Downgrade SGX to Neutral as we believe slowing growth and high inflation in Singapore (our Economists recently lowered GDP growth estimates), coupled with US recession/credit market turmoil, will likely dampen market sentiment, turnover and SGX’s supportable valuations.
We have cut our FY08E/FY09E EPS by 7%/25% (16%/11% below consensus), and estimate daily stock turnover of S$2.1 bn in calendar 2008. We have reduced our 12-m TP to S$8.2 (21X calendar 2008E EPS) from S$15.3 (30X calendar 2008E EPS). SGX has risen 245% since we added it to our Buy List in October 2005, versus MSCI Singapore +69%.
Current view
We had been tempted to argue “it’s all in the price post recent selldown and share price will stabilize then rebound”, as we fundamentally like SGX’s strength in derivatives (19% of revenue; resilience amid market volatility) and product initiatives (OTC, commodities, futures, linkages).
However, we are mindful that exchanges are high-beta binary stocks whose share prices are either up or down and seldom stay flattish for a prolonged period. Given the open nature of Singapore economy and a US slowdown, we believe the risks for SGX’s earnings (no growth for core earnings in FY09E) and share price are still skewed to the downside in the near term. Our new/reset TP of S$8.2 implies 9% downside potential. We have also set a “suggested entry level” for SGX stock at S$5.7, based on 18X our worse-case EPS estimate (daily stock turnover of S$1.6 bn, assuming velocity reverts to historical average).
Things that could still get worse:
Worse-than-expected US recession;
hyperinflation and sharp slowdown in Singapore; sharp fall in turnover;
collateral impact of falling turnover on stable revenue.
What would make us more positive in due course:
Stabilization of inflation in Singapore; faster-than-expected US macro/credit market recovery; faster-than-expected revenue accretion of new products.
More macro headwinds; earnings/price target reset
High inflation and slowing growth in Singapore. Our Economics Team has recently lowered 2008 GDP growth forecast to 5.5% from 6.4% on the back of increased external risks. They also believe the inflation situation will worsen before some relief in 2H2008, and see CPI peaking at around 7% early this year and average 5.5% in 2008. Meanwhile, we also start to see signs of property market weakening, with transaction volumes falling sharply since July/August 2007. We believe slower growth and higher inflation do not provide for a positive backdrop for equities, and this in turn will likely dampen turnover.
US recession and credit market turmoil. We believe the subprime issue will likely be a long-tailed, slow-motioned problem. We also expect the US to slip into a recession this year. Given the open nature of the Singapore economy, a weak external environment will likely slow down the economic growth of Singapore despite still-robust domestic demand.
This in turn will likely reduce investor propensity to trade stocks, hence dampening SGX’s earnings and supportable valuations.
As a result of macro headwinds, we have reduced our FY08E/FY09E EPS estimates by 7%/25%, mainly reflecting lower turnover assumptions. We now expect daily stock turnover of S$2.1 bn in calendar 2008 (assuming no growth in market cap and a velocity of 60%), versus S$2.13 bn ytd and S$2.41 bn in calendar 2007.
Our net profit estimates are 16%/11% below consensus estimates in FY08E/FY09E. We expect core net profit growth (ex-exceptional gains) to fall from 48% in FY2008E to -4% in FY2009E.
We have also reduced 12-month price target to S$8.2 (21X 2008 EPS) from S$15.3 (30X calendar 2008E EPS).
Still binary situation; some more downside likely; to Neutral
We had been tempted to argue “it’s all in the price post recent selldown and share price will stabilize then rebound”, as we fundamentally like SGX’s strength in derivatives (19% of revenue; resilience amid market volatility) and product initiatives (OTC, commodities, futures, linkages).
However, we are mindful that exchanges are high-beta binary stocks whose share prices are either up or down and seldom stay flattish for a prolonged period.
And given the open nature of Singapore’s economy and a US slowdown, we believe the risks for turnover, SGX’s earnings and share prices are still skewed to the downside in the near term. As a result, we downgrade SGX to Neutral.
Our new/reset TP of S$8.2 implies 9% downside potential.
We have also set a “suggested entry level” for SGX stock at S$5.7, based on 18X our worse-case EPS estimate. This assumes turnover velocity would revert to historical mean (historical average velocity is 45%, but we assume 50% in our computation to account for the increased foreign listings in recent years which are more actively traded than domestic stocks) and market cap would fall 20%, which translates into daily stock turnover of S$1.6 bn.
Downside and upside risks
Things that could still get worse
• Prolonged and worse-than-expected US recession
• Hyperinflation and sharp slowdown in Singapore
• Sharp fall in stock and derivatives turnover in Singapore
• Collateral impact of falling turnover on stable revenue. Although stable revenue (e.g. listing fees, information revenue, depository/corporate action fees) is more resilient than transaction-based revenue, we believe it is ultimately still a function of market activities. If there were a prolonged slump in stock market and turnover, it would inevitably exert pressure on stable revenue (e.g. demand for market data/information would fall, there would be fewer corporate actions).
What would get us more positive in due course
• Stabilization of inflation in Singapore
• Faster-than-expected US macro recovery and credit market stabilization
• Faster-than-expected revenue accretion of new products (e.g. OTC/commodities, single stock derivatives, index futures) and linkages/cooperation with other exchanges (e.g. derivatives link with Tokyo Stock Exchange, trading link with Bursa Malaysia, business collaboration with Bombay Stock Exchange).
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