When the global economy hums along nicely, credit rating agencies go largely unnoticed. But when the economy enters choppy waters, and rating agencies make tough, and sometimes unpopular calls, they attract intense media glare.
One recent example is the surprising move by Fitch Ratings to lower the U.S. government's credit rating last week. The downgrade made Fitch the first company to do so since a similar move was made by Standard & Poor's in 2011. The decision created ripples across global financial markets, triggering a spike in VIX, Wall Street’s fear gauge.
This may be an opportune time to look at ratings and benchmark companies that provide financial data, analytics, research, and stock market updates for investment performance. The following companies operate in an oligopolistic market, each with a sizeable market share, robust competitive advantages and established products and services that face limited or no competition.
The largest credit rating agency in the world, S&P Global (SPGI) provides data and benchmarks to capital and commodity market participants. Its ratings business is over 45% of the firm's revenue and over 55% of operating income. The firm's other segments include market intelligence (data solutions to investment banks, corporations), indexes (benchmarks for financial markets), and Platts (benchmarks to commodity markets).
“Whether through credit ratings, financial indexes, or commodity price reporting, S&P Global has established a wide moat from its data-driven benchmarks,” says a Morningstar equity report.
The embedded nature of these benchmarks affords S&P a strong competitive position and strong operating margins, the report adds.
With the US$44 billion acquisition of IHS Markit in 2022, the rating agency gained a new source of revenue and diversification.
The issuance of bonds plays a pivotal role in fueling revenue for S&P's ratings division, making up around a third of the company's adjusted operating income. “Over the long term, mid-single-digit revenue growth, driven by GDP growth and pricing, is a reasonable expectation for S&P Ratings,” says Morningstar, equity analyst, Rajiv Bhatia, who recently lifted the stock’s fair value to US$375 from US$370, after incorporating second-quarter financial results.
After a rocky 2022, the company’s ratings revenue is expected to “grow in the mid- to high-single-digit percentage range over the next several years,” says Bhatia, stressing that “S&P's businesses are generally moaty and that pricing power is strong, particularly in ratings.”
Moody’s (MCO) is a leading provider of credit ratings on fixed income securities. It provides ratings through a segment called Moody’s Investors Service (MIS), which includes corporates, structured finance, financial institutions, and public finance ratings. The segment accounts for the bulk of the firm’s revenue and profits. Moody’s Analytics segment comprises Research, Data, and Analytics or RD&A and Enterprise Risk Solutions.
Moody’s enjoys a strong competitive position and solid operating margin underpinned by “the embedded nature of credit ratings among capital markets participants, regulators, and index providers,” says a Morningstar equity report.
Bond issuance volumes are the primary driver of Moody’s ratings business - Moody’s Investors Service. It accounts for about two thirds of the firm’s adjusted operating income. “Over the long term, we believe that mid-single-digit revenue growth, driven by GDP and pricing, is a reasonable expectation for MIS,” asserts Bhatia.
Moody's Analytics (MA) has been a significant driver of expansion through both organic investments and acquisitions. MA currently makes up over 40% of the firm’s revenue but just one fourth of the firm’s adjusted operating income. “The subscription revenue model and high retention rates help offset some of the volatility in the ratings business,” says Bhatia, who recently raised the stock’s fair value to US$325 from US$315, prompted by the firm's second-quarter financial results.
Moody’s wide economic moat stems from intangible assets and network effects in its ratings business.
MSCI (MSCI) is a formidable player in providing data and software to asset managers and asset owners. The most valuable asset of the company is the index segment, which accounts for about 60% of overall revenue and 80% of operating profit. The firm boasts over US$15 trillion in benchmarked assets. Since index data is highly valuable to stakeholders that benchmark to MSCI, its index subscriptions have enviable retention and pricing power.
A beneficiary of the growing popularity of exchange-traded funds (ETFs), about 41% of MSCI’s index segment revenue is asset-based fees, the largest bucket of which is from ETFs. “Though pressure on ETF expense ratios has weighed on MSCI’s license fee rate (which is roughly 2.5 basis points), the firm has benefited from market appreciation and robust net inflows as investors seek low-cost passive ETFs,” says a Morningstar equity report.
While BlackRock makes up almost half of MSCI’s asset-based fees, it also earns fees for passive mutual funds and royalty revenue for the trading of MSCI-linked futures and options.
Its analytics segment (about 25% of revenue) has gained significant boost from the mainstreaming of environmental, social, and governance (ESG) data, which continues to be a focus for the company.
“MSCI's ESG data business is just under 10% of revenue but its fastest grower,” says Bhatia, who recently lifted the stock’s fair value to US$440 from US$430, incorporating “our out-year index subscription sales forecasts.”
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