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SGX Stocks and Warrants

Author: kimeng   |   Latest post: Mon, 20 Aug 2018, 09:58 AM

 

SGX - Down to Sell on Four Pressure Points. Target $6.60 : Goldman Sachs

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We downgrade SGX to Sell from Buy as we cut our 12-month target price to S$6.6 from S$8.7, implying 16% potential downside. India exchanges’ decision to cut off data access to foreign exchanges for derivatives products is likely, in our view, to cause the following four pressure points for the stock:

  1. Nifty F&O and INR futures revenue loss,
  2. lower market data revenues,
  3. collateral damage for other derivatives and
  4. multiple compression.

We lower our EPS estimates by up to 11% for FY18-20E, reflecting the first two of these (leaving other derivative revenues unchanged for now), while lower forecast growth means our DDM-derived target multiple declines to 19X CY18E P/E (prior 24X CY18E P/E).

We downgrade SGX from Buy to Sell on a negative earnings outlook post the joint announcement made on Friday, February 9, by India exchanges. India exchanges (NSE, BSE and MSE) announced plans for a termination notice of licensing agreements with foreign exchanges, index providers and third-party vendors for market data that had allowed the trading and settlement of index derivative products of India securities such as Nifty 50 futures & options.

We upgraded SGX to Buy (from Neutral) on September 26, 2017, on the thesis of an improving volume and earnings outlook. Since then, SGX’s share price has risen 6%, outperforming the STI slightly (by 1pp). However, we believe this investment thesis is now at risk, given the earnings pressure from a potential roll-off of India derivative revenues.

The four key pressure points we see for the stock are:

1. Nifty F&O and INR futures revenue loss: we estimate 10% of SGX’s derivatives business revenue comes from Nifty F&O and INR futures, its two key India offerings. The derivatives business revenue contribution to the group’s top line is 40%. Hence the loss to revenue could be around 4%. The impact on bottom line could be 2X the top-line impact as SGX runs on ~50% NPAT margin. Hence Nifty product closure and significant reduction in INR futures volumes is likely to shave off ~8% of SGX’s EPS. While SGX has said it is currently working closely with NSE to develop viable solutions for international investors into India, we reflect this impact into our estimates as a base case.

2. Lower market data revenues: SGX does not disclose the breakup of its market data revenues, which contribute 5% to its top line. We believe the loss of a key product is likely to reduce data demand and hence revenues in this business by 10-20%.

3. Collateral damage for other derivatives: SGX’s edge and key proposition to clients was the ability to invest in multiple Asian derivatives products in one venue. Cross-margining and other benefits have kept client flow sticky and fostered incremental demand. With the loss of the Indian product there could be lower volumes in other derivatives products.

4. Multiple compression: Derivatives business has been the only growth engine for SGX over the last few years with the cash market in steady decline. With a dent to the derivatives story we believe the valuation multiple for SGX could come under pressure. Our DDM-derived target P/E multiple decreases from 23.7x to 18.8x. This is close to where the stock traded seeing no growth in FY12 as well as FY14.
Post our revisions, SGX’s target price implies the most downside potential (-16%) within our coverage space. Our coverage space (HK financials) offers an average of 10% upside potential.

Direct Impact on Derivative Revenues

SGX’s India derivative products suite is a core offering in its offshore derivative franchise. Securities-related derivatives include the Nifty 50 futures and options, Nifty sector futures and most recently single-stock futures (SSFs) on Nifty 50 companies (launched on Feb 5, 2018, per SGX commentary SSFs are currently not affected by the licensing termination). That said, only the SGX Nifty 50 futures & options currently have meaningful volumes traded on SGX.

SGX Nifty 50 futures & options currently contribute ~7% to the derivative topline (CY2017). Based on commentary from the India exchanges, the licensing agreement with SGX will end in 6 months from the time notice is given, wherein SGX would have to end the trading/settlement of its India index derivatives contracts.

Additionally, SGX’s INR FX futures (accounting for c.80% of FX futures traded on SGX) will be at risk as well, given that much of the INR volume trading came as a hedging tool when trading Nifty 50 futures & options. FX futures currently account for ~4% of the derivative revenue mix (CY2017).

Thus, collectively, we see 10% of derivative revenues directly at risk from both the Nifty 50 and INR products. Given that derivatives currently account for ~40% of revenues (~25% trading, ~15% collateral management), we see a 4% risk to overall revenues. The impact on bottom line could be 2X the top-line impact as SGX runs on ~50% NPAT margin. Hence Nifty product closure and significant reduction in INR futures volumes is likely to shave off ~8% of SGX’s EPS.

Indirect Impact

We see the indirect impact as a potential loss of market data revenues and collateral damage for other derivatives.

Lower market data revenues: SGX does not disclose the breakup of its market data revenues which contribute 5% to its top-line. We believe the loss of a key product is likely to reduce data demand and hence revenues in this business by 10-20%.

Collateral damage for other derivatives: SGX’s edge and key proposition to clients was the ability to invest in multiple Asian derivatives products in one venue. Cross-margining and other benefits have kept the client flow sticky and fostered incremental demand. With the loss of the Indian product there could be lower volumes in other derivatives products although we do not reflect this in our estimates at this stage.

Cut Target Price on Lower EPS and Target P/E

We cut EPS estimates to factor in earnings pressure from Nifty F&O/INR futures and market data revenues loss leading to FY18/19/20E revisions of -1%/-8%/-11%. Specifically, we factor in the roll off of Nifty 50 F&O in 6 months, factor a negative impact on INR FX futures volumes from the loss of cross-margin benefits and pencil in a low single digit yoy market data contraction starting 1QFY19. We are on average approximately 6% below Thomson Reuters Consensus estimates on FY19/20 given our bearish view on earnings.

We had previously forecast Nifty 50 F&O growth of 17%/24%/26% and SGX FX futures growth (SGX INR futures account for c.80% of volumes) of 108%/50%/43% fo FY18/19/20E. We had also previously estimated average ~5% yoy growth in market data revenues over the next 3 years.

Our 12-month DDM-derived price target moves to S$6.6 (prior S$8.7) on a 19X CY18E P/E (prior 24X CY18E P/E) and implies 16% downside. Our target multiple moves lower given the slower growth outlook. That said, we note that our target multiple falls in line with historical periods of P/E contraction on earnings outlook concerns (see next section for more details).
 

Source: Goldman Sachs Research - 11 Feb 2018

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Date Type Subject
16-Aug-2018 Announcement Disclosure of Interest/ Changes in Interest

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