Description

TLDR – I’m bringing SNEXy back

Executive Summary

StoneX is a financial services company facilitating access to the global financial markets for their clients. StoneX is a classic compounder story with a highly aligned management team where insiders own ~16% of the Company.

StoneX returns are driven by 1) client size, 2) activity levels, and 3) interest rates. Volatility drives activity and can widen spreads, both of which enhance StoneX’s returns on capital. If you believe we have passed zero interest rates (ZIRP), then StoneX will be able to maintain a higher return on capital going forward driven by interest earnings and a return of “normal” volatility to markets.

Today, StoneX trades for ~1.4x book value (below its average p/b multiple). The base case calls for high teens ROE’s which should generate healthy double digits returns to shareholders going forward. In a downside scenario StoneX will generate ~10% ROE’s should interest rates return to zero and volatility dampen.

What I Expect

• Non-zero interest rates drive higher returns on capital
  • Client float will grow over time and with a positive spread on interest rates StoneX will see sustained net interest income.
• Volatility will remain above ZIRP levels
  • Volatility drives earnings and increases potential credit losses. There is a sweet spot in volatility that markets move but do not move too much to destroy market participants (i.e., credit losses). Much of the 2010’s was characterized by lower volatility. With a real cost to capital post ZIRP, I expect volatility will be closer to the “sweet” spot.
• Capital allocation
  • Management owns 16% of the equity and often finds the best use of capital is to support organic growth.
  • StoneX has a long history of acquiring smaller subscale loss-making financial institutions to plug into their network. These acquisitions typically generate bargain purchase gains.
  • Management is active in repurchasing equity when the valuation is attractive. Stock buybacks typically begin around ~1.3x book value.

Risks

StoneX is a complicated financial entity with a complex balance sheet and financial accounts. As with any levered financial there is a left tail where the equity is wiped to zero. I believe these risks are unlikely, however they are not zero.

• Nickle Fiasco
  • Long story short a Chinese nickel tycoon went full “yolo” in attempting to trade nickel prices (long physical short futures) and got squeezed. The result led to massive systemic risk where “four or five of the brokerages that are LME members would have failed”. The LME, owned by the Hong Kong exchange, cancelled the trades. What would have happened had it not cancelled the trades? Who knows but this is a prime, relevant, and recent example of the risks associated with facilitating financial transactions with levered market participants.
• Regulation
  • Following the financial crisis StoneX faced multiple years of regulatory burden. Another incident in the financial markets could lead to further regulatory burdens and dampen StoneX’s ability to monetize its client’s activity at current levels.

Company Description

StoneX Group Inc., through its subsidiaries, connects clients to the global markets ecosystem – providing them with institutional-grade market access, end-to-end clearing and execution, and high-touch expertise.

Clients use StoneX’s global financial services network to find and pursue trading opportunities, to make investments efficiently, to manage their financial market risks, and to improve their business performance.

The Company monetizes client activity over its network through commissions and spreads on trades and other transactions, fees for access to market intelligence and expertise, and interest earned on customer deposits.

History

Sean O’Conner began his career at Standard Charter in London and joined International Assets Holding Corp in 2001 along with Scott Branch. Upon his arrival and promotion to CEO he redirected the company and sold off its retail business unit to focus on wholesale and institutional clients. Since then, the Company has made a series of acquisitions to supplement the organic growth of the business.

Under O’Conner’s tenure StoneX has benefited from compounding growth

Financial Model

I’ve decomposed the income statement as a % of average total capital. I expect the “services” business to continue to deliver high single digits EBIT as % of total capital and net interest income as a % of total capital to contribute high single digits as well.

Prior to Q4 2019, SNEX consolidated corporate funding costs into “interest expense”. As evidenced below, higher interest rate lift interest earnings driving returns on capital. There are some marginal trade offs as clients push back on commissions but at current interest rate levels StoneX will capture ~70% of the movement in rates. If rates fall substantially or client’s optimize their cash allocations then StoneX will feel some pressure on this earnings stream. A good chuck of StoneX’s float comes from margin posted for trading which is stickier and less rate sensitive, especially for commercial hedgers.

Part of my thesis is that FQ1 2019 to FQ2 2023 is more representative of “normal” volatility and market activity. In this period StoneX averaged 10% returns on total capital.

With a ~60/40 split equity to debt SNEX should deliver a high teens ROE or ~$11 EPS over the next twelve months.

Valuation

Links

• Investor Presentation
• Bond Info

Why the sell off?

StoneX sold off ~13% when it released earnings after the market close on May 3rd. There is no clear reason why but here are a few factors

• The Company took a $14.6 million reorganization/retirement cost hit which depressed EPS by ~$0.50. These costs will be recovered through lower overhead over time (18-24 months)
• There was some banking related concerns around the same time (correlation/factor)
• StoneX average daily volume is 117,000 shares. If a forced seller hits the tape it wont take much to move the equity

DISCLAIMER: This does not constitute a recommendation to buy or sell this stock. We have a position in this company, and we may buy shares or sell shares at any time.

Catalyst

Consistent high teens and low 20's ROE's will drive multiple expansion and fund organic growth.