Singapore Exchange Limited: Strong Start to FY18 October 17, 2017

PSR Recommendation: ACCUMULATEStatus: MaintainedTarget Price: SGD8.39
  • Expect strong SDAV and DDAV to continue in FY18 (FYE June) on the back of synchronous global recovery, peppered with regional volatility.
  • Higher market capitalisation for large cap stocks in finance, consumer services (property stocks included) and technology brought SDAV higher.
  • Expect stronger performance from China A50, USD/CNH and INR/USD futures as changes in domestic regulation make SGX a favourable overseas trading platform.
  • Number of new IPOs remain lacklustre compared to peers and delistings have accelerated.
  • Expect total DPS to increase from previous S$0.28 in FY17 to S$0.32 in FY18.
  • Maintain Accumulate with higher TP of S$8.39 (previous TP S$7.63).

SDAV expected to perform as global economy and domestic property market improves.

Global equities markets have risen on the back of improving economic growth around the globe. This has benefited Singapore listed companies in the finance, technology and consumer services sectors. Property stock prices have also begun to rise as the domestic property market sentiments improved dramatically on the back of strong residential enbloc sales momentum. Average SDAV from July to September was S$1.16bn, higher than the preceding average SDAV of S$1.15bn from April to June.

Episodic regional tensions and regulatory changes help drive trading volumes for SGX’s foreign currency and equity index futures.

USD/CNH futures saw stronger traded volumes during heightened tensions in the Korean Peninsula. A replay of this tension could see hedgers drive up the USD/CNH traded volume. At the same time, regulatory changes in China and India have encouraged market participants to approach SGX as a platform to trade USD/CNH, INR/USD and China A50 futures.

However, new IPOs have not been able to keep pace with the number and size of companies slated for delisting.

The number of listed securities on SGX have been on a decline and there is a lack of large cap stocks with high free float to replace the delistings. A review on listing rules could address the falling number of listed securities. And we expect the delisting of Global Logistics Properties to have an impact on the securities traded volumes.

 

INVESTMENT ACTIONS

We are revising our FY18e SDAV to c.S$1.16bn from previous estimate of S$1.08bn as stock market capitalisation and trading volumes improve. We think that FY18e operating expenses could come in above the guided range of S$425mn to S$435mn as business activity picks up hence we estimate FY18e operating expenses to be c.S$440mn. Our estimates for FY18e total derivatives volume is also revised upwards to 187mn contracts (previous estimate 180mn contracts). We expect SGX’s 1Q18 revenue to come in at S$218mn and PATMI to be at S$93.5mn, up 12.5% YoY. We expect 1Q18 operating expenses to come in at c.S$109mn, forming 24.8% of our FY18e operating expense forecast.

Given the expectation of better overall performance this year, we expect FY18e total DPS to increase by S$0.04 from FY17 total DPS of S$0.28 to S$0.32. Maintain Accumulate with higher TP of S$8.39 (previous TP of S$7.63).

Brief summary of selected Listing Rules for comparison. Please refer to actual exchange rules for more details and conditions.

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Challenges to SGX’s Securities business.

Competition from HKEX Stock Connect with Shanghai and Shenzhen. The connection allows Hong Kong listed firms will have a wider audience from mainland China via southbound trades. At the moment, mainland individual investors must have a balance of RMB500,000 in their cash and securities accounts to be eligible to trade Hong Kong listed stocks. Companies may be listing on HKEX in anticipation of any possible relaxation to the eligibility and quota for southbound trades.

SGX’s IPO listing requirements are stricter. SGX’s higher requirements for profitability, market capitalisation, revenues and cash flow compared to HKEX and ASX reduces the pool of eligible issuers. Even though Razer Inc and Sea Limited’s (formerly known as Garena) could qualify based on valuations and revenues, the consideration for profit criteria is weak because in both cases the losses have widened in FY15 and FY16. SGX face a conundrum where the large companies avoid it for the poorer liquidity, whilst smaller candidates avoid it for the stricter listing requirements.

More costly to maintain listing on SGX. The additional costs from quarterly reporting and issuance of annual sustainability reports may discourage issuers from listing on SGX.

Better valuation from overseas listing. Growth prospects for Singapore companies are increasingly driven by overseas expansion. Singapore companies may find that better valuations in overseas markets where they have been operationally active and are gaining strong growth traction especially for consumer goods and services companies whose branding has a stronger visceral effect on the local retail market.

Singapore’s IPO market has been slow but pipeline strategy in the works. SGX has partnered with IMDA to help high growth Infocomm and Media (ICM) companies that are accredited by IMDA to leverage capital markets for expansion. The accreditation process has helped the accredited companies generate over S$80mn worth of government project pipeline (S$70mn in May 2017) and helped the companies raise over S$59mn in new investment capital (S$28.9mn in May 2017).

 

Figure 1: The number of IPOs on  the SGX pale in comparison to its regional peers

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Figure 2: SGX’s 2017 YTD IPO proceeds exceeded 2016 because of the Netlink Trust IPO which raised S$2.3bn.

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Figure 3: SGX’s listed securities are on a decline as IPOs had been slow and delistings are accelerating.

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Delisting of Global Logistics Properties (GLP) could reduce SGX’s monthly securities market turnover value by c.3.6%. With a market capitalisation of S$15.5bn, GLP is ranked 11 in the STI stocks list by market capitalisation. GLP has a free float of c.38%. As of 29 Sept 2017, GLP’s total return YTD is 52.8%. Owing to its high market capitalization and sizable free float, we estimate GLP’s average monthly Volume Weighted Average Price (VWAP) turnover value (monthly average VWAP x monthly volume) over the period from January 2016 to August 2017 to be S$851mn. This is about 3.6% of SGX’s average monthly securities market turnover value of S$23.6bn. We also think that the recent big weight IPO of Net Link Trust will not fully compensate for the delisting of GLP slated to be completed by 14 April 2018. Though Net Link Trust has a free float of c.75% (Twice of GLP’s free float), the market capitalization of S$3.2bn is only slightly more than one-fifth of GLP’s market capitalisation. 

Figure 4: GLP’s monthly VWAP value could go as high as 5% to 8% of SGX’s monthly Securities Market Turnover Value.

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Major developments to SGX’s derivatives business at the start of FY18 (Financial Year Ending in June).

Continued market dominance in iron ore derivatives market outside China. As SGX controls 95% of the Iron Ore Futures market outside China, the other 5% is controlled by CME. CME has been aggressive in pushing their traders to ramp up volume in Iron Ore futures but we do not think CME poses a threat as CME’s Asian office is only a representative office so their infrastructure and support is not on par with SGX. Besides, CME operates in the European time zone therefore will not see most of the trading activity that happens during the Asian time zone. As such, SGX will not be expected to reduce Iron Ore futures contract fees to compete with CME.

INR/USD futures performance shot through the roof as regulations in India’s domestic derivatives market tightens and volatility picked up. Foreign use of Indian domestic derivative products through Offshore Derivative Instruments (ODIs) also known as participatory notes (P-Notes) is now restricted for the purpose of hedging equity shares held. Therefore as global portfolio managers cut their exposure to Indian equities between July and August, the notional value of ODIs on Derivatives declined sharply over the same period. With reduced exposure to onshore Indian derivatives, foreign market participants will not be able to trade the volatility onshore but trade them offshore. Indeed when volatility picked up in the latter half of September, SGX experienced stronger INR/USD traded volumes.

Korean Peninsula tensions, Chinese central bank action and improving China A50 traded volume helped boost USD/CNH futures volume and market share. The USD/CNH futures benefited from higher volatility as the renminbi strengthened in early September amid rising North Korean missile threat then weakened when the Chinese central bank relaxed certain hedging and reserve related rules that were originally in place to limit the renminbi decline. We believe improving China A50 trading volumes following the relaxation of stock index futures trading rules in China early this year also helped SGX gain market share in the USD/CNH futures market because of hedging synergy between USD/CNH and China A50 futures.

We do not see the listing of Asia Pacific Exchange (Apex) as the third derivatives exchange in Singapore a major threat.  Apex plans to open its exchange with refined palm oil contracts which SGX does not offer as a derivatives product. However, if Apex decides to offer iron ore and coking coal futures contracts, there will be competition for SGX Iron Ore futures market share outside China.  Apex is majority owned by a China markets veteran, Mr Eugene Zhu Yuchen who held a senior position at Dalian Commodity Exchange. Dalian Commodity Exchange has the largest Iron Ore futures market with trade volume of 465 million Iron Ore futures contracts YTD. In comparison, SGX, which controls 95% Iron Ore market share outside China, had managed 10 million Iron Ore futures contracts YTD. Given Mr Eugene Zhu’s background, we think that Apex may eventually roll out iron ore futures contracts to capture and grow the market outside China. But being based in Singapore, we believe that adherence to rules pertaining to “risk-based” exposures wherein customers have to fulfil stricter margin requirements and maintain a special reserve fund would raise the bar for Apex’s growth strategies.  We estimate that SGX’s margin requirement is between 11% and 14% compared with Dalian Commodity Exchange’s minimum of 5%.

Figure 5: INR/USD and USD/CNH futures are SGX’s main FX derivatives products with INR/USD futures making the bulk of it.

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Figure 6: China A50 volume bottomed out in early 2017 following the relaxation of stock index futures trading rules in China.

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About the author

Profile photo of Jeremy Teong

Jeremy Teong
Investment Analyst
Phillip Securities Research Pte Ltd

Jeremy covers primarily the Banking and Finance sector. He has 6 years’ experience in equities related dealing and research roles.

He graduated with Bachelors of Mechanical Engineering from Nanyang Technological University.

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