SGX continues to expand upon its product base, though at a progressive pace with management noting that many products have a substantial gestation period, eg the Nifty contract was nurtured for almost seven years before trading in it took off. On the equity side, while IPO interest remains lacklustre, the number of ETFs (Exchange Traded Funds) on the market has reached 35 while SGX boasts the second-largest REIT market capitalisation after Japan. On the derivatives side, single stock futures launched in February 2009 are showing a steady increase in open interest while AsiaClear, the rapidly-growing OTC clearing business, recently added iron ore contracts to its existing freight and fuel oil contracts. Areas for future development include the options market and the commodities derivatives business via commodities exchange SICOM (SGX acquired this platform last year).
SGX’s capex plans have not been derailed by more difficult operating conditions — two new trading engines were switched on within the space of six months over FY09 (for equities and derivatives, respectively) and a new clearing system will go live at end-FY09F. For FY10F, a new data engine will be put in place, boosting the emerging growth business of algorithmic trading, which is now between 10% and 20% of trades on SGX as compared to around 40% in US-Europe.
Our Gordon growth-based price target (methodology unchanged: 11.5% cost of equity, long-term annual dividend payout of 85%, long-term growth of 7%) is S$7.40, or 19x FY10F (June year end) earnings. Dividend payout is likely to remain above the 80% minimum policy as capex (S$20mn-S$40mn annually) can comfortably be funded from ex-dividend cashflow — hence, yield is comfortably supported above 4%. We note that SGX’s mean historical P/E is 10% higher at 21x, and during periods of market bullishness, when DVT tends to rapidly expand, the P/E ratio commanded by a stock exchange like SGX will expand with similar speed. Continued infrastructure upgrades and a responsive regulatory environment underpin our view that SGX is well- positioned to capture a recovery in capital market sentiment which, apart from the direct beneficial impact of rising DVT, should also benefit revenue drivers such as IPO and corporate activity fees. In short, we see SGX as a high-quality leverage play on the recovering market with an attractive dividend.
The most immediate risk to revenues would be another slump in market sentiment which would depress trading interest and hence, clearing fees. The crystallisation of direct competition for SGX within Singapore is, we think, a low-probability event, still. Even should rival electronic trading platforms establish themselves (eg, Chi-X), they would remain primarily low-margin trade matching services for institutional flows, steering clear of the high-margin businesses of clearing and depository. However, a pick-up in regional competition for listings and derivatives contracts would stunt SGX’s growth appeal, given its drive to become the region’s primary pan-Asian listing and derivatives market.
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