SGX had its ups and downs this year. It rebounded strongly from its March lows of $8.06 to hit a 5 year high of $10.39 in one month. One month later after hitting all time high, it announced that it is reducing its licence agreement with MSCI from February 2021. Both MSCI and SGX will retain their partnership on MSCI Singapore Index products and will both work to extend it well beyond 2021, while other products will expire in February 2021. This resulted in its share price to crash 18% in 2 days.
Share price of SGX has been hovering around $8 level for 2 months ever since the crash and just recently it announced that its revenue exceeds $1B at $1.05B, increased 16% YOY, the highest since listing. Net Profit and EPS are at $472M and 44.1cents, 21% higher YOY for both. Company proposed dividend for the latest quarter at 8 cents, up 0.5 cent. The annualised quarterly dividend going forward will be 32 cents, an increase of 7%.
Noting the fact that with the reduction in license agreement, there will be a negative impact of 10-15% to its FY21E net profit, before mitigating actions are considered. We will now analyse whether SGX is a buy after reporting excellent results for the FY.
SGX prides itself as Asia’s Most International Exchange. Headquartered in AAA-rated Singapore, with offices in nine cities around the world, SGX is a global multi-asset exchange operating equity, fixed income, currency and commodity markets to the highest regulatory standards.
SGX reclassified late last year where it is now classified into three broad categories – Equities, Fixed Income, Currencies & Commodities (FICC) and Data, Connectivity & Indices (DCI). SGX guided that its FICC and DCI segment will continue to grow at a faster pace as management will strive to double its size in the next 5 years.
FICC contributes 16% of total revenue in FY20, an increase of 23% YOY. FICC revenue consists of two portions – Fixed Income and Derivatives for Currencies and Commodities. Under the Fixed Income, it can be further classified into Listing and Corporate Actions and others. Revenue from Fixed Income grew slightly at 1.5% YOY. As for Derivatives for Currencies and Commodities, it is further classified into Trading and Clearing and Treasury. Its Derivatives segment of Currencies and Commodities grew 25.5% YOY compared to a year ago.
Equities is the largest earnings contribution for SGX, contributing 72% of total revenue in FY20, an increase of 14% YOY. Equities revenue consists of both Cash and Derivatives. Under its Cash segment, it can be further classified into Listing, Corporate Actions and Other, Trading and Clearing, Securities Settlement and Depository Management and Treasury and other. Revenue from Cash Equity rose 19.2% YOY as SGX saw an increase in revenue of 30% YOY in Trading and Clearing which also resulted in an increase of 17.6% YOY in Securities Settlement and Depository Management. Under its Derivatives segment, it can be further classified into Trading and Clearing and Treasury, Licence and others. SGX saw an increase of 17.8% YOY in Treasury, licence and others while Trading and Clearing grew slightly at just 2.3%.
Lastly, DCI contributes 12% of total revenue, an increase of 19% YOY. The segment can be further classified into Market Data and Indices which grew an astounding 38.1% YOY and Connectivity which only grew by a mere 4.5% YOY.
From the above image, you could tell that SGX revenue and profit have been on the upward trajectory since FY2017. In the latest FY, its revenue grew 16% to a record high of $1.05B and net profit grew 21% to $472M, the highest since its listing in 2000.
A look at the Detailed Notes on Revenue for the latest FY, Currencies and Commodities – Derivatives contributed the most gain of 25.5% YOY, followed by Equities – Cash which grew 19.2% probably due to the higher volatility in the market and lastly DCI which grew 19% YOY, boosted by Market data and Indices which grew 38% YOY.
I have decided to use 10 years of financial performance to stay relevant. In general, both SGX’s Revenue and Net Profit have been growing for the past 10 years. SGX grew its revenue by $413 million in 10 years from $640 million in 2010 to $1.053 billion in 2020. Net Profit had also done well over the past 10 years. Profit grew $152 million from $320 million in 2010 to $472 million in 2020.
Similar to Net Profit, EPS grew from 33.9 cents in FY2018 to 44.1 cents in FY2020, an increase of 30% in 3 years. As SGX’s EPS started to grow from FY2018, it also bumped up its dividends from 28 cents in FY2017 to 30 cents in FY2018. Due to better results reported, it increased its DPS to 8 cents per quarter. The annualised quarterly dividend going forward will be 32 cents, an increase of 7%.
SGX has been giving out sustainable dividends for the past 10 years. There’s not a year where DPS is higher than EPS. Do note that SGX had an extremely high payout ratio of close to 100% from 2010 to 2012. However, management has been very cautious in growing its DPS at the rate its EPS is growing as shown on the later part of the chart. Nonetheless, it is heartened to note that the higher quarterly dividend is in line with their policy to pay a sustainable and growing dividend over time, consistent with their long-term growth prospects.
Revenue by Business Segments
At one glance, revenue contribution from Equities and Fixed Income had been fairly stable from 2014 to 2019 but encountered a sharp drop in revenue in 2019. In 2014, this segment contributed 58% of total revenue but it is now down to just 38%.
Market Data and Connectivity business has been growing steadily, from $76.6 million in 2014 to $102.5 million in 2019. Although this segment has been growing, its contribution percentage has been hovering around 11% level for the past 5 years. This is because Derivatives business growth was astounding where its revenue doubled from $208.7 million in 2014 to $459.7 million in 2019, contributing 50% of revenue in 2019, an increase from the 30% in 2014.
Equities and Fixed Income
As discussed earlier, revenue contribution from Equities and Fixed Income had been fairly stable from 2014 to 2019 but suffered a huge drop in revenue in 2019. With the above chart, we will be able to tell which sub-segment accounted for the huge drop.
SGX recognised revenue under the Issuer Services segment when companies raised equity and debt capital in search of global funds to grow their businesses. SGX also earned revenue from listed companies through corporate action services and corporate solutions. Revenue from Issuer Services has been fairly stable for the past 6 years. Performance from Issuer Services is mainly dependent on how many bond and equity listings in a year.
SGX recognised revenue from Securities Trading and Clearing when investors trade listed securities including equity securities, investment/business trusts, debt securities, ETFs and structured warrants. Revenue from this segment has been fairly stable from 2014 to 2019 but suffered a huge drop in 2019 from $221.1 million in 2018 to $182.1 million in 2019. Performance from Securities Trading and Clearing is mainly dependent on Securities Daily Average Traded Value, the market volatility and the number of trading days in a year.
Post Trade Services revenue is derived from settlement, custody and asset servicing relating to both listed and unlisted securities in Singapore. Revenue from this segment increased from 2014 to 2016 where it grew $23.2 million or 24% from 2014 to 2016. Revenue has been declining since 2017 from $115.7 million in 2017 to just $85.7 million in 2019. Performance from this segment is mainly dependent on volumes of securities settlement instructions, securities market activities for the year and number of new accounts opened by Depository Agents.
As discussed earlier, Issuer Services can be further classified into two sub categories – Listing Revenue and Corporate Actions. Listing revenue has been stable for the past 6 years. The increase in Listing Revenue by 9% in 2015 was mainly due to the revision in listing fees. Furthermore, the increase in revenue from Corporate actions and others in 2015 by 17% was due to fee revision.
Revenue from Listing is unpredictable as it depends on how many listings were there in a year and how much was raised for that particular year. Based on the commentary that is available on their Annual Report, SGX attracts more bond listings tha equity listings. In a good year, there can be more than 1000 bond listings raising $481.9 billion while SGX could not attract a lot of equity listings due to competition from neighbouring stock exchanges such as Hong Kong Stock Exchange.
Securities Trading and Clearing can be further classified into three sub categories – Clearing Revenue, Access Revenue and Collateral Management, Membership Issuer Services.
Clearing Revenue has been sliding since 2014. From the high of $178.4 million in 2014, it has decreased significantly to $138.9 million in 2015. Performance from Clearing Revenue depends largely on Securities daily average traded value (SDAV), total traded value, market volatility, number of trading days in a year, turnover velocity.
SDAV had been hovering around $1.1B since 2014 with its peak reached in 2018 at $1.26B. Its SDAV suffered significantly in 2019 to $1.04B. This is akin to Total Traded Value where it had been hovering around $276B since 2015. Its TTV was hit significantly in 2019 to $259.5B compared to a year ago when it peaked at $314B in 2018.
Turnover Velocity is defined as the annualised ratio of the traded value of shares to the market value of stocks. This metric suggests how much of the market is actually in play, or how easy it is to buy or sell a security. Turnover Velocity for SGX has been hovering around 36% to 40%. It is reported in 2015 that SGX lags regional peers in turnover velocity, an indicator of breadth and liquidity in the market.
Average clearing fee has been on a downward trend since 2014. It is reported that average clearing fee was 3.0 basis points, a decrease of 3% from 3.1 basis points in 2014. SGX blamed it on a downward revision of clearing fees. SGX usually blames lower average clearing fees on increased participation of market makers and liquidity providers and increase in trading of other products such as warrants and ETFs. The average clearing fee for other products such as structured warrants, daily leveraged certificates and ETFs slumped from a high of 0.72 basis points in 2017 to just 0.59 basis points since 2018.
In summary, the significant slump in clearing revenue in 2019 can be mainly attributed to a significant drop in SDAV, TTV, lower average clearing fees, fewer trading days and lower turnover velocity.
Post Trade Services can be further classified into three sub categories – Depository Management, Contract Processing Revenue and Securities Settlement Revenue.
Contract processing revenue has ceased since 2019 as contract processing is now performed by brokers since 2017 as they have already migrated to their own back office systems since February 2018.
Revenue from Securities Settlement increased for the first 4 years in 2014 but subsequently on a downward trend since then. Its revenue in 2014 was at $71.4 million where it grew steadily for the next 4 years and peaked at $95.7 million. SGX attributed the increase in Securities Settlement to revised fees, higher volumes of securities settlement instructions and changes in the mix of securities settlement instructions. Securities Settlement started to decline steadily from its peak at $95.7 million in 2017 to $87.6 million and $76.6 million in 2018 and 2019. SGX blamed it on a change in mix of subsequent settlement instructions, downward re-pricing of their delivery-versus-payment guarantee fee and decline in subsequent settlement activities.
Derivatives can be further classified into two sub categories – Collateral Management, Licence, Membership and Equity and Commodities.
SGX recognises revenue from derivatives when dealing with trading and clearing of derivatives on Asian equity index, global commodities and foreign currencies. Clearing of OTC commodities and financial derivatives.
Unexpectedly, revenue from Collateral Management, Licence and Membership is the bright spot for Derivatives business. Its revenue has more than doubled in 6 years from $59.7 million in 2014 to $167.7 million in 2019. Performance from this segment is largely dependent on and is directly related to the margin balances, derivatives trading volumes by clients. In recent years, there’s been an increase in interest and usage of SGX’s derivatives contracts for portfolio risk management thus having higher margin balances.
Derivatives revenue from Equity and Commodities have also increased since 2014. Its revenue almost doubled in 6 years from $149 million in 2014 to $292.1 million in 2019. Performance from this segment largely depends on trading volumes for its derivatives products in which it faced competition from Hong Kong Stock Exchange after it had a new index licensing agreement with MSCI in May this year to introduce 37 futures and options contracts, benchmarked against MSCI indices.
Market Data and Connectivity
SGX recognises revenue from Market Data and Connectivity through sales and distribution of market price data and other information to market users. Furthermore, it also recognises revenue through access and connectivity to their trading and clearing platforms in securities and derivatives markets.
Both revenues from Market Data and Connectivity sub categories grew steadily since 2014 though the Connectivity segment growth outpaced the growth of Market Data. Revenue from Market Data grew from $41.5 million in 2014 to $59.5 million in 2019, an increase of 43% over 6 years while Revenue from Connectivity grew from $35 million in 2014 to $43 million in 2019, an increase of 23% over the same reporting period.
Performance from this segment largely depends on higher take-up of low latency market data feed and increased usage of data in trading, risk management and back office applications. In addition, growth in Market Data can be attributed to an increased revenue from derivatives market data feed and index services, continued growth in data licenses for application systems usage and higher reported usage of non-display data. As for its connectivity segment which growth outpaced the ones of Market Data, it is largely due to the continued growth of co-location services business and higher derivatives connectivity subscriptions.
Balance Sheet and Cash Flow
As SGX is a cash generative business, it has been able to increase its cash and cash equivalents from $789 million in 2015 to a high of $907 million in 2020.
It is important to note that SGX has no borrowings till 2020 when it borrowed $289 million in the 3Q of 2020 and $295 million in 4Q of 2020 and repaid $295 million in the same financial quarter. In summary, at the end of FY2020, it has $304 million worth of borrowings to be payable in less than one year. Furthermore, Cash and cash equivalents are at all time high at the end of FY2020 at $907 million, a significant increase compared to a year ago when cash and cash equivalents was just $666 million.
Looking at the past 6 year of Cash Flow statements, SGX is a cash generative business that produces strong operating cash flow ranging from $400 million to more than $600 million in the latest FY.
With the Cash Flow statements, we are able to calculate Free Cash Flow to check against whether the dividend payout is sustainable as SGX has a high dividend payout ratio against EPS. Based on the chart above, we can deduce that the majority of the dividend payout from 2015 to 2020 is sustainable except in 2019 when its dividend payout exceeded the FCF. Barring unforeseen circumstances in its business, management is confident that the dividend payout will be sustainable as the latest payout ratio is just 56.74% of its FCF.
As part of SGX’s plan to double its FICC and DCI business in the next 5 years, management has recently acquired two companies in achieving it. The first being BidFX which is aimed to grow its FICC business while the second being Scientific Beta which aims to scale up and accelerate the growth of its DCI business.
The FX market is the largest financial market in the world, with average daily turnover in the OTC market amounting to US$6.6 trillion. The market grew at an average of 10% CAGR from 2001 to 2019. Singapore is the largest FX centre Asia Pacific, third largest globally where it handles US$640 billion traded OTC daily or about 10% market share globally. SGX has a diverse asian currency suite of 22 currency futures and options contracts with more than 80% market share in USD/CNH and more than 60% market share in INR/USD.
As part of SGX’s multi-asset strategy to build a multi-asset exchange especially for its FICC business, SGX has announced to acquire the remaining 80% stake in BidFx – a move that presents SGX a significant opportunity to grow its dominance in Asian FX futures and expand its reach beyond FX futures into the global FX OTC market.
BidFX, established in 2017, is a leading cloud-based FX trading platform for institutional investors, and has seen record trading volumes in recent quarters. Average daily volumes grew at a 57% CAGR to US$31 billion in MAY 2020. BidFX continues to acquire new clients and counts institutional investors such as 100 of the world’s largest banks, hedge funds and asset managers as their clients.
In hopes of scaling up and accelerating the growth of DCI business, SGX has proceeded with the acquisition of a 93% stake in Scientific Beta for $280 million. Scientific Beta is an independent index provider specialising in smart beta strategies, with expertise in factor-based and risk-managed solutions. It provides investable smart beta indices to its clients, drawing on the expertise of ERI Asia in portfolio construction and risk allocation. Factor investing has seen significant growth in recent years, with assets using factor-based strategies forecast to reach US$2.7 trillion by 2020, at a compound annual growth rate of 17% between 2011 and 2020.
Since establishment, Scientific Beta manages US$54.7 billion in assets replicating its indices, growing more than 10 times in just under four years. It counts over 60 asset owners and asset managers as its clients to track or benchmark their smart beta investments.
With this acquisition, it marks an important step in the evolution of SGX’s index business. The acquisition is complementary to its existing SGX Index Edge thematic and custom index capabilities and management is also seeing new product opportunities based on Scientific Beta’s indices.
In summary, the acquisitions mentioned above are in a bid to reduce reliance on revenue from Equities which contributes 72% in the latest FY.
Competition from Neighboring Stock Exchange
Company’s decision to list elsewhere instead of SGX
It does not come as a surprise that even though it is a monopoly business in Singapore, it faces competition in Listing from neighboring stock exchanges such as Hong Kong Stock Exchange.
There are a few areas where investors have to take note of and one of them is Listing Revenue. I don’t think it is a big issue for SGX not getting blockbuster IPOs as listing revenue only contributed 5% of total revenue in 2019. for competition.
There are some reasons for SGX not getting blockbuster IPOs and it even lagged behind neighbouring ASEAN stock exchanges such as the one in Vietnam and Thailand.
Firstly, Hong Kong Stock Exchange has been getting many companies to list on their stock exchange mainly because China is supplying most of its business. According to an article , Singapore does not have a Singaporean version of Li Ka Shing where he can attract punters to drive the share price upwards. For example, Razer’s IPO in Hong Kong, boosted by backing from Li Ka Shing, resulted in its public portion of offerings to be oversubscribed by 290 times and Razer’s shares jumped 18% on debut.
Lastly, companies intending to IPO have a perception that they will get better valuations from listing outside of SGX as businesses can raise more funds in markets where stocks are valued at a higher multiple. Instead of choosing SGX as the exchange to list, going public in Hong Kong will allow companies to gain easier access to Chinese Capital thus providing better valuations. Case in point, Man Wah Holdings was listed on SGX before privatising and re-listed in Hong Kong within six months at about eight times its market value. This perception resulted in IPO proceeds from listing on SGX to decline from $380 million in 2010 to $85 million 10 years later.
The State of Trading on SGX
Not only that many companies are not listing on SGX, there are also existing SGX listed companies delisting from the exchange. Number of companies delisting from the exchange outnumbered companies which want to list in Singapore. According to data given, the number of listed companies decreased from 783 in 2010 to just 723 in 2019.
Many companies who delisted from SGX cited reasons for doing so such as low valuations for many listed companies and availability of private funding. One of the notable companies who delisted from SGX include OSIM and CityNeon Holdings. OSIM gave reasons such as its company was not fairly valued by investors in Singapore due to lack of financial depth and liquidity. Furthermore, Cityneon’s CEO decided to take his company private because he was dissatisfied with its valuation. As a growing company which doesn’t pay dividends, investors are misunderstood for its valuation potential as they are accustomed to companies paying steady dividends.
Unfortunately, SGX had a bad track record in the past due to scandal from penny-stock crash by Blumont Group, Asiasons Capital and LionGold. Many punters were burnt badly and resulted in losing confidence in punting penny stocks on SGX. This scandal cost SGX a significant decrease in securities clearing revenue from $239.3 million in 2010 to just $138.9 million in 2019.
I acknowledge that SGX is indeed a dead stock exchange compared to Hong Kong Exchange and stock exchanges from the United States. Although the significant decrease in clearing revenue is something to be concerned about, it only contributes 15% of total revenue in 2019. What investors should be concerned about will be the threats from its derivatives business by Hong Kong Stock Exchange.
Competition and Headwinds in Derivatives Business
SGX has faced much competition and headwinds in Derivatives as it tries to reduce its reliance on securities since 2010. Now that derivatives contribute 50% of total revenue, it will be difficult for SGX to manage if such headwinds from its rival from HKex will impact its topline and bottomline.
The bright spot for SGX’s derivative has always been FTSE China A50 Index Futures. Volume has increased 5 times from 16,838,000 in FY2013 to 88,338,000 in FY2020. Everything was going fine for SGX until its rival Hong Kong Stock Exchange partnered with MSCI in 2019 to launch a futures contract for MSCI China Share Index. It will be competing with SGX’s FTSE A50 Index Futures contract which allows offshore investors to track 50 Chinese A-shares directly. It pales in comparison with HKEx futures contract which tracks the entire 421 large and mid cap A shares. Since then volumes have decreased by 16.5% since the partnership from 105,820,000 in 2019 to 88,338,000 in FY2020.
We are not sure how much impact the partnership will make in the coming years. It is worthy to note that China A50 futures constitute 36.41% of total derivatives volume in FY2020. I believe that the impact to the derivatives revenue will be huge if many flock to HKex for hedging tools.
To reduce reliance on China A50 futures, it is heartening to see that SGX is growing its derivatives in Currency Futures and Iron Ore Derivatives as shown on the chart below. SGX has built its platform for iron ore-related derivatives where it allows clients to trade the entire steel value chain and benefit from margin offsets, resulting in client stickiness. In the latest FY result, both Currency Futures and Iron Ore Derivatives contributed 19.54% of total derivatives volume in FY2020.
Facing another headwind from HKex will be HKex partnership with MSCI to introduce a total of 37 futures and options contracts, benchmarked against MSCI indices. This comes after SGX announced that it is reducing its licence agreement with MSCI from February 2021 while keeping the MSCI Singapore Index products beyond 2021. This sent the share price to crash 18% in 2 days. The affected products are MSCI Taiwan, MSCI Indonesia and MSCI Net Total Return derivatives. All of which contributed 11.73% to total derivatives volume in FY2020. Management has guided that there will be a negative impact of 10-15% to its FY21e net profit, before mitigating actions are considered. After knowing that only 11.73% of the volumes will be affected, I feel that the crash was overdone.
Management was very swift in introducing mitigating actions. SGX launched its FTSE Taiwan Index Futures on 20 July for global investors to gain exposure to a broad representation of large and mid-capitalisation Taiwan stocks, while meeting fund managers’ diversification objectives. It is widely known to be the replacement product for MSCI Taiwan Futures.
In just one week after launching the replacement product, SGX announced that Total turnover of new SGX FTSE Taiwan Index Futures exceeds US$1.5 billion in the first week of trading, while open interest surpasses US$191 million as participation expands to 50 entities across 17 clearing members. In addition, Market impact cost of executing a US$1 million order comes in 96% lower than similar order execution on HKEX MSCI Taiwan Index Futures.
This is the longest article that I have written since the launch of this page. Many invest in SGX because of its monopoly business, but there is more to just being a monopoly. It continues to face a downward trend in their revenue from Cash Equities segment as the market is not as bustling as other stock exchanges like HKex.
It is important to note that SGX is not a stock exchange anymore as it has successfully transformed itself to a derivatives exchange, which contributes 51% of revenues in 2019. The uprising of HKex into growing its derivatives business through the partnership with MSCI to introduce 37 futures and options contracts, warns SGX that it has to look to its laurels to continue to grow its derivatives business.
I believe that the introduction of a replacement product for MSCI Taiwan Index Futures which contributed close to 10% of total derivatives volume is a great move as it gives investors enough time to transition themselves to FTSE Taiwan Index. I am also heartened to hear that the replacement product has been well received compared to its rival in HKex. I believe that with the replacement product announced, the earnings impact would be smaller than expected.
SGX understands that it has been futile reviving its equity market, therefore it has been putting more effort into growing its other businesses such as FICC and DCI. The $280 million Scientific Beta acquisition will definitely grow its business where it aims to double its size in five years. As for its FICC business, SGX has acquired the remaining 80% stake in BidFx, a move that presents SGX a significant opportunity to grow its dominance in Asian FX futures and expand its reach beyond FX futures into the global FX OTC market.
Judging its valuation based on an average P/E ratio of 22.668 with the latest EPS at 44.1 cents, we should be seeing a lot of upside. Furthermore, SGX CEO acknowledged that stock exchanges have benefitted from extreme market volatility that boosted volumes of equities and derivatives, but this has since been stabilized. He has warned that market volatility and activity could ease in the second half of FY2020 but due to the prolonged low interest rate environment, investors might turn to capital markets for better returns.
In my opinion, my projected EPS for next year will be about 10% lower than 44.1 cents due to the decline in market volatility and outstanding headwinds from HKex’s derivatives business. Investors might chase for SGX as it is reporting better results, but I believe that the headwinds and problems that SGX is facing currently should give investors reasons not to do so. I believe in SGX growth strategy but will not be chasing for it immediately.
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