A Wide-Moat Stock to Invest in That’s 35% Undervalued

MarketAxess MKTX stock is down more than 30% this year. The company’s market share has been declining, even as fixed-income markets continue to shift toward electronic platforms. We think MarketAxess needs to show that its new data and service offerings can allow it to regain some momentum. We nevertheless think that the company has carved out a wide economic moat and that its stock is seriously undervalued today. In fact, MarketAxess is one of 5 Ultracheap Stocks to Buy With the Best Return on Investment. The stock also made our list of 10 Cheap Dividend-Growth Stocks to Buy this quarter.

MarketAxess operates the leading platform for the electronic trading of corporate bonds. While it is primarily focused on US securities, 30%-40% of its corporate bond trading volume comes from emerging-market debt and eurobonds, giving the company a strong international presence. MarketAxess also offers trading in US Treasuries and municipal bonds, but corporate bonds are the core of its business. We expect this will remain true, a consequence of being a relative newcomer to the Treasury trading market and the smaller size of the municipal debt market. We expect 2024 to be a better year for growth for MarketAxess, as last year the company faced dual headwinds from low corporate bond issuance levels and an unfavorable mix shift creating downward pressure on its average fees. While these headwinds are still a factor, the company is benefiting from higher trading volume industrywide, and if interest rates fall, it will see some relief for its average pricing.

Key Morningstar Metrics for MarketAxess

• Fair Value Estimate: $300
• Star Rating: 4 Stars
• Economic Moat Rating: Wide
• Uncertainty Rating: High

Economic Moat Rating

In our view, MarketAxess has achieved a wide economic moat as a result of its position as the leading platform for the electronic trading of US corporate bonds as well as its strong position in eurobonds and emerging-market corporate debt. MarketAxess and its closest competitor, Tradeweb, have dominant positions in the section of the bond market that is electronically traded, and it has benefited significantly from the ongoing transition in fixed-income markets toward electronic trading and away from voice-negotiated trades. This trend has provided the company with steady growth as the implicit and explicit cost reductions offered through its trading protocols pull more trading volume to its platform. This tailwind along with the company’s leading position in the electronic trading of corporate bonds has provided it with impressive returns on invested capital, wide margins, and a long roadmap for future growth, since the majority of US corporate debt trading is still voice-driven.

Read more about MarketAxess’ moat rating.

Fair Value Estimate for MarketAxess Stock

Our $300 fair value estimate equates to 40.7 times our 2024 earnings estimate and a 2024 enterprise value/EBITDA ratio of 26 times. We use a 7.5% per cost of equity. We expect the company to enjoy average revenue growth of just under 9% from 2023 to 2028. The majority of revenue growth should come from higher trading volume, not price increases. That said, we expect the weak capture rates on investment-grade bond trading seen in 2022 and 2023 to normalize over time, providing a tailwind to trading revenue. We see operating expenses growing at around an average rate of 8.1% over the next five years. We expect operating margin to recover as the company scales against its fixed costs, reaching 46.3% by 2028 after falling to 41.9% in 2023.

Read more about MarketAxess’ fair value estimate.

Risk and Uncertainty

MarketAxess generates most of its revenue through variable transaction fees. This can be a source of volatility as it ties the company’s revenue directly to the trading volume on its platform, which can vary based on market conditions. Additionally, the majority of revenue comes from corporate bond trading fees, making the company’s near-term performance reliant on the level of corporate bond issuance and credit spread volatility. Corporate bond trading volume industrywide can change quite sharply, and this volatility filters down into MarketAxess’ earnings.

Read more about MarketAxess’ risk and uncertainty.

MarketAxess Bulls Say

• MarketAxess holds the largest market share for the electronic trading of US credit bonds, with particular strength in high-yield bond trading.
• The company is benefiting from the transition away from voice-negotiated trading toward electronic platforms, creating strong tailwinds for continued revenue growth.
• US corporate bond markets are seeing higher turnover rates as automated trading algorithms see more adoption and trading costs decrease. This increases transaction volume industrywide, creating another tailwind for MarketAxess.

MarketAxess Bears Say

• MarketAxess’ revenue base is mostly transactional, and results can vary from one quarter to the next based on market events.
• Tradeweb and Trumid have been able to quickly establish themselves as competitive options in the US bond market and have rapidly built market share over the last few years.
• MarketAxess’ counterparties have incentive to aid new competitors. BlackRock’s and T. Rowe Price’s support for the much smaller Trumid is an example of this.

This article was compiled by Susan Dziubinski and Sylvia Hauser.