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TMX Group Stock: Undervalued and Highly Profitable
Stock Analysis & Ideas

TMX Group Stock: Undervalued and Highly Profitable

Story Highlights

The exchanges operated by TMX Group are the only ones Canadian investors take seriously. As a result, the company has a wide moat which translates into high profitability.

As the operator of Canada’s major exchanges, TMX Group (TSE: X) has a dominant position in the financial industry. Any Canadian company that wants its stock to be taken seriously among Canadian investors has to list on either the Toronto Stock Exchange or the TSX Venture. Therefore, the company has a definite competitive advantage in that regard.

As a result, this advantage shows up on its financial statements as well in the form of a very high gross margin. Indeed, it consistently hovers above 90% and recently hit 93.6% in the last 12 months. This translates into very high free cash flow margins as well, which came in at 36% in the trailing 12 months.

As the financial markets grow and more people get involved in stock market investing, so will TMX Group. Although interest in stocks tends to vary from time to time because of market volatility, investors can take comfort in the fact that TMX is really the only game in town when it comes to Canadian exchanges.

TMX’s Dividend Yield Has Remained Steady

For income-oriented investors, TMX pays a 2.6% dividend yield on an annualized basis. When taking a look at its historical dividend yield, you can see that it has remained relatively flat over the past several years:

At 2.6%, the current yield is near the middle of the range, indicating that income-oriented investors are paying a fair price relative to yields they have been able to receive in the past.

Why TMX Group May be Undervalued

To value TMX Group, I will use the H-Model, which is similar to a three-stage DCF model. The H-Model assumes that growth will decelerate linearly over a specified period of time. I believe this is a reasonable assumption, as companies gradually slow down as they mature.

The formula is as follows:

Stock Value = (CF(1+tg))/(r-tg) + (CFH(hg-tg))/(r-tg)

Where:
CF = free cash flow per share
tg = terminal growth rate
hg = high growth rate
r = discount rate
H = half-life of the forecast period

For TMX Group, I used the following assumptions:

For TMX Group, we used the following assumptions:
CF = C$6.97 per share
tg = 3.04% (used 30-year Government of Canada Bond yield)
hg = 5.3% (five-year FCF CAGR)
r = 8.0%
H = five years (I am assuming it will take 10 years to reach terminal growth)

As a result, I estimate that the fair value of TMX Group is approximately C$160.68 under current market conditions. The current price of the stock is about C$126.

Analysts See Upside Potential for TMX Group

TMX Group has a Moderate Buy consensus rating based on three Buys and three Holds assigned in the past three months. The average TMX Group price target of $152.16 implies 20.7% upside potential.

Final Thoughts: TMX Stock Could be a Great Opportunity

TMX Group is a highly-profitable company with a very wide moat. The chances of a new exchange springing up and disrupting the company are unlikely.

In addition, the company appears undervalued as both analysts and the H-Model assign a higher stock price. Thus, investors may want to consider taking a deeper look into the company.

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