Friday morning, October 24, Moody’s reported stronger-than-expected third quarter results. Moody’s had increased its annual guidance at its investor day on the last day of the third quarter, so we believe most investors expected solid results. We think most people thought, though, that the increased annual guidance was more reflective of the company’s much stronger-than-expected first-half results (McGraw Hill Financial had increased its guidance after the second-quarter results, but Moody’s had not—which is why the consensus was already ahead of the guidance before the investor day) than of the third-quarter performance, partly because some of the external data from Thomson Reuters about issuance activity showed much weaker issuance data than people had projected for Moody’s. Moody’s delivered a better-than-expected third-quarter though.
EPS of $0.97 were $0.08 above the consensus and $0.07 above our estimate. Revenue growth of 16% exceeded our estimate by $14 million and the consensus by $27 million. The Ratings business was generally in line with our expectations, and probably ahead of the consensus expectation. This performance is much better than the year-over-year change in the Thomson data would indicate, but it is consistent with the two-year CAGR in that data, which confirms our view that there was something unusual affecting the data relative to Moody’s and S&P last year. There was no significant changes to management’s revenue and EPS guidance for 2014, although the company tweaked upwards some of its guidance for certain parts of the Ratings business.
The biggest source of upside came from the Moody’s Analytics segment. Revenue for that segment was about $12 million ahead of our estimate and grew 20% year-over-year, including roughly 14% organic growth. This represents an acceleration from around 10% growth in the prior two quarters. The company’s RD&A business continues to deliver impressive growth of 10%, but the biggest source of upside was from the ERS and professional services practices. We estimate that both of those segments grew roughly 20% organically, versus 5%-10% growth in the professional services practice and around 12% growth in the ERS practice during the prior two quarters. Revenue from the ERS practice can be somewhat lumpy, but the press release attributes the growth mainly to subscription and services revenue.
We also note that trailing 12 months’ sales growth for this practice increased to 15% at the end of the second quarter, versus 9% at the end of the first quarter. Encouragingly, the segment’s operating margin also expanded 250 basis points year-over-year, resulting in 36% growth in segment operating profits for the quarter. Adjusted operating margins for the segment were down year-over-year in the first half of the year, so we would not extrapolate that pace of improvement. Still, investors’ expectations about margin improvement could be bolstered by the combination of this performance and management’s commentary at its investor day that it is more focused now on driving the profit margin for this segment from 18% today to a rate in the mid-20s over time.