Financial derivatives trader CMC Markets (LON:CMCX) today issued a trading update warning that revenues of some of its products, namely spreadbets and contract for difference (CFD) trading would be lower than initially anticipated. The share price immediately fell:
This comes as no surprise, as the markets hate mid-day warnings. There is no good reason for it, and particularly on a Friday afternoon. It has to be said, it comes at not a great time for the sector, with the recent Plus500 debacle potentially making investors jittery. There, what started out as a routine profit warning then became a far greater examination of the business, with PLUS admitting that previous details had been omitted.
A double blow for companies in this sector has been the additional regulations placed on it by the European Markets and Securities Authority (ESMA), which introduced a raft of measures to protect retail investors; namely a reduction of leverage in some markets, negative balance protection, banning of bonus incentives and automatic close-oules among other things.
This has had an immediate impact, with the obvious effect being that some types of trading would be heavily hit (for instance, cryptocurrencies), and some types of trader as well such as those who need the leverage. IG Group predicted that the measures would result in a drop of 10% of revenues, but this effect should be more pronounced for firms such as Plus500 and CMC, who have a greater proportion of ‘recreational’ punters.
CMC have been around a long time in the UK markets, operating since 1989. The emergence of the internet and it becoming a platform for trading allowed it to really scale up its operations, based around its spreadbetting product. It has only been listed since 2016, and since its 2016 debut has been a bumpy ride for investors with several profit warnings in that short time. Ironically today’s drop takes it back close to the all time lows.
Today’s warning is not the easiest to digest, having come out at a time where people’s thoughts may be elsewhere. The previous update was given less than a month earlier and covered Q3, with a quote:
The Group has made an encouraging start to Q4, which together with CMC’s ongoing focus on operating cost control, means that the Group’s FY 2019 outlook is unchanged.
So things have gone wrong quite quickly as today’s warning shows:
However, following an encouraging start to Q4, market conditions have been challenging from a revenue perspective in January and February 2019, with exceptionally strong client performance, particularly around commodities and FX.
One must wonder if the ‘strong client performance’ is similar to the ones that caused Plus500 to lose $103m. It continues:
Depending on the trading conditions in the remainder of the quarter, CMC now expects CFD and spreadbet revenue to be between c. 25% and c. 35% lower year-on-year, compared to previous guidance for a c. 20% reduction year-on-year.
That is a fair deterioration for one quarter to be impacting things so much. And, to illustrate how much these products mean to them:
Regulations have not come in overnight, and issues were seen as far back as 2016 shortly after CMC floated. They have actively worked on trying to mitigate some of these issues, for example concentrating on higher value clients (most whom can be designated as professional and not retail) and expansion into other areas such as stockbroking.
Comparisons with PLUS500 are quite striking, considering the broadly similar products. CMC had a smaller amount of active clients at just under 60,000 – this is far under the highs seen at Plus at over 200,000. CMC actually has the least number of clients in the UK, but gains the highest revenue from them, on average. It seems evident from these results and the customer churn at Plus500 that focusing on retaining valuable clients is a really successful strategy as they will give you a stream of revenues every year. Customer acquisition costs in this industry are high.
Profits have been coming along nicely here, although not as nicely as others such as the market leader, IG Group. Like other firms in the sector they pay a well-covered dividend, and also have net cash. Despite today’s announcement, even if we were to take the worst case scenario, it is difficult to imagine this causing any immediate difficulties for the company or even threatening a loss.
This isn’t a good time for the financial stocks. There are plenty of headwinds here, not least the recent difficulties of PLUS. Another one that seems likely to dog the industry for some years is regulation. These could change in future, to offer even greater protection for the consumer. We have seen in the UK, governments have chosen to reduce stakes on FOBTs to just £2, and whilst quite unrelated to here, shows that they are likely to act on anything that creates bad press with the public.
On the upside, there are a few good things. Regulation may actually benefit stronger players in the industry, making it harder for new entrants to come in, as one of the main tools (bonuses) has been taken away.
Another thing is that many of these companies are very keenly priced at the moment. There is an element of anticipation of future troubles priced in, and the market cap today is under £300m, putting this into value territory should the declines be addressed.
I find the timing of the statement quite insincere though, and despite claiming this it is ‘increasingly diverse’, it is still heavily reliant on the CFD/spread markets for its income. Marks off for this.
The price is cheap. On pure earnings multiples, this is not as cheap as Plus500 (although there may be doubts on that veracity), but a lot cheaper than IG Group. Whilst I think the strategy to focus on higher-value clients will be fine in the end, with a heavy reliance on these markets there may be choppy waters ahead. 3/5.