Moody’s Corporation (NYSE:MCO) Q4 2022 Earnings Call Transcript

Moody’s Corporation (NYSE:MCO) Q4 2022 Earnings Call Transcript January 31, 2023

Operator: Good day, everyone, and welcome to the Moody’s Corporation Fourth Quarter and Full Year 2022 Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode. At the request of the Company, we will open the conference up for questions and answers following the presentation. I would now turn the call over to Shivani Kak, Head of Investor Relations. Please go ahead.

Shivani Kak: Thank you, and good afternoon, and thank you for joining us today. I’m Shivani Kak, Head of Investor Relations. This morning, Moody’s released its results for the fourth quarter and full year of 2022, our outlook for full year 2023 and an update on our medium-term targets. The earnings press release and the presentation to accompany this teleconference are both available on our website at ir.moodys.com. During this call, we will also be presenting non-GAAP or adjusted figures. Please refer to the tables at the end of our earnings press release filed this morning for a reconciliation between all adjusted measures referenced during this call and U.S. GAAP. I call your attention to the Safe Harbor language which can be found towards the end of our earnings release.

Today’s remarks may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In accordance with the act, I also direct your attention to the Management’s Discussion and Analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31, 2021, and in other SEC filings made by the company, which are available on our website and on the SEC’s website. These, together with the Safe Harbor statement, set forth important factors that could cause actual results to differ materially from those contained in any such forward-looking statements. I would also like to point out that members of the media may be on the call this morning in a listen-only mode.

Rob Fauber, Moody’s President and Chief Executive Officer, will provide an overview of our results, key business highlights and outlook; after which, he’ll be joined by Mark Kaye, Moody’s Chief Financial Officer, to answer your questions. I’ll now turn the call over to Rob.

Rob Fauber : Thanks, Shivani. Good afternoon, and thanks to everybody for joining today’s call. I’m going to start with some key takeaways from our 2022 results, and then I’ll look ahead to what we’re expecting for 2023 before we take your questions. Our fourth quarter and full year 2022 financial results demonstrate the positive momentum and resilience of MA; while at the same time, reflecting the impact of challenging market conditions on MIS. And MA had a very strong finish to the year. It delivered its 60th consecutive quarter of growth and 10% ARR growth. Revenue grew 15% for the year; and for the first time, MA’s full year adjusted operating margin exceeded 30%, and those are results that achieve the Rule of 40 distinction.

MIS generated $2.7 billion in revenue as it weathered a challenging year for issuance, and we continue to advance our ratings franchise to ensure that we’re well positioned to capture future issuance growth. And during the fourth quarter, we executed on the expanded expense management program that we announced in October and that’s expected to deliver over $200 million in annualized savings in 2023. And it really significantly strengthens our financial position and flexibility for the coming year. Now for the full year 2023, we expect Moody’s revenue to grow in the mid- to high single-digit percent range. And in addition, we’re maintaining our previously communicated medium-term growth targets with a reset of the base year to 2022. And in what is clearly a fast-paced and ever-evolving landscape, we’re investing with intent to grow and scale and to expand our capabilities to deliver on our mission, and that is providing best-in-class integrated perspectives on risk.

So turning to our full year financials. Moody’s total revenue was $5.5 billion. MA contributed approximately half of our total revenue for the first time in our history. And as I mentioned, MA revenue grew by 15%. And excluding the negative impact of foreign exchange, growth would have been 20%. Organic constant dollar growth for both MA revenue and ARR was 10%. And overall, Moody’s achieved a 42.6% adjusted operating margin with an adjusted diluted EPS of $8.57. Now moving on. We remain laser focused on the four strategic priorities that I outlined in February of 2021. In order to realize the potential of our global integrated risk assessment strategy, and the success of this strategy has been made possible by our incredibly talented and committed employees.

They’ve helped us launch new products, expand into new markets and improve the experience for our customers. And it’s really wonderful to see our collective work achieve a number of important industry awards. For the first time, Moody’s earned the top ranking in the Chartis RiskTech100. And we placed ahead of hundreds of companies in the risk and compliance technology space that ranges from household names in our sector to earlier-stage innovators. And it’s really a testament to the momentum of our risk assessment strategy and the quality of our portfolio of solutions. And in addition, for the 11th consecutive year, MIS was voted the Best Credit Rating Agency by Institutional Investor and really demonstrates that we remain the clear agency of choice with investors.

In MIS, in 2022, we made several important investments to enhance our ratings presence in emerging markets. And that includes the acquisition of our majority stake in the largest domestic rating agency in Africa and the further expansion of Moody’s Local in Latin America. We also met the need for greater transparency in ESG risks, specifically as they relate to credit by rolling out more than 10,000 new ESG credit impact scores across MIS. Now across MA, we enhanced a number of our workflow offerings through the integration of data and analytics, and we created new products to meet evolving customer needs. In fact, newly developed organic products contributed a significant portion of MA sales growth in 2022. I’m going to touch on several of these in a few minutes.

Turning to the outlook for MIS. As I mentioned last quarter, we expect that the factors that impacted issuance in 2022 to persist really through the first half of 2023. The inflationary environment, the pace of interest rate increases are still causing volatility in equity and debt markets, and the trajectory of economic growth in major economies remains uncertain. So it’s going to take some time for these issues to resolve and for debt market activity to fully resume but refunding needs and pent-up issuance demand and baseline economic growth, they all point to a recovery in issuance, which we expect to pick up in the second half of the year. And in this environment, we are proactively balancing our commitment to serve issuers and investors with the highest quality ratings and research and insights; while at the same time, prudently managing cost.

And we expect that the swift and decisive expense management actions that we took in the fourth quarter will enable MIS’ adjusted operating margin to return to the mid-50s percent range in 2023. So moving to MA. I want to highlight the impact of the significant investments that we’ve made in product development and sales and acquisitions. And over the last three years, these investments have helped us deliver $1 billion in additional recurring revenue. And on an organic constant currency basis, recurring revenue growth has been steadily improving each year from 9.2% in 2020 to 9.7% in 2021 and 11.1% in 2022. And we’re well positioned for future growth as three of our businesses with revenue of more than $100 million each delivered ARR growth in excess of 10%.

In fact, our KYC and compliance business, which is our fastest-growing business, had ARR growth greater than 20%. And even some of our more established products such as Orbis and CreditView, delivered high single-digit ARR growth last year. So let me give you a little bit of insight into how several of our newly-launched products are contributing to this growth. And I’m going to start with our KYC Lifecycle solution, which offers customers a user-friendly configurable portal and risk engine. And it enables fast and accurate checks that leverage our vast company, people and news data sets. And this solution integrates the capabilities that we’ve built and acquired over the past several years, so it’s opening the door to new markets and customer segments with a powerful new workflow tool for financial crime compliance and third-party due diligence.

And it is resonating with our customers. In the fourth quarter, we completed one of our largest-ever sales to a nonfinancial corporate customer in MA with a combined offering supporting both customer and supplier vetting and screening capabilities. We also recently launched an enhanced version of our Climate on Demand product, which integrates our very rich climate analytics from RMS and MA and broadens the scope of our capabilities in the banking and insurance sectors and beyond. And Climate on Demand is part of our growing suite of physical and transition risk offerings, which are gaining traction with our customers. For example, we were awarded an important sales mandate late last year as a major U.S. financial regulator selected us to help them better understand and measure the impact of climate on risks facing financial institutions in the broader economy.

And we were selected because of our ability to bring together some unique capabilities from across Moody’s, and that includes our ability to quantify the financial impact of climate risk, physical risk assessment of bank operations and exposures as well as finance emissions. And in banking, we extended our CreditLens origination solution into commercial real estate, and that’s one of the largest asset classes on bank’s balance sheets. And this product integrates our proprietary property data, market forecast and credit analytics to meet the specific needs of commercial real estate lenders. And we’re excited to partner on this product with one of the largest real estate lenders in the United States, and we’re encouraged by the positive customer feedback and sales progress to date.

So together, these examples, I think, demonstrate how we are integrating capabilities, we’re driving product innovation and leveraging our very strong sales distribution to build a robust pipeline as a foundation for continued growth. So let me turn to the outlook for 2023, and I want to highlight just a few of our guidance metrics. We project that Moody’s revenue will grow in the mid- to high single-digit percent range and adjusted operating margin to be in the range of 44% to 45%. Adjusted diluted EPS is forecast to be in the range of $9 to $9.50. And for the medium term, we’re maintaining our previously communicated growth targets with a reset of the base year to 2022. And in summary, we made strong progress in the fourth quarter to position the business for success, closing out what we’d characterize as both a challenging and a productive year.

And indeed, against the backdrop of macroeconomic headwinds, we’ve continued to unlock the growing potential of MA and reinforced the foundation for MIS to capture the immense opportunity we see once issuance levels recover. So we’ve entered 2023 in a position of strength, and I have tremendous confidence in the growth potential of the business as we continue to execute and invest in building Moody’s as the leading provider of integrated perspectives on risk. And with that, Mark and I would be pleased to take your questions. Operator?

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Q&A Session

Operator: And your first question comes from the line of Manav Patnaik from Barclays.

Manav Patnaik : Rob, I just wanted to touch on that — the medium-term guidance for the ratings business, which you’ve maintained at low to mid-single digits even though the base, I guess, has come down a lot. I just wanted to try and flush through a little bit more in your assumptions. And I always thought it was a GDP plus 3 to 4 type pricing business, and your competitor obviously had a more optimistic outlook there, too. So just trying to understand how you guys are thinking through that.

Rob Fauber : Yes. Manav, we’ve gotten some questions around how quickly things are effectively going to snap back to 2020 and ’21. And just to kind of put that in perspective, 2021 total issuance was more than 35% higher than the average from ’09 to 2022 if you exclude the 2020 and ’21 years. So those two pandemic years were, in fact, extraordinary and unusual years. And so obviously, we are re-baselining off of what we believe are, in fact, kind of more normalized levels of issuance. In fact, if you look at 2022 total issuance, it was down something like 5% from that average that I was talking about, historical average. But another way to kind of look at this, Manav, and you’re kind of, I think, getting at, is there also some upside to the way we’re thinking about the medium term?

So while overall issuance in 2022 was about 5% below that historical average ex those two extraordinary years. If you look at corporate issuance, it was down something like 15%. And if you look at the mix of corporate issuance as a percent of total issuance, we’re actually down a good bit in 2022 and as we kind of look forward. So I think in a way, there’s been a mix shift against us here. And so if you think that there’s more opportunity for corporate issuance as a percent of the total, there might be some upside to the way we think about the medium term.

Mark Kaye : Yes. And add on to just Rob’s remarks, that we do recognize that some investors may now see this guidance as being slightly conservative in nature. We do remain open to the possibility of revisiting and looking at this specific target once we have better insight into the macroeconomic and the issuance environment as the year unfolds.

Manav Patnaik : Okay, got it. Makes sense. And then Mark, just perhaps maybe even an open-ended question to talk about the expense ramp and stuff that you typically do. But what I was looking for is the expense savings that you’ve talked about, like how does that split between the two segments?

Mark Kaye : Manav, thank you. So maybe let me start firstly with the expense ramp. So we anticipate operating growth, inclusive of the annual merit increases, the reset of our incentive compensation and then our incremental organic investments to contribute to an expense ramp of between $10 million and $30 million between the fourth quarter of 2022 and the first quarter of 2023 that exclude any restructuring-related items. And then from the first quarter of 2023 to the fourth quarter of 2023, we expect expenses to remain relatively stable and only ramp between $10 million and $20 million. And that’s primarily as we realize the benefits of both our 2022, 2023 geolocation restructuring program and any additional cost efficiency actions.

On your second sub-question, restructuring. So through year-end 2023, we still expect to incur up to $170 million in aggregate charges, and that will be split into $70 million to $90 million for MIS and $65 million to $80 million for MA, and that’s related to both the real estate rationalization and the reduction of personnel as we selectively downsize and utilize alternative lower-cost locations. For the full year 2022, we were able to accelerate some of our actions. And so we accrued $114 million in total restructuring charges for the year, and that is indeed up from the $85 million we guided to back in October. And that splits into approximately $49 million for MA and $65 million for MIS. And then finally, looking forward, we estimate we’ll incur up to $15 million in incremental pre-tax personnel-related charges and $20 million to $40 million in real estate charges in 2023.

Operator: Your next question comes from the line of Owen Lau from Oppenheimer.

Owen Lau : I have a question related to the previous one but it’s related to seasonality. Could you please give a sense of maybe the seasonality in terms of the revenue and also margin expectation on a quarterly basis in 2023?

Mark Kaye : Owen, good afternoon. So our central case assumption is for the cyclical market disruption that we experienced during the majority of 2022 to really persist through the first half of 2023. And as a result, for MIS, we expect the transaction revenue to be significantly weaker in the first half vis-à-vis the second half of the year when prior period comparables, the capital market conditions and spreads become more constructive. So specifically, the midpoint of our full year 2023 MIS revenue guidance implies first half revenue to decline in the low teens percent range and second half revenue to grow in the mid-20s percent range. And that also underscores our expectation then for higher MIS margins in the second half of the year versus the first half of the year.

If I look at MA, we forecasted full year 2023 total revenue will increase by approximately 10%, and that’s underpinned by broad-based strength across all lines of business. And given that MA revenue is highly recurring, we expect absolute dollar MA revenue to progressively increase over the course of 2023. And as such, we expect MA’s first quarter adjusted operating margin to be similar to our actual fourth quarter 2022 margin before improving through the remainder of the year, obviously, as revenue increases and as we realize the benefits of our cost savings. In addition, as we expand our product capability suite, as we continue to grow the size of our sales force to meet customer demand, we anticipate ARR to also steadily increase throughout the year.

And it’s going to be similar to what we saw in 2022, ultimately achieving low double-digit percent growth by the end of 2023. On Moody’s total operating expenses, our guidance here is for an increase in the low single-digit percent range. And while we don’t typically provide expense growth forecast by segment, given we anticipate the majority of our 2023 strategic investments to support MA revenue growth opportunities, the full year segment operating expense guidance would be along the lines of low to mid-single-digit percent decline in MIS and a high single-digit percent growth in MA. And then finally, for EPS modeling purposes, I’d just like to remind you our first quarter effective tax rate tends to be lower compared to the full year results, and that’s simply due to the excess tax benefits around employee stock-based compensation.

Operator: Your next question comes from the line of Kevin McVeigh from Credit Suisse.