In my opinion, Virtu Financial, Inc. (NASDAQ:VIRT) continues to blow past expectations. Once again, the company proved that it could be a viable hedge against volatile market conditions (i.e., violent pullbacks). But it’s also continued to prove that it can consistently be a free cash flow machine through all types of market environments. Moreover, VIRT has a very shareholder-friendly management team focused on creating sustainable long-term profitability for investors. A testament to this is its firm commitment to paying a dividend even through a worldwide pandemic and economic recession! Lastly, from a valuation standpoint, I consider the stock continues to be undervalued. My conservative valuation model suggests that the stock should be worth roughly $30 a share. Thus, VIRT seems like one of those few great long-term holds for dividend and value investors.
Source: company website.
VIRT once again proved that it’s a one of a kind stock. While 2020 has been disastrous for most companies, VIRT has seen once again record revenues. This is because the company’s business model benefits from volatility. Thus, the COVID-19 pandemic and the subsequent market crash in early 2020 were incredibly profitable for VIRT. For context, the company’s revenues are expected to increase by approximately 80% this year versus 2019.
Naturally, this is an excellent year for VIRT, and so its revenues will likely pull back to normal levels again in 2021. Nevertheless, VIRT’s balance sheet will be more robust now, thanks to a historically volatile 2020. You see, 2020 has been essentially an unexpected cash windfall for VIRT. And as a result, the company’s equity (assets minus liabilities) has so far increased by $679.5 million this year.
Source: Seeking Alpha.
An excellent example of this dynamic is VIRT’s recent $100 million long-term debt prepayment. This effectively strengthens VIRT’s balance sheet and compounds capital, which is ultimately our goal as investors. So, as a whole, VIRT’s hedge status is unquestionably well deserved. I’d consider such an asset to trade at a premium, as it is effectively uncorrelated to the broader market. However, it seems the market continues to underestimate VIRT, representing an opportunity for investors at these levels (more on this later).
Source: VIRT’s investor presentation.
Thus, the company undoubtedly has a resilient business model. This is huge, as it shows that VIRT can perform throughout all economic cycles. Naturally, periods of extraordinary market volatility (like 2020) are going to be better for VIRT. However, even during cycles with historically low volatility (like 2019), the company consistently produced a healthy free cash flow while growing its top line.
A shareholder-friendly FCF machine
And this is one of the company’s main selling points. It’s a stock that, year after year, manages to remain FCF positive. The way I think of VIRT at this point is akin to a market turnpike. This is because VIRT’s services provide liquidity for institutions and retail investors. Market makers such as VIRT are an essential part of modern financial markets, and thanks to them, trading costs have now sunk to all-time lows. In fact, much of the recent move towards commission-free trading is thanks to the contributions of market makers and HFT firms such as Virtu Financial. And while selling order flow remains somewhat controversial, it’s undeniable that commissions and fees have decreased substantially over time. Therefore, this opens up financial markets for virtually everyone and will likely increase retail trading volume, which should be another secular tailwind for VIRT.
Source: VIRT’s investor presentation.
I’ll concede that the company’s growth isn’t as exciting as some hyper-growth tech companies. However, its revenues have increased at a healthy 21.23% CAGR since 2011. For context, in 2011, VIRT’s revenues were just $422.5 million, and now, its TTM revenues are a whopping $2389 million! But, more importantly, I believe VIRT’s growth is sustainable over the long term, which makes it ideal for compounding capital and maybe even growing its dividends.
This takes me to another excellent trait VIRT has, which is its shareholder-friendly management. In my view, the company’s focus on returning capital to investors, and long-term profitability is a gem in today’s market.
So, again, this is not a business where I’m particularly focused on, Oh, I want to be 33% or 34% or 32% or 31%, I want to be — I want to be profitable, I want to provide a good service, I want to provide really good price improvement. I’m very, very comfortable where we’re at right now.
Douglas Cifu, VIRT’s CEO.
Countless companies today focus on top-line growth and ignore profitability. Unlike them, VIRT’s priority is profitability instead of growth. And this was once again echoed by Douglas Cifu (VIRT’s CEO) in their last earnings call. There, he mentioned that VIRT could expand into other businesses (such as options trading), and they intend to do it eventually. However, they’re not rushing it or making it a priority because they prefer to focus on profitable growth and not just revenue growth for the sake of it. If you read the transcript, several analysts questioned management about several potential growth projects, and time and time again, Douglas returned to the idea of profitability over “growth.” I believe such business philosophy might now be as sexy as concentrating on hyper-growth, but it’ll ultimately prove incredibly rewarding for long-term shareholders.
Furthermore, I applaud the company’s commitment to paying a dividend regardless of the economic cycle, even during these trying times. Back when I first started covering the company, the stock yielded an attractive 5.77%. Since then, the stock has returned over 40%, including dividends. Even today, the stock’s dividend remains compelling at 4.20%, comparable to many junk bond yields. But unlike those highly speculative bonds, VIRT’s dividend seems secure due to its low payout ratio of 18.04%, strong balance sheet, and consistent FCF.
Source: Seeking Alpha
My only recommendation would be for management to step up their buyback program. After all, the stock appears undervalued, and VIRT’s substantial FCF could be put to use that way. Even though share buybacks have gained a bad reputation, the reality is that, if they’re executed at cheap valuations, they can be incredibly effective at returning capital to shareholders. Share repurchases can reduce the company’s dividend expenses (as share count decreases) and often help drive stock prices higher for investors. Hence, I consider this would likely supercharge VIRT’s returns over the long term.
A compelling valuation
Lastly, I gather the stock remains undervalued after considering the Fed has depressed interest rates. Thus, I think it’s remarkable that a company like VIRT with a dividend yield of 4.20% exists, while the Fed is implementing ZIRP. In my view, VIRT’s valuation is quite straight forward and can be done through its relatively predictable FCF. The results are quite surprising.
As you can see, my valuation model suggests that VIRT’s fair value per share should be $30.59. This implies a potential upside of 34.5%. And it’s also worth noting that I performed this valuation through relatively conservative assumptions. For instance, I priced VIRT’s FCF at a multiple of 10 (or 10% FCF yield), which should be once again incredibly attractive in today’s market. And lastly, my valuation model already assumes that, by 2021, VIRT’s revenues will return to more historically normal levels. While this may be the case, it’s worth considering that we’re once again close to an incredibly controversial presidential election, which could easily send volatility through the roof once more. So, overall, I deem my valuation inputs very conservative.
Finally, it’s worth mentioning one of VIRT’s main risks. In particular, I’d argue that lawmakers could derail the company’s long-term success if they pass harsh regulations or taxes. And, unfortunately, this is not entirely outside the realm of possibility. After all, high-frequency trading (for market-making purposes or otherwise) is already relatively controversial in the financial community. Often people accuse HFTs of front-running other traders, which is outright illegal. On the other hand, New Jersey is currently considering imposing a new tax on financial transactions. Such a tax would directly impact VIRT and other financial entities like the Nasdaq (NASDAQ:NDAQ) or the NYSE.
Although, I believe regulators understand that VIRT (and other market makers) aren’t frontrunning everyone. And if VIRT ever engaged in such practices, I think that, by now, they’d have been fined, which hasn’t been the case. So, that first argument is likely hollow, in my opinion.
Nonetheless, regarding regulations and taxes, I do think that there are some risks for shareholders. But let’s not forget that VIRT is not alone in that fight. A great example of this is how VIRT is joining other financial giants like the NDAQ or the NYSE to oppose any legislation or taxes that’d make a significant dent in their respective bottom lines. In my view, that’s likely going to be enough to avoid this second risk type. Even if New Jersey passed new taxes, VIRT can still move elsewhere and continue operating without significant setbacks. So, overall, I think these risks are negligible in the bigger picture for long-term investors.
Virtu Financial is not without its risks. The company indeed continues to face regulatory uncertainties, and high-frequency trading remains in the sights of the taxman. Nevertheless, VIRT’s underlying fundamentals seem remarkably durable with a capable management team. Its attractive valuation and consistent dividend yield make it a desirable addition to virtually all investment portfolios. Therefore, I consider that VIRT will most likely turn out a great long-term hold for investors, so I reason investors will almost surely compound their capital at an acceptable rate over the long term. Consequently, I recommend you consider adding VIRT to your investment portfolio.
Thank you for reading, and good luck.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in VIRT over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.