Macquarie Equities Research (MER) downgraded SGX to Underperform last Thursday (18 April), with a 12 month target price of $6.60. The stock has posted strong performance in recent months and FY/3Q13 results were strong. But headwinds from slowing market activity necessitate a downgrade, in MER’s view.

Investors who hold a negative view on SGX share price performance could buy a put warrant over the stock. Put warrants tend to increase in value when the price of the underlying share decreases.

Please find extracts from the MER report below:

Impact
Still a market proxy. Of the 3 Asian exchanges that MER covers (HK, Singapore and Malaysia), SGX has been the most successful in broadening its scope of operations, and the FY3Q results bear this out. But securities markets – all securities-related revenues, not just trading – still account for 68% of earnings. This may trend down over time as SGX continues to roll out its diversified business strategy in derivatives and over the counter (OTC) clearing. But for now, MER thinks that the stock’s 72% historical correlation with daily turnover will remain the more relevant driver of share price performance.

ADT in slowdown mode. The 30-day average daily turnover (ADT) for SGX as of 15 Apr was S$1.5bn, down 19% since the S$1.8bn peak during the CY1Q surge Feb. MER thinks the slowdown will continue over the next several months and MER expects muted trading volumes against this backdrop.

But FY3Q results were good. As noted above, FY3Q results were very strong, with net income of S$98m up 26% YoY / 28% QoQ and 4% ahead of consensus, driven by strength in securities turnover and record high derivative trading.

Price catalyst
MER’s 12-month price target: S$6.60 based on a fair value average methodology.

Catalyst: Falling ADT which MER thinks will persist given 1) global events, eg, Europe, Korea, et al; and 2) lack of evidence of a Great Rotation, and normal sell-in-May-go-away seasonality. More specific to Singapore, 1) limited index upside and 2) MER views that the earnings downgrade cycle is still ongoing.

MER’s Action and recommendation
Downgrade to Underperform. FY3Q results were strong, and the long-term outlook for the growth areas – in particular, derivatives and OTC clearing – remains positive in MER’s view. But MER believes the stock is set for a short term sell-off cyclically as the market cools after a strong CY-1Q13. The stock is up 20% in the past six months, and it is trading at 24x FY14E price-earnings ratio, which MER sees as pricey in a market downcycle.

Risks to MER’s view include 1) the obvious – an unexpected resurgence of market activity in Singapore – and 2) a breakdown of the stock price’s historical relationship with ADT that occurs more rapidly than what MER expects.

Source: Macquarie Research - 23 Apr 2013