MarketAxess Q4 2020 Earnings Review
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Results
(Source - MarketAxess Investor Relations)
It’s funny - quarter after quarter of impressive results from MarketAxess can start to lull the market to sleep after a while.
EPS has grown in the high double digits nearly every year since MarketAxess became a public company. Revenue has closely matched this feat. The company ended 2020 on a particularly high note with revenue +32% YoY in Q4 and EPS +45%. Everywhere investors look they see huge increases in trading volumes & profitability, and they’ve come to expect as much from MarketAxess. The stock trades at a pricey 60x-70x earnings multiple as a result of this high consistent growth - where’s the alpha?
Management’s commentary during this quarter’s earnings call does a great job helping us focus on the bigger picture & the company’s longer term prospects. MarketAxess is an electronic trading platform for corporate bonds, and they trade ~20% of the investment grade market & ~17% of the high yield market. This share has been steadily rising since the ‘08 Financial Crisis as regulations have slowly pushed bond trading away from banks and onto regulated exchanges. It started with smaller sized bond trades - the odd lot orders that would save more in transaction costs by choosing MarketAxess to trade over a traditional dealer. To begin to go after larger sized bond trades, MarketAxess rolled out “Open Trading”, a way for bond market participants to trade electronically with counterparties other than the legacy banks & dealers. Open Trading is now a sizable portion of the overall platform, accounting for over a third of total trading volume:
Understanding the runway for MarketAxess’s future growth begins with Open Trading. Once a critical mass of Open Trading volume is reached, it becomes cheaper for new volume to migrate to MarketAxess over standard voice trading. 2020 saw this dynamic play out in high-yield bonds - HY market share grew +50% throughout the year driven in large part by Open Trading improvements.
The next key to MarketAxess gaining more share & attracting block trades is automated execution. The exchange rolled out two features - Auto-X and Auto-Responder - to help firms cut down on manual parts of their trading & begin to use algorithms to trade corporate bonds. The introduction of algorithmic trading should help boost total industry volumes & electronic share for MarketAxess - here’s CEO Rich McVey in his own words:
“Our plan for automation is quite sophisticated in how we're starting to combine Auto-X and Auto-Responder together to create what are the early days of the traditional algorithm for clients to help clients take a large block order, be passive throughout the period of the day, have a timed auto-execution later in the day, so they can still see the success of the position getting executed, but they can improve their execution quality throughout the day.”
(Source)
How does this all connect back to the long term outlook for market share? MarketAxess management believes the corporate bond market can be ~90% electronic at full maturity. McVey expressed his view that five years from now, more corporate bonds will be traded electronically than not. This still leaves plenty of runway for the exchange to lower transaction costs and build volume over the next few years, regardless of overall industry activity. Management also expressed confidence in growth outside of their core corporate bond business - including US Treasuries, emerging markets, munis, and ESG-focused bonds. Even if corporate share growth doesn’t accelerate, we could still see results continue to grow in the double digits for a considerable period of time.
I think MarketAxess has posted results that fulfill its premium valuation every quarter in 2020. Even though 2021 comes up against some tough comps vs. a volatile year prior, I think any pullbacks in the stock will be short-lived. The market is convinced that corporate bonds are going electronic, and MarketAxess has laid out their plan to take advantage of this shift and expand into adjacent markets, all while managing expenses well & returning capital to shareholders. I don’t own the stock today, but am certainly watching for dips in sentiment to consider starting a position.
Disclaimer: I am not a financial advisor. Nothing on this site or in the Front Month newsletter should be considered investment advice. Any discussion about future results or projections may not pan out as expected. Do your own research & speak to a licensed professional before making any investment decisions. As of the publishing of this post, I am long ICE, CME, CBOE, NDAQ and VIRT. I am also long Bitcoin.