The Positives

+ Derivatives achieved a third consecutive quarter of record revenue at S$112.9m, offsetting the decline in equities (-30% YoY) and fixed income (-12.6% YoY) revenue. Derivatives volume grew 12% YoY, consisting of higher trading volumes in key equity derivatives (+8% YoY), record FX futures volume (+48% YoY) and iron ore derivatives (+30% YoY).  Volume was boosted by China A50, MSCI NTR product suite, growth in passive investing and greater need for hedging with rising exposure into Asia.

The average fee per contract rose 5% from $1.06 to $1.11 due to the pulling back of rebates for China A50 index futures and 30% higher volume for the higher-priced iron ore derivatives. Collateral management income rose 62% YoY from higher open interest and margin balances from increased demand for risk management solutions. Derivatives contributed 52% to total revenue in 3Q19. We forecast a higher FY20e DDAV of 1,107k, 15% above 9M18’s DDAV of 963k.

The Negatives

– Equities revenue continues to contract, falling 30% YoY, the slowest in five years. The significant fall in SDAV was partly due to a high SDAV of $1.45bn in 3Q18, the highest since 4Q13. In addition, average clearing fees declined from 2.72 bps to 2.67. Our 9M19e SDAV of 1.08bn was 5% above the actual 9M19 SDAV of $1.02bn, hence we lower our FY19e SDAV estimate from S$1.08bn to S$1.02bn. We pen in a more conservative SDAV for FY20e of S$1.02bn, 5% lower than the previous SDAV of S$1.07bn.

Other Updates

SGX-IISL arbitration

Both NSE and SGX have agreed on a proposition and submitted a joint proposal to their respective authorities. No additional details were announced at this point and we await further announcement from SGX.  

Competition from Hong Kong Exchange

SGX does not expect absolute volume for China A50 to be impacted although market share may decrease as Hong Kong Exchange joins in as a competitor. A vast majority of SGX’s clients trade a range of products and SGX expects it’s quality service and offering of margin offsets across various derivatives products with a good track record to be strong enough to retain clients. Furthermore, with the liberalization of the Chinese market, higher onshore activity usually creates higher offshore activity as well, creating a larger market for both exchanges.

Outlook

We believe that continued stock-market volatility should support derivatives volume growth. The low-interest rate environment in the upcoming months is expected to drive more REIT and bond listings. SGX expanded the number of DLC offerings to 62, with 44 belonging to single stock and 22 from indices. SGX is also a leader in market share in the derivatives FX for CNH and INR futures exchange. In the meanwhile, the boost in derivatives business volume and product offerings will be more than sufficient in supporting earnings growth.

Investment Actions

We maintain Accumulate at a lower TP of S$8.09 (previously S$8.17) as we peg our TP to 21.4x P/E, 1 SD below SGX’s 5-year mean. The lower TP is due to higher DDAV partly offset by lower SDAV. We assume S$1.02bn of SDAV, 20% YoY growth in derivative revenues and 50% operating margins for FY20E. SGX’s attractiveness as an investment in the medium term remains intact with superior ROE, dividend yield and attractive valuation. SGX is a defensive stock with consistent and diversified earnings, valuation and dividend support for resilience in an uncertain environment.

Chart 1: Peer comparison