & Bradstreet and Moody’s are 1.9% and 1.7%, respectively. In terms of profitability, Moody’s is top-notch with a nearly 40% operating margin. Dun & Bradstreet is the least profitable among the three with only a 28% operating margin, whereas the operating margin of McGraw-Hill is 32.3%.

Foolish Bottom Line

Moody’s is really a cash cow with historical consistent positive free cash flow. It hasn't only generated the highest operating margin compared to McGraw-Hill and Dun & Bradstreet, but it has also employed a quite comfortable debt position. With a reasonable valuation, Moody’s could be considered a long-term position for value investors. 

hoangquocanh has no position in any stocks mentioned. The Motley Fool recommends Moody's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus