Disappointing derivatives

SGX's 4QFY14 net profit is expected to be down slightly qoq on seasonally higher staff costs. We believe that its bright spot will be securities clearing fees, as securities ADVT picked up marginally in the last two quarters, while its removal of the cap on institutional clearing fees should increase SGX's effective securities clearing rate starting Jun. The disappointment this quarter is likely to show up in derivatives, as growth in traded volumes has come off with lower interest in SGX's two key products: Nikkei 225 and China A50 index futures. In view of its subdued trading volumes, we maintain our Hold rating and cut our FY14-16 EPS by 3-6% for lower derivatives volumes. Our DDM-based target price falls to S$7.43 accordingly (discount rate 9.5%).

What Happened

We expect SGX to report 4Q net profit of S$73.1m (-3.6% qoq, -21.6% yoy) on 31 Aug. We expect the qoq fall to be driven by lower derivatives clearing fees (S$50.3m, -3.7% qoq) and seasonally higher staff costs (S$36.7m, +19.1% qoq), partially countered by higher securities clearing fees (S$42.6m, +3.1% qoq).

What We Think

Higher effective securities clearing rate. Securities average daily value traded (ADVT) rose 3.6% qoq to S$1.1bn, as trading picked up in Apr-May but died down in Jun during the World Cup season (Figures 2-3). SGX also rolled out a new securities clearing fee structure on 1 Jun, which lowers its clearing rate from 4bp to 3.25bp of contract values. At the same time, it removed its cap of S$600 on trades above S$1.5m. We believe that this will raise its effective clearing rate from 5.9bp in FY13 to 6.5bp, starting Jun.

Derivatives disappoint. Derivatives traded volume fell 4.2% qoq to 25m contracts, as interest in equity index futures fell. The main culprits were the Nikkei 225 (-26.5% qoq) and China A50 (-6.0% qoq) index futures. New products added (MSCI India, Indonesia, Philippines and Thailand) are gaining traction but only make up 0.2% of its total equity index futures traded volume.

What You Should Do

Hold for now. We believe that trading volumes will remain subdued in the short term. It remains to be seen if its lower securities clearing fees can encourage more retail participation. We estimate that a 10% rise in securities ADVT from our current estimate of S$1.26bn would result in 7% upside to our FY15 earnings forecast.