We initiate coverage on HKEx with a HOLD rating and TP at HK$ 248. We see the long-term growth story of HKEx still lies in its unique position of enjoying China’s capital market opening-up through the Connect Scheme, with mid-term drivers from efforts to broaden product scope and optimize market microstructure to grow liquidity. But as we do not see a clear trend in market activity recovery and recent good news takes time to translate into revenue, the current 33x 1-yr forward P/E (vs. 5-yr avg. of 30x) valuation looks fair in near-term.
- Good news in the price; await future catalyst to materialize. HKEx’s equity market velocity reached close to historical low (~45%) with cash ADT down 20% YoY in 11M19, while good news like Alibaba’s homecoming and potential launch of MSCI China A Index futures likely held up its stock price. Our scenario analysis suggests that these positives either have limited financial impact for now or are with uncertain materializing time.
- Mid- to long-term growth prospect intact: three ways to grow liquidity. Due to its turnover-driven business nature (~54% revenue contribution), growing liquidity is crucial for HKEx’s organic growth. In the mid run, we expect market activity to progress through 1) further penetration of Stock Connect from both directions, 2) introducing new products esp. derivatives which delivered resilient and less volatile growth, and 3) optimizing market microstructure to allow easier access to the market.
- We expect HKEx’s net profit to grow 1%/5% YoY to HK$ 9.4bn/9.9bn in FY19E/FY20E. Our estimates are 1%/6% lower than consensus, due to our more cautious assumptions on cash ADT and invt. yield as well as slightly higher opex.
- Our 3-stage DDM-derived TP of HK$ 248 implies 3% downside with a dividend yield of 2.8% and target FY20E P/E of 31.8x. We noticed that market sentiment restored in the past few weeks as trade tension eased, and market ADT rebounded to HK$ 89bn (vs. Jul-Nov HK$ 77bn). Our target price implies HK$ 98bn headline cash equity ADT in FY20E. Initiate at HOLD.
- Key upside risks include 1) launch of MSCI China A Index future products; 2) substantial recovery of market turnover. Key downside risks include keen competition from other exchanges (esp. China onshore ones) in luring China listings and issuing China-related products.
