Improvements To Swap Connect And Orion Derivatives Platform Will Boost Future Trading Volumes

Key Takeaways

• Expanding derivatives and Stock Connect programs is expected to boost trading volumes and revenue by attracting more investors and increasing fees.
  
• Strategic international partnerships and tech improvements aim to enhance market liquidity and global engagement, potentially driving higher earnings and margins.
  
• HKEX faces revenue and margin pressures due to reduced investment income, lower listing fees, increased expenses, geopolitical risks, and macroeconomic challenges.

Catalysts

Owns and operates stock exchanges and futures exchanges, and related clearing houses in Hong Kong, Mainland China, and the United Kingdom.

• HKEX is enhancing its market infrastructure and increasing product offerings, such as improvements to Swap Connect and the Orion Derivatives Platform, which are expected to boost trading volumes and, in turn, increase revenue and profits.
  
• The derivatives market is showing strong growth trends, with record volumes expected to drive further increases in revenue and net margins due to higher trading fees and expanded product offerings.
  
• Expansion of Stock Connect programs, including enhancements such as the inclusion of ETFs and the potential introduction of RMB Counters, is anticipated to increase trading activity and strengthen HKEX's revenue growth by attracting more Mainland investors.
  
• Strategic international partnerships and market recognition, such as those with exchanges in Abu Dhabi and Dubai, could open new revenue streams and potentially improve net margins due to increased global investor engagement.
  
• Ongoing efforts in technology and operational improvements, like severe weather trading and minimum spread reductions, are aimed at boosting market liquidity and efficiency, which could lead to increased earnings per share through higher trading activities and reduced transaction costs.

Hong Kong Exchanges and Clearing Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Hong Kong Exchanges and Clearing's revenue will grow by 7.0% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 58.6% today to 57.9% in 3 years time.
• Analysts expect earnings to reach HK$15.8 billion (and earnings per share of HK$12.43) by about April 2028, up from HK$13.0 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting HK$20.2 billion in earnings, and the most bearish expecting HK$12.0 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 38.4x on those 2028 earnings, up from 33.1x today. This future PE is greater than the current PE for the HK Capital Markets industry at 20.6x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.55%, as per the Simply Wall St company report.

Hong Kong Exchanges and Clearing Future Earnings Per Share Growth

Risks

• The lower net investment income due to reduced margin fund size and lower listing fees from fewer newly listed derivative warrants and CBBCs could impact HKEX's future revenue and earnings.
  
• The decrease in the average daily turnover (ADT) in the cash market by 4% compared to the previous year, despite improvement in the derivatives and commodities markets, might pose a risk to net margins if the trend does not improve consistently across different market segments.
  
• The challenging macroeconomic backdrop and sustained high interest rate environment mentioned in the analysis could negatively affect trading activities and, consequently, HKEX's future revenue and profit margins.
  
• Operating expenses increased by 7%, attributed to investments in talent, infrastructure, and operational excellence, which could pressure net margins if not offset by proportional revenue increases.
  
• The reliance on improving Southbound and Northbound trading volumes through Connect programs and foreign partnerships could be susceptible to geopolitical tensions and policy changes in China, potentially impacting revenue streams reliant on these connections.

Valuation

• The analysts have a consensus price target of HK$386.213 for Hong Kong Exchanges and Clearing based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of HK$440.0, and the most bearish reporting a price target of just HK$320.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be HK$27.3 billion, earnings will come to HK$15.8 billion, and it would be trading on a PE ratio of 38.4x, assuming you use a discount rate of 7.6%.
• Given the current share price of HK$341.6, the analyst price target of HK$386.21 is 11.6% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.