Moody’s Corporation (NYSE:MCO) Q3 2023 Earnings Call Transcript

Moody’s Corporation (NYSE:MCO) Q3 2023 Earnings Call Transcript October 25, 2023

Moody’s Corporation beats earnings expectations. Reported EPS is $2.43, expectations were $2.3.

Operator: Good day, everyone, and welcome to the Moody’s Corporation Third Quarter 2023 Earnings Conference Call. At this time, I would like to inform you that this conference is being recorded. [Operator Instructions]. I will now turn the call over to Shivani Kak, Head of Investor Relations. Please go ahead.

Shivani Kak: Thank you. Good morning and thank you for joining us today. I’m Shivani Kak, Head of Investor Relations. This morning, Moody’s released its results for the third quarter of 2023 as well as our revised outlook for select metrics for full year 2023. The earnings press release and a 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 in U.S. GAAP. I call your attention to the safe harbor language, which can be found towards the end of our earnings release.

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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 & Analysis section and the risk factors discussed in our annual report on Form 10-K for the year ended December 31, 2022, 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’d 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 Caroline Sullivan, Moody’s interim Chief Financial Officer, to answer your questions. I will now turn the call over to Rob.

Rob Fauber: Thanks, Shivani. Good morning, and thanks to everybody for joining today’s call. I’m excited to share our strong financial results as well as some key business highlights. And that’s going to include some notable innovations and investments, progress on our GenAI strategy and a spotlight on our fastest-growing business in MA, that is our Know Your Customer business, or KYC as we commonly refer to it. And before I get started, I just want to say how proud I am that Moody’s has again finished #1 in the Chartis RiskTech100. That is the most comprehensive global ranking of risk and compliance technology providers. And it is a great recognition of the breadth and depth of our solutions based on both market research and customer feedback.

I also want to take a moment to recognize the incredible resilience and dedication of our people. And I’ve really appreciated how our people have come together recently to support each other and to continue to deliver for our customers. So as you all will have seen from this morning’s earnings release, we reported 15% overall revenue growth with strong top line performance and improved adjusted operating margins from each of our businesses. And that contributed to a 31% increase in adjusted diluted EPS in the third quarter. MA revenue grew 13% while achieving its fourth consecutive quarter of 10% ARR growth. And MA’s growth continues to be led by our KYC business. We now have over $300 million of annualized recurring revenue, or ARR. And that’s growing at 18%.

MA also produced an adjusted operating margin of 33.6%. Now MIS grew 18% in the quarter as the leveraged finance issuance markets continued to improve from last year’s subdued levels, I would call it. And MIS revenue is now expected to grow in the mid- to high single-digit percentage range for the full year. And that acknowledges the current uncertainties in the capital markets. Last week, we published our annual refinancing wall study. And that showed a 21% increase in the total U.S. nonfinancial corporate debt coming due over the next 5 years. And as I’ve mentioned on prior calls, these refi walls are a very important component of our long-term growth algorithm. And that remains firmly intact. And as those of you who attended our Innovation Open House last month would have heard, we’re moving quickly to integrate our broad data and analytic capabilities across our product suite and to leverage the power of GenAI to develop new and cutting-edge solutions to empower both our customers and our employees.

And the pace of innovation is clearly accelerating across our businesses. We’re investing, we’re launching new products, entering into strategic partnerships, all that will enable us to continue delivering market-leading growth. And if you look just at the third quarter, we announced some really interesting things. And I want to take you through a few of those. And I’m going to start with ratings. We’ve talked about on prior calls about how deepening our participation in developing capital markets, and in particular, domestic issuance markets, is important to that long-term growth algorithm that I just mentioned. And that includes Latin America, where Moody’s Local has grown its customer count by more than 20% this year. And the Asia-Pacific region also has some exciting opportunities, which is why in September, we further extended our domestic ratings business with the opening of VIS Rating in Vietnam.

And that is a small but fast-growing domestic bond market. I also talked about how the relevance and importance of our voice in the markets is a really critical part of what makes MIS the agency of choice for both issuers and investors. And last month, we published really a groundbreaking cross-industry report on cyber risk and practices. And it leveraged our relationship with BitSight. And we had nearly 2,000 companies that provided data and inputs. And we were able to highlight the more than $20 trillion of rated debt that is at high risk from cyber threats. And that is, I think, a really great example of the importance of a multidimensional view of risk, in this case, understanding how cyber risks are impacting credit risks. Now moving to MA.

We’re launching our first GenAI-enabled product. We call it Research Assistant. And we’ve already previewed it with over 150 customers. Our strategy is to commercialize the launch as we head into the year-end renewal cycle. And initially, our thinking is that Research Assistant will be sold as an add-on to our flagship product, which is CreditView. And leveraging the power of an LLM with Moody’s trusted proprietary content allows customers to generate rich credit insights in just seconds and with capabilities in multiple languages. We also expanded our coverage in CreditView to now include 12,000 new unrated names. And that allows us to better serve the private credit market. And customers who purchase that module are going to have a seamless, integrated experience that includes financials, ownership structures, credit scores, sector research, interactive scorecards and peer analysis.

And I think that is a great example of content integration to serve new customers and new use cases. We’re also constantly investing in our data estate that includes Orbis, which is one of the world’s largest databases on companies. And we’ve expanded again our partnership with BitSight by integrating their cyber data and scores for about 250,000 entities into Orbis. And that enables our customers to better understand cyber risk. We also have several exciting product launches across Decision Solutions. So in banking, we launched a new module in CreditLens that will integrate a bank’s own loan-level data with Moody’s content. And this portfolio module really provides a dynamic view of a bank’s loan portfolio by monitoring and measuring performance and providing early warning signals.

We’re also integrating RMS’s physical and transition risk models with our proprietary ESG and climate data into a range of banking solutions. And that is empowering our customers to make better, more informed decisions around lending, portfolio management, stress testing and regulatory reporting. And these are some of the original synergies that we envisioned with the RMS acquisition. So it’s great to see this in practice. And speaking of RMS, I was in Europe last month at a major insurance industry gathering with a bunch of CEOs and Chief Risk Officers. And I again came away very excited about what we’re doing with the industry. Together with BitSight, we recently launched the Moody’s RMS Cyber Industry Steering Group with two major market players, Munich Re and Gallagher.

And we’re also partnering with Lloyd’s of London to develop a carbon emissions accounting platform for their ecosystem. Now in addition to these recent product launches and initiatives, we’re continuing to leverage GenAI across our organization. And as you heard at our Innovation Open House last month, our colleagues are taking a really active and hands-on approach in innovating and driving change. In fact, over 70% of our people have used our in-house CoPilot tool. And that includes for things like coding, preparing a report or improving an internal process. And this adoption is also reinforcing our early-mover advantage as we’re now benefiting from an internal feedback loop. And that’s allowing us to share learnings from our own GenAI journey with our customers.

And speaking of customers, we’ve been engaging extensively with customers around our GenAI strategy, including the relevance of our curated and proprietary data and research and our approach to data integrity and security. And in particular, since July, we’ve demoed our Research Assistant, as I said, with a number of our customers. And nearly every one of these customers believes that this product will have meaningful benefits for both their productivity and their insight. We’re also revving up the work that we’ve been doing as part of our partnership with Microsoft and leveraging their secure Azure OpenAI Service. We’re building new functionality and content sets and entitlement capabilities into Research Assistant. We’re also continuing to expand the ways that we leverage Microsoft Teams to collaborate internally.

And I think importantly, we’re seeking to expand our joint go-to-market opportunities, broadening the appeal of this partnership to new customers and market segments. And that includes creating Teams plug-ins that will be available to Microsoft’s 300 million monthly users and infusing Moody’s content into their Dynamics and Power Platforms to enable CRM and workflow integrations. We’re also continuing to explore migrating our content sets to Microsoft Fabric to enable entitlement and delivery of content and insights to our shared customers. So really taken together, I’d say we’re very energized by the progress we’ve made. And we’re excited about the opportunities that lie ahead. In addition to Microsoft, we’re working closely with other leading cloud and software players, leveraging our respective strengths to deliver new and innovative GenAI solutions.

And partnerships can take many forms. It can include joint product development, joint go-to-market activities or direct commercial opportunities. And to help maximize this opportunity, we’ve developed a strategy and a framework and a team for third-party partnerships. I think a good example of this is the work we announced earlier this week with Google. And through this partnership, Moody’s and Google Cloud are going to explore creating LLMs and AI applications specifically to help financial professionals perform faster and deeper analysis of financial reports and disclosures and other materials. So we’re certainly excited to be at the cutting edge of GenAI innovation with some leading partners. In recent quarters, we’ve been spotlighting one of the three cloud-based SaaS businesses within Decision Solutions.

And so I want to cap off that series, if you will, with KYC. And unlike banking and insurance, which are obviously industry-specific, KYC is relevant to all of our customer base. And as I said before, a really important objective for many of our customers is to have a better understanding of who they are doing business with, whether it’s making a loan, underwriting an insurance policy, onboarding a customer or monitoring a supplier. And over the years, we have tried to be very thoughtful about how we have added to our capabilities to build a business that, as I said earlier, is generating over $300 million in ARR and growing at 18%. And two significant acquisitions that some of you ask about from time-to-time, and that’s BvD and RDC, really foundational elements of our KYC solutions.

And they have both outperformed their original acquisition targets. And there are several thematic drivers behind the growth of the KYC business. Specifically, I would call out the digitization and automation of what are very manual and expensive in-house compliance processes; the growth in online transactions and payments; and also the need for greater breadth and precision amidst new and increasing regulations; and all of this combines with the need for better analytics and insights, again not just about customers but more broadly, who companies are doing business with. So by combining our proprietary data on companies and people with analytics and through a modern cloud-based SaaS platform, we’re delivering solutions for our customers in some pretty compelling ways.

And these solutions use traditional AI, you’ve heard us talk about that on this call before, that includes machine learning, natural language processing and integrating data on over 470 million public and private companies with more than 1.7 billion ownership links, profiles on over 20 million politically exposed people and sanctions in adverse media. And recently, based on customer feedback, we’ve also added an ESG scores and credit scores. So we offer access to our KYC tools and content in several different ways. And that includes via data feeds or APIs into customers’ in-house systems. It also includes full end-to-end workflow with proprietary and third-party data that supports customer acquisition and onboarding, screening, monitoring and third-party risk management processes.

And the front-end workflow software is what we acquired when we bought PassFort Pack in 2021. So that moved us from being just a data provider to being a full-service provider in this space. And that combination is increasingly being recognized across the industry, including the recent Chartis awards, as the only vendor that’s identified as a market leader for both data and workflow. We’re also seeing significant growth outside of the financial sector. And we are investing to enhance the relevance of our offerings in the corporate and government space. That includes our recent launch of something called Sanctions360. That enables customers to efficiently and effectively comply with regulatory requirements regarding their customers, counterparties and suppliers by better understanding the implications of both sanctions and sanctions by extension.

And our ability to build solutions that reach a broad set of customers is really a key element of our land-and-expand strategy. In fact, approximately 25% of MA’s overall new customer ARR growth in the last year came from KYC. And generating these new relationships then provides additional opportunities for us to cross-sell from other parts of MA. Likewise, our existing customer base also provides some very significant runway for future growth. Currently, only about 20% or about 3,000 of MA’s customers buy one of our KYC solutions. And that represents an important cross-sell opportunity for our remaining 13,000-or-so customers. Now turning to MIS. In the third quarter, issuance was consistent with normal seasonal patterns. I’d say that activity was relatively subdued in July and August.

And we certainly saw some stronger volumes in September. Growth was driven by leveraged finance on the back of what was the strongest leverage loan volume since the first quarter of 2022. And that, coupled with elevated activity from infrequent banking issuers and an improvement in project and public finance issuance versus the prior year, all of that contributed to a favorable mix. As a result, while global issuance was up about 12%, MIS transactional revenue was up 31% versus last year. And together with 5% recurring revenue growth, MIS revenue grew 18% for the quarter. And as we head into the fourth quarter, I’d say the general market sentiment remains a bit fragile. We’ve updated our guidance to reflect an expectation of modestly lower issuance volumes in the fourth quarter, particularly in investment-grade and structured finance, than we had been anticipating back in July.

And the heightened geopolitical turmoil, combined with macroeconomic concerns around a higher-for-longer interest rate environment, will continue to drive some volatility and uncertainty around yields and spreads. And these conditions are likely to be particularly impactful on opportunistic investment-grade issuers. And that’s a reason that we’re lowering the outlook for investment-grade issuance to approximately 25% growth for the full year 2023. We also continue to see the knock-on impacts of lower asset generation on the structured finance sector. And so we’re updating our outlook to decline by around 25% compared to the prior year. So these two forecast updates result in an overall revision to our expectation for issuance for the year. And we now expect issuance growth to be in the low to mid-single-digit range in 2023 and MIS to grow in the mid- to high single-digit range.

So while there are some headwinds to accelerating issuance growth in the near term, refunding walls continue to grow. And they are a key factor supporting medium-term issuance growth. And our annual study on refinancing, which we, as I mentioned, just recently published, captures nonfinancial corporate maturities in both the U.S. and EMEA. And we look at the next 4 years as an aggregate figure, and with approximately $4.4 trillion coming due in the next 4 years, that’s up by about 10% versus last year’s study. And you can see that, I believe, in the appendix in our supplemental materials. I also want to spotlight the U.S. in particular. Obviously, this is the largest of all the global bond markets. And looking out over 5 years, and that’s the length of the U.S. study, the aggregate forward maturity wall grew by about 21% compared to the study — last year’s study.

And the main contributor to this is leveraged finance, which grew approximately 27%. So that’s certainly going to be helpful to future mix over the coming years. So forward maturities continue to provide support for future issuance and continue to be an important part of the MIS long-term growth algorithm. And I would also say that overall corporate debt velocity, which is total corporate issuance as a percent of total corporate debt outstanding, remains pretty far below historical averages. So that implies the potential for pent-up issuance demand in the future. So on that note, I’m going to pause here. I’m happy to open the call for questions. Operator?

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Q&A Session

Operator: [Operator Instructions]. Our first question comes from Heather Balsky with Bank of America.

Heather Balsky: I was hoping you could talk about the refinancing wall that you’ve just addressed and how you’re seeing your customers manage through the higher-for-longer rate environment. Are they delaying refinancing right now? Is more getting pushed into 2024? And when you look at those potential customers who may refi, any concerns about some of that debt not getting refi-ed that maybe those companies could be under some stress?

Rob Fauber: Heather, yes, I’d say that, first of all, just in terms of how our customers are thinking about financing and tapping the market, and you’ve probably heard me say this in the past, volatility is really the biggest challenge, I think, for a CFO or a Treasurer. At the end of September, we saw a little bit of that with the jobs print and questions about rates and how much higher for how much longer. Certainly, geopolitical events can also erode confidence. I don’t think we are in a risk-off mode at the moment. I would say there is some caution. But I don’t think we are in a risk-off mode. And in fact, where we see the most leveraged issuers, which is bank loans, is where we’re actually seeing some issuance at the moment.

So that’s — I think that’s good. When I think about the maturity walls, Heather, it’s interesting. Overall, they’re up about 10% between the U.S. and Europe. If I zero in on investment-grade maturities, they’re up about 12%. And one interesting thing here, Heather — and by the way, the U.S. study is 5 years and the Europe is 4, so I don’t mean to confuse everybody. But when I look at the U.S. study, and we’ll share these reports with folks if they’re interested after the call, the share of U.S. investment-grade maturities within the first 3 years of that 5-year study has increased. So it’s up to the low 60s percent from the kind of high 50s this time last year. And I think what that means and the reason for that is that companies have, in some cases, opted for shorter financing tenors.

And also, I think higher rates have dissuaded some refinancing, so — and it’s interesting to look at what’s going with average tenors. As far as the last part of your question, do I think that some issuers may opt not to refinance? I think for many folks, that will be difficult to do. So there may be select companies that have the cash to be able to do that. But I don’t think that will be a widespread trend.

Operator: We’ll take our next question from Faiza Alwy with Deutsche Bank.

Faiza Alwy: Rob, I wanted to stick with issuance and ask you, you said that current trends are well below sort of normal levels. And I’m curious if you’ve evolved your view in terms of what normal issuance might look like in the current higher-for-longer rate environment.

Rob Fauber: Yes. As I said, a couple of things that lead us to believe that there is some, I’d say, pent-up demand. I mentioned this concept of corporate debt velocity. That’s just the amount of issuance over — the amount of corporate issuance over the amount of corporate debt outstanding. And that’s really at a decade-plus low and continues to be this year. So that leads us to believe that there is further opportunity for issuance. I talked about the refinancing walls. And over the medium term, they look promising. The other thing I think that tends to be a catalyst for issuance is M&A. And it’s been a pretty spotty year for M&A. And it’s about what we had expected. But private equity firms have a tremendous amount of dry powder.

Somewhere, I think the other day, I saw they have $2 trillion to invest. I think M&A is probably not a Q4 story at this point. I think that’s something that we’re going to look into 2024 to see if that can be a catalyst for issuance. So I do think there are some things that at some point can change the trajectory of issuance.

Operator: We’ll take our next question from Alex Kramm with UBS.

Alexander Kramm: Just staying on the ratings side for a minute, can you talk about how your commercial interactions have changed at all with issuers in this? Again, everybody is using a higher-for-longer environment here. I guess, what are you doing to drive, I guess, new issuers? And I’m asking from the perspective also — and this is very anecdotal. But I’ve heard in Europe, for example, there are some companies that are, actually given the higher interest rate environment that they haven’t seen in many decades, are considering ratings for the first time. So again, maybe anecdotal but just wondering what you’re seeing to, I guess, feed to — continue to feed the business outside of the, I guess, macro environment.

Rob Fauber: Yes, Alex, I would say two things. So we have really active engagement with issuers on both sides of the ratings business. One, as you’d expect, very active engagement with the analysts, especially around — especially in periods like this, where there’s some economic uncertainty and lots of questions from investors, lots of engagement with our analysts. And that’s why having very experienced analysts is so important so that we can communicate effectively with our issuers, understand their credit stories and be able to communicate those to the investors. And that’s a big part of value proposition. But second, Alex, I might also point to we’ve tried to broaden out the product suite over the years in MIS so that we can engage with not just issuers in the public markets but folks who may be thinking about coming to market.

So a number of years ago, in fact, back when I was in MIS, we developed something called a Private Monitored Rating. And that was a great tool to be able to develop an analytical relationship on a private basis with a company who wanted to develop that relationship and understand what their credit profile looks like and also give them the opportunity then to flip that into a public rating if they decide they want to tap the markets when there’s a window. So that’s — we have a commercial team that’s probably between 150 and 200 people around the world, very engaged with not only our existing issuers but also with companies who may be thinking about getting a rating either public or private. So pretty active engagement.

Alexander Kramm: But not seeing a change there, given the higher rate environment, that was really my question.

Rob Fauber: No. I mean, Alex, in fairness, I think the first-time mandates, when you look at that, that’s obviously come down from the highs of 2020 and ’21. And that’s, I’d say — we often say it’s pretty closely aligned to the leveraged finance markets. But we’re still looking at something in the range of 500 FTMs for the year. And as I said, lots of engagement. In fact, that number started to tick up this last quarter.

Operator: We’ll take our next question from Andrew Nicholas with William Blair.

Andrew Nicholas: I wanted to ask a little bit more on the monetization plans for Research Assistant. I think you mentioned it would be an add-on cost. Is there any additional color you can give there in terms of maybe the magnitude or the potential opportunity? And then maybe relatedly, of the 150-plus customers who previewed the tool, is the expectation that the vast majority of them would opt in? Or what kind of success rate do you have within the customer base that did have access to the tool already?