Singapore Exchange Ltd (SGX SP) - Maybank Kim Eng 2017-12-20: Part 1 ~ Riding On Cyclical Upturn

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SINGAPORE EXCHANGE LIMITED S68.SI

Singapore Exchange Ltd (SGX SP) - Initiation Coverage Report Part 1

Initiate with BUY; Target Price SGD8.30 

• We initiate coverage of Singapore Exchange Ltd (SGX) with a BUY and TP SGD8.30, based on 23x FY19E EPS, in line its P/E mean since 2012. 
• A quasi-monopoly with high barriers to entry and higher operating margins, SGX focuses on its multi-asset strategy to grow different businesses and asset classes. 
• We see support from its strong cash position, healthy balance sheet and decent dividend yields of c4% (vs SGS yield of 2%).

INVESTMENT THESIS

Proxy for cyclical upside

• SGX remains a good proxy to ride the cyclical upturn. We believe SGX has room for further upside in FY18-19E as robust growth in the economy tends to bode well for capital markets.
• We believe its EQFI business should continue to see sustained momentum in:
  1. healthy listing pipeline from both bond and equity listings; and
  2. stronger SDAV levels from an improving economic outlook, more fund flows into Singapore, and risk-on market sentiment. 
• SGX’s ability to attract bigger listings from REITs and business trusts has supported the overall increase in IPO market cap this year.
• SGX has been expanding its product suite in equity, commodities and FX derivatives. Open interest is also at new highs in five years of 5.5m contracts as at Nov 2017. We think derivatives will be a bigger revenue driver as we are positive that further growth can be sustained through its ability to extend the derivatives value chain through vertical integration and expansion of product offerings.

But structural issues loom 

• Structural issues, especially for its equities business, remain a key concern. Management seeks to address some of these issues with various initiatives, although their effectiveness remains to be seen as more time is needed to assess their impact.
• For equities, some issues are:
  1. low turnover velocity due to low traded value and difficulty in growing market cap substantially;
  2. low valuations of companies, and
  3. an inability to attract bigger IPO listings. 
• With the participation of market makers and liquidity providers (MMLP), as well as proliferation of alternative products such as ETFs in the market, we believe it is inevitable for clearing fees to come down.
• Derivatives face concentration risk as major contracts (for e.g. China A50, Nikkei 225, Nifty 50 and iron-ore futures) accounted for 67% of derivative volumes as at FYTD18 (financial year to date 2018). That said, we think SGX is looking to diversify its revenue and volume mix through various contracts such as FX futures. 
• We expect derivatives’ average fee per contract to come down as we think SGX faces pricing pressure from competition as it looks to defend and/or gain market share for its key derivatives contracts.

Risks 

• Risks include:
  1. lower SDAV and DDAV levels;
  2. significant regulatory changes and potential disruptors that could make SGX’s platforms and technologies irrelevant;
  3. increased competition; and
  4. capital raising efforts for potential M&A deals that could potentially dilute ROEs.

Undemanding valuation 

• SGX currently trades at 20.6x FY19E EPS, a discount to its regional peers’ 32.3x average. SGX’s valuations are cheaper than most of its Asian peers, yet it generates higher ROEs of c34-35% for FY18-19E. This is supported by its strong cash position, healthy balance sheet (zero debt) and decent dividend yields of c4% (vs 10-year SGS yield of 2%). 
• Our TP of SGD8.30, based on 23x FY19E EPS, is in line with its P/E mean since 2012.

COMPANY OVERVIEW

A multi-asset exchange 

• SGX was formed in 1999 to bring about the demutualization and merger of the securities and derivatives exchanges, which was initiated by the Singapore government in 1998. It effectively operates as a quasi-monopoly with high barriers to entry and higher operating margins as its business model is hard to replicate. 
• Over the years, it progressed into a multi-asset exchange, focusing on growing different businesses and asset classes such as FX and index business.

Overview of key business drivers 

• Starting from 1 Jan 2016, SGX has streamlined its three business segments:
  1. Equities and Fixed Income (EQFI);
  2. Derivatives; and
  3. Market Data and Connectivity (MDC). 
• EQFI comprises three sub-segments: 
  1. Issuer services;
  2. Securities Trading and Clearing; and
  3. Post Trade Services.
• As at 1Q18, EQFI and derivatives formed 49% and 39% of total revenue respectively. This was little changed from 51%/38% in FY17.
• Contribution from EQFI fell from 69% in FY10 to 51% in FY17 due to the subdued equities market in recent years. EQFI struggled with lower velocity and traded value. Turnover velocity fell from 39% in FY12 to 29% in FY17. Also, market capitalisation grew at a CAGR of just 4% over FY12- 17. Within the EQFI business, securities trading and clearing drove 51% of EQFI revenues in FY17, followed by post-trade services at 29% and issuer services at 21%. Contribution to total revenues was c11%/26%/14% respectively.
• In contrast, derivatives became a bigger driver of total revenue, which helped pick up the slack from the volatile EQFI segment. Derivatives revenue has grown faster, at a 5-year CAGR of 13% vs 0.2% for EQFI. The number of derivative products has expanded to 95 from 43 five years ago.
• However in FY17, derivatives revenue decreased by 7% YoY to SGD303m, mainly due to lower volumes from China A50 and Nikkei 225 Index futures, coupled with slightly lower average fee per contract at SGD1.18 (FY16: SGD1.19).

PROXY FOR CYCLICAL UPSIDE

EQFI: TO BENEFIT FROM UPTURN IN MARKET ACTIVITY

Healthy listing pipeline 

• SGX has been successful in attracting REITS, business trusts and high dividend-paying mature companies. There are 50 REITs and business trusts on SGX and they comprise 7% of total listings. REITs and business trusts formed 16% of new listings between FY14 to FY17.
• Meanwhile, bond listings have been robust. In FY17, new bond listings increased two-fold to 819 listings (FY16: 349 listings), which raised SGD385b (FY16: SGD172b). With a higher number of bond listings, we estimate listing revenue will improve at a 3-year CAGR of 6%.
• A risk-on market in calendar year 2017 has supported a healthy IPO pipeline. For calendar year 2017 (note that calendar year is different from SGX’s FY end-June), there have been 20 IPOs from various industries such as REITs, business trusts, healthcare, consumer and education. (read also: SGX 2017’s IPO Fund Raisings Have Doubled 2016 Levels)
• From Jul to Dec 2017, there were a total of 11 IPOs (five Mainboard and six Catalist listings), bringing in a total IPO market cap of SGD6.3b. The increase in market capitalisation was supported by the bigger listings from REITs and business trusts such as Netlink NBN Trust, Cromwell European REIT and Keppel-KBS US REIT. These three listings alone added SGD5.3b, or 83% of total IPO market cap currently.
• FYTD18 (from Jul to Nov 2017), total equity market cap increased by SGD42b to SGD1.06t, from FY17’s level of SGD1.02t (as at Jun’17). This implies that the net addition of ~SGD4.9b market cap contributed 12% of the absolute increase in total market cap of SGD42b FYTD.
• Based on various media reports, the companies that can potentially list on SGX over the next two years could be: MyRepublic (Telco, targets to list by end-2018 or early-2019); ayondo (FinTech, targets to list by early 2018).
• Our base case assumes a healthy IPO pipeline in FY18-19E, barring any significant market risk-off sentiment. We estimate FY18-20E average equity market cap of SGD1.05t/ SGD1.12t/ SGD1.16t. Therefore, average market cap will grow 4-10% YoY across FY18-20E and post a 3-year CAGR of c6.5%.

SDAV momentum to be sustained 

• Securities daily average value (SDAV) trended higher at SGD1.18b on average as at Nov 2017 from an improving economic outlook and risk-on market sentiment. SDAV contribution from institutional investors continued to be the bigger driver at 58% in FY17, while retail and MMLP have been consistent at 24% and 18% respectively.
• We estimate SDAV will be SGD1.22b/SGD1.27b/SGD1.25b for FY18E/19E/20E. With YTD’s SDAV now at SGD1.18b, this implies SDAV of SGD1.25b for the rest of FY18, based on our FY18E estimate of SGD1.22b.
• Economic recovery, more fund flows into Singapore, risk-on market sentiment, as well as uncertainties in macro outlook can also create volatility and drive SDAV levels further.

DERIVATIVES: A BIGGER REVENUE DRIVER

• Derivatives have provided SGX with a more stable and consistent revenue stream in recent years, and formed 39% of revenue in 1Q18 vs 21% in FY10. SGX has been expanding its product suite in equity, commodities, and FX derivatives. The number of derivatives products has expanded to 95 (as at Nov 2017) from 43 five years ago.
• As at FYTD18, DDAV (i.e. number of contracts traded daily) has been robust, up 14% YoY on average. Overall derivatives volume (i.e. total contracts traded) has improved in recent months from China A50 index futures, iron ore contracts, and higher FX futures volume from INR/USD and USD/CNH FX futures.
• Open interest, which represents the total number of outstanding derivatives contracts that have yet to be settled, increased by 15% YoY in 1Q18 to 5m contracts. With strong underlying demand and liquidity, this could boost DDAV. There is a positive correlation between DDAV and open interest, as correlation coefficient is ~0.50 based on historical 5-year monthly data.
• To grow the derivatives market, several initiatives were introduced by SGX especially in extending its derivatives value chain. We think SGX is in the right direction to grow the derivatives market. These include: 
  1. strengthening its offerings across the steel value chain through vertical integration, for e.g. offering iron ore hedging instruments with coking coal tools enables customers in the downstream industry to manage upstream volatility; 
  2. acquiring Baltic exchange to grow freight derivatives business; 
  3. strengthening FX futures market position; 
  4. launching SGX TITAN platform for participants to manage their derivatives trading and clearing positions 24/7.
• We think derivatives provide more scope for profitability. Some of these initiatives are starting to see results, for instance coking coal futures saw volume growth of 40% MoM in Nov 2017.

Continue Reading: Singapore Exchange Ltd (SGX SP) - Maybank Kim Eng 2017-12-20: Part 2 - Structural Issues Loom

Ng Li Hiang Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-12-20

Maybank Kim Eng SGX Stock Analyst Report BUY Initiate BUY 8.30 Same 8.30