Singapore Exchange - Downgrading to Neutral

Trading volumes have increased in recent weeks, and we believe these higher levels are sustainable due to an economic recovery and a decline in risk aversion among investors. We raise our FY10/11/12 EPS estimates for Singapore Exchange (SGX) from S$0.35/0.40/0.46 to S$0.39/0.43/0.48, and our price target from S$9.00 to S$9.20. However, we believe the stock is fully valued at current levels and thus downgrade our rating from Buy to Neutral.

We expect foreign inflows to Asia to continue because of its better economic growth prospects relative to the west. Additionally, we think local retail participation in Singapore’s equity market could rebound after having fallen from an average of 15.2% of household wealth in 2003-07 to an estimated 9.3% at the end of 2008. However, we believe this will be offset by fewer Chinese listings because of the better valuation premium commanded by similar listings in China.

We believe SGX’s main risk, the potential break-up of its monopoly, has been mitigated by its announcement of a joint venture with Chi-X to set up the first exchange-backed “dark pool” in Asia. We think this partnership should eliminate criticism of SGX’s monopoly status and allow it to defend its market share.

We continue to derive our price target using a DCF-based methodology, explicitly forecasting long-term valuation drivers with UBS’s VCAM tool. Our new price target reflects our higher estimates. Our key assumptions include a WACC of 8.9% (previously 8.6%) and a long-term growth rate of 3%. The change in WACC is due to higher beta.

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Singapore Exchange - Back to the Bull

Liquidity support: SGX reported 4Q09 profit of S$91.2mn, up 65% QoQ and 1% YoY on higher trading and market activity. A slight beat on better cost control. Final dividend S$0.155ps, in line. SGX will increase the base dividend to S$0.15ps (S$0.0375ps per qtr) from FY10. FY09 profit was S$306mn, down 31% YoY.

Operating revenue: Up 42% QoQ; down 1% YoY. Securities market fees were up 80% QoQ and 10% YoY as average daily traded value jumped 82% QoQ, to S$1.7bn. Derivative fees increased 15% QoQ, down 14% YoY, with an 18% QoQ rise in traded contracts, a tad disappointing and due to lower structured warrants activity. Stable revenue was up 5% QoQ, down 14% YoY with higher corporate actions. Market-driven revenue was 79% of total mix (vs. 72% in 3Q09).

Operating expenses: Up 18% QoQ; down 4% YoY. Bonus accruals were up 152% QoQ (4Q seasonality), down 17% YoY. Good cost controls in staff costs, marketing and travel expenses offset increased system investments, with system maintenance and depreciation costs both increasing. Improved markets led to a 7ppt QoQ fall in operating efficiency, to 38%.

Back to Bull: SGX is rational with shareholder capital, in our view, and continues to seek to expand the proposition and diversify revenue streams. The announcement of the new CEO removed an uncertainty. With global monetary policy conditions likely to remain loose for some time, we expect liquidity to continue to expand and flow into risky assets and also increase corporate activity. SGX is a leveraged play on this thematic, and we see average daily traded value reaching and holding the S$2-2.5bn range. Trading on 22x FY10e EPS, SGX appears very reasonable compared with HKEx at 38x.

SGX - Lower earnings due to securities turnover plunge

Raised FY10 ADT assumption and SGX target price, but SELL maintained. SGX reported FY09 net profit of S$305.7m, down 36% YoY, in line with our forecast S$296m. The decline was mainly due to the 23% fall in operating revenue to S$595m. Given the strong S$1.58b ADT for Jul 09, we raised our FY10 ADT assumption from S$1.36b to S$1.47b. Correspondingly, we raise our FY10 net profit forecast by 3% to S$341.1m. Applying a 22x P/E multiple (similar to the 22x average over the past 4 years), we derive a target price of S$7.00 (versus previous S$6.20). Based on the current SGX share price of S$8.59, the market is imputing a FY10 ADT of S$2.0b, which we believe is unlikely.

Securities market revenue plunged 34% to S$299m. Securities market trading value (excluding derivative warrants) fell 42% to S$309m, with average daily turnover (ADT) falling a similar percentage to S$1.23b.

Derivatives trading was more resilient. Net derivatives clearing revenue was flat versus FY08 at S$156m. Whilst futures clearing revenue was up 8% to S$147m, structured warrants clearing revenue plunged 55% to S$9m. Futures trading volume rose 8% to 58.3m contracts, whilst structured warrants trading volume collapsed 60% to 46b units.

Final dividend of 15.5S¢/share declared. SGX is committed to an annual base dividend of 14S¢ from FY09 onwards. We are forecasting FY10 dividend of 28.9S¢/share, based on a 90% payout ratio (FY09 payout ratio was 90%). We see 22x P/E as fair. SGX hit a high of 37x P/E in Oct 07, when ADT was as high as S$3.0b and economic growth was robust. But we are now only emerging from economic contraction. Liquidity could drive equity market volumes in the short term, but we believe SGX could only hit those high P/Es when fundamental growth can be sustained. We believe a fairer P/E rating is the historical average of 22x.

SGX - boosted by market rebound; expect stock to move sideways

SGX reported FY6/4Q09 net profit of S$91.1 mn (65% QoQ, 1% YoY) driven by a bounce in securities market activity. Performance of other drivers (derivatives and stable fee) was lacklustre.

After bottoming at S$0.8 bn in February, average daily equity turnover has recovered and stabilised at S$1.6 bn in June-July at 75-80% turnover velocity. Derivatives turnover is down 6% YoY as market volatility has reduced considerably.

4Q09 saw just one IPO, the worst in recent times. We do not expect new listings or new product launches to be significant drivers near term. After last quarter’s market rebound, upside to equity turnover near term seems limited as well.

We increase our FY10-FY11 estimates by 13-24%, mainly driven by higher turnover assumption (S$1.7-1.8 bn from S$1.1-1.2 bn).

We assume coverage with a NEUTRAL rating and target price of S$8.50 (from S$5.80) at 24x 12M forward P/E (five-year average 40% premium to Singapore market). With stock price and equity turnover more than doubling from March lows, drivers have peaked near term.

Singapore Exchange - Securities momentum

SGX reported FY6/09 net profits of S$305.7m, 3% ahead of consensus and 6% ahead of our estimate. The key variance with our forecast lies in stronger securities clearing fees. Given the recent improvement in market volume, we have raised our target price by 17% to S$10.28. We maintain our Outperform rating.

Securities clearing revenue doubled in 4Q FY6/09, as a result of a doubling in trading value. However, securities revenues were 38% lower YoY, due to a 42% decrease in securities trading value. We note the recent surge in securities trading value, which reached an average of S$1.58bn in July but exceeded S$2bn a day in the first two days of August. We believe that there is momentum in securities trading volumes.

Derivatives revenue for 4Q FY6/09 rose 15% QoQ, as the number of contracts rose 19%. Total derivatives contracts traded rose 8.3% YoY for FY6/09, although clearing revenue remained flat. We estimate that derivatives volume will rise by 7% YoY in FY6/10.

Stable revenue fell by 14% YoY but increased its contribution to total revenue to 24% from 21%. Stable revenues were 62% of operating expenses in FY6/09, compared with 68% a year ago. We remain comfortable with the sustainability of this revenue.

Post-results, we have raised our net profit estimate for FY6/10 by 17% on higher securities turnover assumptions. We raised our target price to S$10.28.

12-month price target: S$10.28 based on a DDM methodology. SGX’s FY6/10E PER remains below its historical mean of 25.4x. A comparison with regional exchanges indicates that Singapore Exchange remains at a discount to both Hong Kong Exchange and Bursa Malaysia. SGX is trading at a 17% discount to HKEx and at a larger 23% discount to Bursa Malaysia. We are maintaining our Outperform rating.

SGX - Diversifying the platform

As anticipated in our upgrade note on 3 April (SGX: Setting sail), SGX’s 4Q FY09F results due to be released on 5 August are expected to reflect sharply improved q-q revenue momentum, chiefly underpinned by a sharp pick-up in securities market trading activity over April-June, which should take the full-year average daily value traded (DVT) above our forecast S$1.2bn (S$1.08bn to end-3Q FY09). Derivatives revenues are also expected to show recovery after trending lower over the first three financial quarters as large market shares in the MSCI Taiwan and CNX Nifty futures contracts reflect the underlying spike in trading interest in these respective markets.

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.

Singapore Exchange: Proxy to bull market; BUY

Higher trading volume in line, velocity may improve. The pick up in trading volume appears to be sustainable based on the trend over the last month. Given revived interest in equities, we also expect velocity to improve to 80% (from 70% previously), close to the peak in late 2007 and early 2008.

Upgrade assumptions and earnings. We raised FY09F volume and value assumptions to 1.2bn and S$1.1bn (from 1.0bn and S$950m) respectively, to reflect strong 4QFYJun09 market activity. In anticipation of the market gaining momentum towards FYJun10F, we raised FYJun10F volume and value assumptions to 1.8bn and S$1.7bn (from 1.4bn and S$1.3bn), respectively. We also raised ‘stable income’ by 5-8%, in view of higher market capitalisation as values revise upwards. In all, we raised earnings by 3-14% for FYJun09-11F. Correspondingly, DPS for FYJun09-11F are raised to 27cents, 35cents and 40cents (from 26cents, 32cents and 35cents) respectively, based on a 90% dividend payout ratio, which implies a 4-5% yield. Note that SGX has a base DPS of 3.5cents per quarter, with any shortfall made up in the 4Q of the financial year.

Cheapest exchange in the region, Buy. Although SGX is currently trading at 18x forward PE, it is still the cheapest stock exchange in the region. Hence, we upgrade SGX to Buy with a higher TP of S$7.80, based on 20x forward PE. This is derived from a correlation relationship with market velocity, like our valuation methodology for HKSE.

SGX Upgrade to Buy: Target Price S$8, Passing the Earnings Trough

Based on STI going to 2,400 and 2010E ADT of S$1.68bn — 3Q09 profit of S$55.3m for Singapore Exchange (SGX) may mark its earnings trough for this cycle. On a 12m view of the STI going to 2,400, we raise 2010E average daily turnover (ADT) to S$1.68bn giving an S$8 target price (from S$4.7 on ADT of S$0.92bn), and raise 2009E-11E EPS estimates by 17-42%. Based on these new assumptions and target price we upgrade SGX to Buy from Sell.

Citi's new 12m-STI target 2,400 — Citi Singapore Strategist, Hak Bin Chua, has raised his 12m STI target to 2,400 (1.47x P/B, 0.5x s.d. below the post 1997 mean of 1.65x), viewing the 1Q09 flash GDP estimate of minus 11.5% yoy to be the quarter of worst contraction. Past market cycles suggest the STI "normalizes" toward mean P/B levels as expectations of recovery set in. An STI of 2,400 implies the Singapore market could pass S$530bncapitalization.

High beta play to STI recovery — Despite structural earnings improvements in derivatives/other revenues, SGX's key profit leverage remains equity ADT. It earns an estimated 8.8bps per S$ value of ADT, one of the highest among the global exchanges. Further leverage comes as turnover velocity increases as STI levels rise. Our study of past STI cycles shows that with one exception (post Sept-2001), every STI bull market recovered all (or more) of the prior bear market points loss.

Investment risks — Having rallied >50% in just over a month from its c.S$4 trough, we view SGX as susceptible to near-term price volatility and market corrections. A fundamental medium-term risk would be entry of a competitor exchange, which could materially impact SGX's equity pricing structure.

Singapore Exchange: Too early to call for a recovery

3Q earnings fell as expected. Singapore Exchange Ltd's (SGX) 3Q net earnings of S$55.3m (-46% YoY and -26% QoQ) came in exactly in line with our expectation of S$55.9m. Revenue fell 31% YoY and 18% QoQ to S$119.8m, also in line with our expectation of S$119.2m. There were no surprises in SGX's 3Q performance as there were already indications of weaker quarterly performance. Securities Market revenue plunged 43% YoY and 21% QoQ to S$55.3m. Derivatives Revenue fell 20% YoY and 27% QoQ to S$31.2. Even its Stable Revenue was not spared and fell 3% QoQ to S$33.3m. What was heartening was the drop in operating expenses (- 3% QoQ) and the 9% QoQ decline in total staff costs. However, this was partially offset by higher depreciation expenses. Management has declared a 3Q dividend of 3.5 cents to be paid on 14 May 2009 (note the book closure date is 4 May 2009)

Too early to call for a recovery. Average daily volume on the Securities Market was around 1 bn units in Jan-Mar 2009, but has since picked up during the first two weeks of April to 1.76 bn. Average daily traded value has also improved from S$947 bn to S$1300 bn. However, it is still too early to call for a recovery as uncertainties still loom. While some indicators have shown signs of bottoming-out, our view remains that a sustained economics recovery is necessary for confidence to return to the market. As such, we are unlikely to see a return to the peak volumes seen in mid-2007 any time soon.

Retain FY09 estimates. As the 3Q numbers came in within our expectations, we are retaining our FY09 earnings forecast of S$280.4m or 4Q earnings of S$65.9m (up 19.2% from 3Q). Management outlined that SGX will continue to grow the domestic derivatives (including extended settlement contracts) and the options markets. On the operational side, cost containment will continue to be a key focus. On the business side, corporate activities and capital market exercises remained slow. As the decline in global equity markets has stabilised for now, the outlook is better than 3 months ago and we are also raising our valuation to 20x (to be in line with peers as well as to account for better outlook compared to a quarter ago). Based on this, we are raising our fair value estimate to S$5.60 (previous: S$4.50). We retain our HOLD rating.

Singapore Exchange: A prelude to beta play

SGX’s 3QFY09 results were within expectations. Earnings were weak for the quarter due to continued soft trading volume, coupled with a drop in derivatives activities and lower stable income. SGX declared a 3.5cents base dividend, as expected. Volume had picked up strongly for both securities and derivatives in early Apr09. If sustainable, this could be a key re-rating catalyst for SGX. Upgrade to Hold with a target price of S$6.15 based on 17.5x PE, which is equivalent to early mid-cycle PE.

3QFY09 earnings weak, as expected. Net profit was dragged down by all segments, especially securities trading. Average daily trading volume and value fell 11% and 12% q-o-q, respectively. Derivatives activity volume fell 21% q-o-q with reduced trading activity in MSCI Taiwan and CNX Nifty futures. The Nikkei 225 futures product held up the fort. Stable income was lower, mainly due to lower account maintenance and corporate action fees. Meanwhile, operating expenses were stable, as higher depreciation and system maintenance costs were mitigated by lower variable staff costs. We trimmed earnings by 4-7% after revising stable revenue.

Expect a pick up in FY10. Apr09 trading volume surged to 1.7bn, while trading value rose to S$1.3bn (3Q09: 1bn; S$946m). Our expectations of a market recovery in 2010 support our volume and value assumptions for SGX of 1.4bn and S$1.3bn, respectively.

Upgrade to Hold (from Fully Valued), after rolling over our valuation window to FY10F PE. Our target price is raised to S$6.15 based on 17.5x FY10F PE. This is derived based on a correlation relationship with market velocity, similar to our valuation methodology for HKSE. SGX is currently trading at 18x forward PE, which is above the mean PE of 15x since its listing in 2000. Our target PE of 17.5x is equivalent to an early mid-cycle PE. Supporting our call is SGX’s base dividend of 3.5cents per share. Based on 90% payout, FY09F and FY10F DPS should be 26cents and 32 cents, respectively, implying 4-5% dividend yield.

SGX 3Q FY09: below expectations

Average securities daily value traded (DVT) continued to fall in 3Q FY09, by 12% q-q to S$0.91bn, while clearing fees fell a sharper-than-anticipated 21% q-q as the positive trend over 2Q in terms of a rising share of higher-margin uncapped trades (ie, those paying full 4bp fee) reversed. We estimate every 10% change in DVT (no change in share of capped trade) moves forecast earnings by 6%.

Derivatives revenues saw a second straight quarter of decline, by 27% q-q (2Q: -7%). Core Nikkei contract (comprising about 50% of total Asian equity derivatives contracts traded) experienced a deep slump over Jan-Feb (exacerbated by short trading months), while the Nifty contract saw a further 36% q-q drop in contracts traded (2Q: -46%) as investor interest in India remained low. However, significant recovery in broad futures trading activity was seen over March (+23% m-m) and continues to build into 4Q. The OTC clearing business via AsiaClear continues to show strong growth but from a small base, with net contribution at a modest S$2mn.

Notwithstanding a weaker-than-expected 3Q performance, SGX is expected to close the financial year on a strong note (securities and derivatives trading improving sharply in April) with the market to be a key beneficiary of improving financial market sentiment and declining risk aversion. In our view, SGX is a quality leverage play with attractive yield.

We derive our PT using a P/E-based method derived from the Gordon Growth model. We estimate cost of equity of 11.5%, market equity risk premium of 6% and stock beta of 1.6x. We derive a fair P/E of 19x, which when applied to FY10F (June year-end) adjusted net profit of S$415mn, gives a fair value of S$8.0bn. On the current share base of 1,072mn shares, this comes to a PT of S$7.40. Risks include another slump in market sentiment, a pickup in regional competition for listings and derivative contracts, and an SGX participant defaulting on its obligations.