• SGX underwent a business reorganisation and client organization in 1Q20.
• Newly reclassified equities revenue segment which combined both cash equities and equity derivatives is now the largest revenue contributor at 71%.
• FTSE China A50 Index Futures remain the main driver of SGX’s volume, accounting for 37% of total trading volume in 1Q20 (Oct’19: 34%).
• HKEX’s launch of MSCI China A-share futures contract yet to be approved. Regarding SGX and NSE’s IFSC-SGX Connect in GIFT City, no timeline was announced and we await further updates.
• October’s total derivatives volume fell 24% YoY.
• We downgrade to NEUTRAL with an unchanged TP of S$8.60. We peg our TP to 22x P/E, 1 SD below SGX’s 5-year mean. The downgrade is due to the recent price appreciation.

SGX’s revenue reclassification

The new revenue reclassification for SGX’s income statement was put into effect in 1Q20 to reflect a new organisation structure that is now into three revenue categories: Fixed Income, Currencies and Commodities (FICC), Equities (Cash & Derivatives) and Data, Connectivity and Indices (DCI). SGX guided FICC and DCI to grow at a faster pace as efforts will be put into both business units to double in size in the next 5 years.

• FICC revenue consists of fixed income from bond listings and corporate actions, as well as derivative revenue from Commodities and FX futures. This revenue segment contributed to 18% of total revenue in 1Q20.
• Equities: This revenue line now consists of both cash and derivatives, and the equities revenue line is the largest earnings contribution at the moment, making up 71% of total revenue in 1Q20.
• DCI revenue was merely renamed from the old Market Data & Connectivity unit. This revenue segment contributed to 10% of total revenue in 1Q20.

Model update

Following the reclassification of SGX’s income statement, we updated our model accordingly to reflect the respective changes as seen in Figure 3. We have kept our assumptions relatively unchanged. However, the main change lies in the derivative revenue line. The previous largest revenue generator – derivatives – is now split between each derivative component in FICC (Currency and Commodities – derivatives) and Equities (Equities – Derivatives) as seen in Figure 3. Hence, the newly reclassified equities revenue segment which combined both cash equities and equity derivatives is now the largest revenue contributor. Equity derivatives remain the key driver of volumes, contributing to 78% of total volumes in 1Q20 as compared to 84% a year ago.

October market statistics & 1Q20 update

Derivatives: October’s total derivatives volume fell 24% YoY, and Derivatives Daily Average Volume (DDAV) fell 22% YoY to 0.855mn. October saw lower volatility as compared to the two most volatile months (May and August) this year when Trump unleashed his tariff hikes, as evident in DDAV spiking 54% and 33% YoY respectively.

On a quarterly basis, 1Q20’s average fee per contract increased from $1.05 to $1.15 due to a change in product mix traded and more higher-fee paying customers. 1Q20’s total derivative volume and DDAV grew 14% and 12% YoY respectively. Equity derivative volumes increased 6% YoY to 48mn contracts due to increased volume in Nifty 50 (+17% YoY), Nikkei 225 (15% YoY) and MSCI Singapore index futures contracts (22% YoY). Commodities and currencies futures volumes rose 78% and 40% YoY respectively to a total of 14mn contracts, making up 22% of total volumes.  We forecast DDAV for FY20-21E of 1.023mn and 1.106mn respectively.

Securities: SGX’s 1Q20 SDAV came in at S$1.062bn and its YoY growth recovered to -1% as compared to the quarterly average contraction of -16% YoY in FY19. Average clearing fees for cash equities declined to 2.68bps in 1Q20 as compared to 2.88bps a year ago. 1Q20 SDAV exceeded our estimates by 3% due to better than expected impact on equities from the stabilisation in global markets. We forecast SDAV for FY20-21E of S$1.078bn and S$1.122mn respectively.

FY2020 expense and CAPEX guidance

SGX guided total expenditure in FY20 to be in the range of S$465mn to S$475mn; while technology-related CAPEX is expected to be between S$45mn to S$50mn. As of 1Q20, total expenses was well contained at S$113mn (making up 24% of guidance), and CAPEX of S$7mn was 29% lower as compared to a year ago.

We expect operating expense to be higher in 2020 due to three factors; increase headcount, larger depreciation expenses from new systems launched in FY19 and higher royalties and processing fees due to higher derivatives volume expected in 2020.

Structural growth in global derivatives to sustain earnings

Besides benefiting from the occasional volatility due to trade tensions between the U.S. and China, the underlying growth in demand for derivatives will be sustained by increasing interconnectedness and globalisation of markets.  Institutions’ demand for risk management and hedging tools will increase and SGX’s diversified product suite is well-posed to offer access to otherwise hard-to-reach onshore market in emerging markets, namely SGX’s India and China equity derivatives. SGX’s derivative products capture global flows and are not as reliant on local liquidity as the securities business.

Other Updates

SGX-IISL arbitration

SGX is optimistic that the joint proposal submitted by NSE and SGX will receive support from regulatory authorities. No timeline was announced and we await further updates.

Outlook

We are positive that SGX’s diversified product suite will support derivatives volume growth and open interest in 2020. Market volatility has proven to be favourable for derivatives volume and the strength in derivatives growth should offset weaknesses in equities revenue. SGX’s derivatives business contributed to 51% of total revenue in FY19, with the main driver being FTSE China A50 Index Futures, which accounted for 44% of total trading volume in FY19 (1Q20: 37%). While HKEX’s launch of A-share contracts may pose headwinds, a larger trading ecosystem from both exchanges may limit downsides.

Investment Actions

We downgrade to NEUTRAL at an unchanged TP of S$8.60. Our TP is pegged to 22x P/E, 1 SD below SGX’s 5-year mean. The downgrade is due to share price movement. SGX is enjoying structural growth in the derivatives business as it captures global flows into Asian equities, commodities and currencies.

Rationale: We are positive that SGX’s diversified suite of derivative products will sustain growth in 2020. Some of the structural tailwinds SGX is benefiting includes the increased global flows into Asian equities, currency transaction moving into exchange platform and a broader range of commodity futures products.