Stock Analysis: Singapore Exchange (SGX: S68)

When it comes to deciding which companies to invest in, I tend to err on the side of caution. This means that I typically favour companies with a good financial track record, has a business advantage and a sort of recurring income. Sustainable and high dividends would also be nice to have.

In terms of Singapore stocks, Singapore Exchange (SGX) kind of fits that mould.

Being the sole operator and regulator of the Singapore stock exchange, SGX earns a fee for any trading activity in the Singapore market. This includes the listing of companies and regular day-to-day trading of financial instruments. Thus, as long as trading activity remains robust for the Singapore market, SGX will earn a regular and recurring income.

With that said, I thus decided to do an analysis of SGX using data from its annual reports of the past 5 years, including its recent 1H FY2021 business update.

As with every analysis post, I would highlight both the positive aspects of SGX and its potential areas of concerns. I would end the post by giving my own rating of how good an investment SGX would be.

Without further ado, let’s dive right in.

Disclaimer: This post should not be used as a recommendation to buy or sell SGX shares. Rather its intended purpose is to be a source of insight and education. Any decision to buy or sell SGX shares should be made on the personal accord of the reader after doing their own research. As such, I take no responsibility for any future gains or loss amounting from the trading of SGX shares. Lastly, I am also not currently vested in SGX.

Business overview

As a stock exchange company, SGX’s revenue is mainly derived from the listing, trading and clearing of three main asset classes. Previously, these asset classes were categorized into Fixed income and equities, Derivatives and Data, connectivity and indices (DCI).

However, as of FY2020, SGX has instead re-classified its asset classes into Fixed income, currencies and commodities, Equities and Data, connectivity and indices.

For the sake of simplicity and comparison, I would instead continue using SGX’s old classification of its asset classes.

For the past 5 years, much of SGX’s growth has been down to its derivatives business.

As seen, SGX’s revenue contribution from derivatives has climbed from 39.8% in FY2016 to 49.3% in FY2020. This increase has also led to decreased revenue contribution from SGX’s equities segment over the years.

In terms of performance over the years, SGX’s derivatives segment unsurprisingly performed the best out of the lot.

As seen, while SGX recorded positive growth across all its asset classes, the derivatives segment experienced the largest growth. On the other hand, there has been tepid growth in SGX’s fixed income and equities segment. Looking at the data from 1H FY2021, this trend looks set to continue as SGX continues growing its commodities and currency futures business.

With its acquisition of Scientific Beta in early 2020, the positive growth trajectory of SGX’s DCI segment also looks set to continue.

Besides looking at the revenue generated from SGX’s various asset class segments, I also choose to look at its operational sub-segments. Doing so allows me to see which exchange operation yielded the most revenue for SGX.

Note that I will only be using data from FY2019 and FY2020 due to the re-classification done by SGX.

As seen, slightly more than half of SGX’s revenue comes from the trading and clearing sub-segment. This means that much of SGX’s revenue is a direct result of day-to-day trading activities.

Having taken a brief look at SGX’s overall segment performance, I will now move on to what caught my eye as I analysed SGX’s financial results over the past five years.

What I like about SGX

As I looked through SGX’s financial results, there is actually much to like about it. This is mostly a direct result of SGX being the sole exchange operator in Singapore and growth initiatives over the years.

Good top and bottom line results

SGX’s growth in its derivatives and DCI segments has directly contributed to positive results over the years.

As seen, SGX recorded positive growth in its top and bottom line. Even more impressively, the growth rate of SGX’s net profit surpassed that of its revenue. This was mainly achieved on the back of a rather constant level of operating expenses over the years.

The huge jump in numbers between FY2019 and FY2020 can be attributed to increased trading activity due to market volatility in 2020. Whether these numbers can be improved upon remains to be seen.

Nevertheless, while there might be a decline in overall numbers for FY2021, I do not expect too big a drop. This is due to SGX’s sustained trading activities over the years, which I would explain more about in later parts of the post.

Positive returns to shareholders

In addition to achieving positive growth in its top and bottom line, SGX has also delivered good returns to its shareholders.

SGX returns to investors

From the above, we can see that SGX has managed to increase its book value and dividends over the years.

SGX’s return on equity (ROE), a measure of how much profit is entitled to every shareholder dollar, is also quite high at 30%+. Generally speaking, we would want to invest in companies with high ROE percentages.

However, it should also be noted that high ROE can sometimes be a result of high levels of debt. After all, equity is a result of subtracting total liabilities from total assets. Thus, high levels of liabilities can result in lower equity, which then leads to a high ROE value when taken into consideration with an enlarged net profit number.

In the case of SGX, this is generally not the case as it had no debt liabilities from FY2016 to FY2019. For FY2020, SGX took on debt in its acquisition of stakes in Scientific Beta and BidFx.

Financially stable

Though SGX took on debt in FY2020, it is still an overall financially healthy organization.

As seen, SGX is able to cover its short-term liquidity concerns with a current ratio of more than 1. While this ratio has been declining over the years, it has yet to reach levels which concern me. Furthermore, this decline is also mainly due to the usage of cash by SGX to grow its business.

In terms of long-term solvency, SGX is also on pretty good foundations with acceptable debt ratios. While debt ratios have gone up, I expect them to decrease once SGX repays its maturing borrowings within the next 1 year.

Besides looking at liquidity and solvency ratios, I also like to look at operating free cash flow (FCF). An increasing operating FCF is favoured as this means the organization is able to generate more net cash from its business.

In the case of SGX, its operating FCF has been increasing over the years.

Much of SGX’s double-digit CAGR in its operating FCF is due to an exceptional year in FY2020. Excluding FY2020 results, CAGR would have been at 6.5% instead, which is still a rather decent growth rate.

Sustainable dividends

Besides assessing SGX’s financial health, it is also crucial to look at its dividend payout percentage. We do not want a case where dividends are unsustainable which might then lead to future potential dividend cuts.

As seen, SGX’s dividends have not exceeded its operating FCF for the last 5 years. Thus, bar any catastrophic circumstances, investors should not be expecting any dividend cut in the near future.

Based on the figures of FY2019 and FY2020, there could even be a potential dividend increase in the near future. This is due to a rather conservative dividend payout percentage that SGX is having right now.

As of now, however, SGX will continue to pay out 8 cents per share per quarter as dividends.

Having looked at SGX’s financial results, I will now look at SGX’s future prospects and highlight what I like about it.

Increased trading activity

As mentioned earlier in the post, more than half of SGX’s revenue comes from daily trading activities. Thus, for SGX to continue growing, trading activity on the Singapore market has to steadily increase over the years. Thankfully, that has generally been the case.

As seen, there has been a steady growth in trading volume for both derivatives and equities over the years. Looking at the results for 1H FY2021, this trend looks set to continue.

While the growth trend in trading activity is welcome, investors should still continue to observe trading volume to see if this trend can be sustained. After all, the current market volatility would definitely encourage more trading activity. Whether this increased trading activity can be sustained over the long run remains to be seen.

Investing for growth

With its acquisition of BidFx and Scientific Beta in 2020, SGX is building upon its plans to become a leading multi-asset exchange. If results of 1H FY2021 are anything to go by, these acquisitions have already borne fruit with increased revenue from the trading and clearing of commodities and currency derivatives, and market data and indices.

Furthermore, SGX is also enhancing its derivatives offerings by enhancing its partnership with FTSE Russell.

Besides building on its core business segments, I also like that SGX is exploring new frontiers of growth.

One of the growth frontier which I’m quite excited about is SGX’s foray into digital assets.

If you are unaware, SGX has a 10% stake in DBS’s Digital Exchange (which supports digital asset tokenisation and trading of some cryptocurrencies). Furthermore, SGX has also entered into a joint venture with Temasek to introduce blockchain technology into capital markets.

With blockchain technology and cryptocurrency trading becoming increasingly popular, SGX’s foray into digital assets means that it would be well-poised to potentially capture growth opportunities in this asset class.

Points to consider about SGX

As a whole, there is much to like about SGX’s financial results over the years and its future growth prospects.

However, like most companies, SGX does have its slight blemishes or areas of concern.

With that said, a majority of these areas of concern actually has nothing to do with the financial performance of SGX. Rather, they can be categorized as potential threats to SGX’s overall revenue.

Concentration risk

Given the prominence of SGX’s derivatives business in generating its overall revenue, SGX’s reliance on a few main derivative products could possibly result in significant ramifications.

As seen, four derivative offerings take up a bulk of SGX’s derivatives volume. In total as of 1H FY2021, these four derivative offerings contributed to 71% of SGX’s total derivatives trading volume.

Generally, I’m not too concerned with the trading volumes of the China A50 index futures and Nifty 50 Index futures. This is due to the fact that both China and India are in the top 5 countries ranked by their GDP. Hence, interest in index products based on these two countries should remain strong, as long as their respective economies continue on the upward growth trend witnessed in the past few years.

In addition, SGX has also recently announced its deepening partnership with FTSE Russell to deliver multi-asset solutions. This is crucial given that MSCI is cutting ties with SGX for all its derivative products except for its Singapore index futures. With this partnership with FTSE Russell, I hope that SGX would look to further diversify its equity derivative products.

On the commodities and currency derivatives front, there is a continued reliance on two types of derivative products. While there is nothing much that SGX can do with regards to currency futures, the substantial trading volume of iron ore derivatives however makes it susceptible to market prices of iron ores.

Nevertheless, given SGX prominence in the iron ore derivatives market, trading volume should be able to be sustained over the near future. Furthermore, iron ore continues to be a crucial resource in infrastructure development, especially in China.

With that said, the trading of iron ore derivatives contributed to 8.7% of total trading volume for 1H FY2021. In the grand scheme of things, that is not really a substantial percentage. Hence, even if the trading volume of iron ore derivatives declines, trading in SGX’s other derivative products should be able to make up the shortfall.

Decline in derivative fees

While I am not too perturbed with the concentration risk of SGX’s derivative products, its negative CAGR for average fee per derivative contract got me thinking.

As seen, the average fee per derivative contract has declined from FY2016. While 1H FY2021 results seem promising, it is still too early to determine if it is an actual recovery.

Now, I will be the first to admit I do not really know how fees for derivative contracts are charged by SGX. Thus, if my views or interpretation of data is wrong here, please do correct me in the comments.

My thinking for the decline in average fee per derivative contract, despite growth in contracts volume, is that fees have not kept pace with the growth in trading volume. If we look at the explanations in SGX’s annual reports, it kind of validates this thinking.

In its FY2018 annual report, SGX management attributed the decline in average fee to the increased volume of derivative contracts. For the increase in average fee seen in FY2019 and FY2020, SGX attributed it to an increase in higher-fee paying customers and increased contract volume from such higher-fee paying customers respectively.

With these explanations, we can infer that to increase the average fee per derivative contract, SGX has to secure more higher-fee paying customers and greater derivative trading volume. Given that derivative contracts volume has been increasing steadily over the years, SGX already has one part of the equation right.

With SGX’s current growth plans in becoming a prominent currency and derivatives exchange, it should be able to secure more high-fee paying customers down the road. Thus, I feel that the average fee per derivative contract should slowly creep up in the next few years.

Decline in listings

It is no secret that SGX has faced difficulties in attracting equity listings on the Singapore market. Over the years, new equity listings on SGX have been declining, from 21 in FY2016 to 10 in FY2020. If we were to exclude FY2020, new equity listings would have remained roughly the same at 20 in FY2019.

In fact, de-listings have outnumbered new listings on SGX between 2009 to 2019. Within that period, there were 279 new listings as compared to 302 de-listings. While this might seem pretty grim, there remains some hope for the future.

For one, SGX is already trying to improve the Singapore market as an IPO destination through the extension of its partnership with Nasdaq. This would allow firms listed on the New York stock exchange to also dual list on SGX. We have already seen this with the IPO of AMTD in early 2020. Hopefully, this would be a sign of things to come in the future.

Furthermore, with the changing of mandatory quarterly financial reporting to half-yearly instead, except for high-risk companies, SGX is also working to reduce the compliance workload for listed companies. This would reduce compliance costs for listed companies, allowing them to concentrate more on their respective businesses instead.

In addition, the Singapore market continues to remain an attractive destination for the listing of REITs. This is mainly due to a favourable tax environment and enhanced interest from retail investors.

While encouraging, the effectiveness of such initiatives remains to be seen. Personally, I would not be holding my breath to expect quality IPOs in the near future. Thankfully, SGX’s revenue from listings does not constitute a big part of its overall revenue.

Regional rivals

When it comes to potential competitors, Hong Kong Exchanges and Clearing (HKEX) remains SGX’s biggest threat. While there are Southeast Asian rivals in the form of Bursa Malaysia or the Stock Exchange of Thailand, ASEAN’s stock exchanges are able to craft out and work within their own niche without being direct competitors to SGX. For both HKEX and SGX, they are nothing but direct competitors.

In most instances over the years, HKEX has always come out on top. From the shifting of MSCI derivatives business to HKEX and the IPO of prominent Singapore firms, such as Razer, SGX seems to lose out to HKEX at every turn. This is not really surprising given that the HKEX is much bigger in size than SGX and also boost a more mature and liquid market.

Does this means that there is no hope for SGX? Not really actually.

Despite the prominence of HKEX over the years, SGX has still managed to grow steadily, in part to its derivatives business. While the pullout of MSCI derivative products is a loss, SGX has not stood still and has instead launched new products with FTSE Russell to replace the void. Judging from 1H FY2021 results, performance on those new products does look promising.

In addition, geopolitical risks could also work to SGX’s advantage. With China’s growing influence over Hong Kong and its tension with the US, companies could look to Singapore shores instead, given its neutrality and interconnectedness as an international finance hub. Whether this translates to more listings on the Singapore market however remains to be seen.

Lastly, Budget 2021 also announced plans for Singapore to become a green finance hub. This could provide new opportunities for SGX on the sustainability front, especially in the listing of green bonds on the Singapore market.

All in all, despite HKEX size in comparison to SGX, I feel that SGX can continue to grow by focusing on its own niche and future opportunities.

My ratings for SGX

Having gone through what I liked and my potential concerns about SGX, I will end this post by providing my personal rating for SGX as a whole. I would also be doing this for future analysis posts so as to give you, my readers, an overview of what I think about that particular stock as an investment.

The rating system would be based on three main aspects; stability, growth and valuation.

Stability

Rating: 4 out of 5.

Being a financially healthy company with a recurring income model, SGX ranks high in my stability ranking. Furthermore, its dividend payout is also sufficiently covered by its operational free cash flow. Hence, there is a low possibility that dividends would be disrupted or decreased in the near future.

With this level of predictability, I thus give SGX a solid 4 stars rating for stability. The only reason why it was not a full star rating was due to the concentration risk in SGX’s derivatives segment.

Growth

Rating: 3 out of 5.

While I am rather optimistic about SGX’s growth prospects, I also have to be realistic. Much of the good performance in FY2020 was down to increased trading possibly due to market volatility. Whether this can be sustained in the years remains to be seen.

In addition, SGX’s growth over the years was mainly down to its derivatives segment. Given that a majority of MSCI suite of products have left SGX, it would take some time for the current FTSE Russell suite of products to gain trading volume and traction.

Nevertheless, I still remain excited about growth prospects in sustainability and market data and indices.

Thus, given that I feel SGX’s growth trajectory can be quite uncertain, I gave it a neutral but slightly optimistic rating of 3 stars.

Valuation

Rating: 2.5 out of 5.

In terms of valuation, I will be looking at three values; PE ratio, PB ratio and dividend yield.

PE ratio

With its current market price, SGX’s PE ratio stands at around 22.7. By itself, the PE ratio might seem a little high given that the average market PE ratio stands at around 15.0.

However, if we were to compare against the 5-year historical PE ratio of SGX, it is only slightly overvalued. The average 5-year PE ratio of SGX, give and take, stands at around 22. Using FY2020 earnings per share figure, this works to a price of $9.66.

PB ratio

At its current price, SGX’s PB ratio is around 8.43.

When compared to its 5-year average, it is only slightly overvalued.

As seen, the 5-year average PB ratio hovers around 8.28. Based on this number, the ‘fair’ market value of SGX comes to around $9.77.

Dividend yield

Given that SGX has committed to paying out 8 cents per quarter in dividend for FY2021, its forward dividend yield stands at 3.22%.

In comparison, the forward dividend yield for the STI ETF is around 2.76%. Based on this figure, it might seem like SGX is undervalued as compared to the market.

However, if one was to look at SGX’s 5-year historical dividend yield, you would realise that it hovers around 3%. As such, based on this figure it could be said that the current market price of SGX seems about fair.

Looking at all three valuation methods, I feel that the current market price of SGX is slightly overvalued.

At what price would I buy SGX? Well, I would buy in at the range of $9 to $9.50.

Conclusion and final rating

Rating: 3 out of 5.

Overall, I do feel that SGX remains a good company to invest in. This is mainly due to its strong fundamentals and recurring cash flow. Furthermore, it has also shown that it can build upon its own niche and prosper despite competition from regional rivals.

Moving forth, investors should continue to monitor trading volume on the Singapore market to see if SGX can maintain its growth trajectory.

Putting it all together, I would give SGX a rating of 3 stars out of 5 based on its current market price. I would definitely be placing it on my watchlist and look to invest once the price drops!


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