Hong Kong Exchanges and Clearing Limited (HKG: 0388) runs the Hong Kong stock exchange, one of the world’s largest with a total market capitalisation of $38 trillion as of Dec-2019. It provides world-class facilities for trading and clearing of securities and derivatives in various asset classes including equities, commodities, fixed income, and currency.
In this article, I will share more about its businesses, latest earnings, historical financials, and competitive strengths.
Hong Kong Exchanges and Clearing Limited (HKEX) positions itself as the financial market operator that facilitates capital flow between China and the international market. Leveraging Hong Kong’s status as an international financial centre, it has been the primary fund-raising hub for mainland Chinese companies and a connector for international funds entering the Chinese equity market.
The group has five revenue streams:
- Cash Equity – trading of equity products and listing of new companies
- Equity and Financial Derivatives – trading of derivatives such as options and warrants
- Commodities – trading of industrial metals on London Metal Exchange
- Post Trade – fees from clearing, settlements, and depository services
- Technology – fees from data line usage, software sub-license, and hosting services
- Corporate Items – net investment income of the corporate funds
The major revenue segments are the Post Trade, Cash Equity, and Equity and Financial Derivatives, which make up 38%, 22%, and 18% of total revenue in 2019.
HKEX’s first quarter 2020 revenue fell 7% year-on-year to HK$4 billion, due to net losses suffered in its investment portfolio. Excluding that, revenue from core businesses would have increased by 19%.
Profit attributable to shareholders dropped 13% to HK$2.2 billion.
HKEX had a good quarter as all its business segments recorded revenue growth of between 4% and 27%. The fall in revenue and earnings are due to the negative macro-environment that dented its global portfolio valuation.
Source: 1Q 2020 Results Presentation
HKEX’s revenue and shareholders’ earnings show a similar trend of modest growth in the past financial years, except for 2016 when both had a substantial drop due to the China equity market crash triggered by the Renminbi devaluation in 2015.
The Average Daily Trading (ADT) volume of equities and structured products show a similar trend of gradual increase except for 2016. This indicates that the revenue and earnings of HKEX are tied to trading activities which are influenced by market conditions.
Source: 2019 Annual Report
HKEX had been able to maintain a high net profit margin that ranged between 50% to 60%. Impressively, its Return on Equity remained above 20% even when its gearing ratio dropped from 10% to 1% in the last five years. These are clear signs of a robust business that generate consistent returns for shareholders without incurring huge debts.
Top to bottom: Net Profit Margin, Return on Equity, Total Debt/Equity. Source: Corporate Website
Cash Flow Trend
HKEX’s cash flow from operating activities tracks the revenue and earnings closely, with modest growth in the last five years except for 2016.
Capital expenditure had been hovering below HK$1 billion, far below the operating cash flow. This gives rise to a business that churns out large free cash, a healthy sign.
Dark Blue: Cash Flow from Operating Activities. Light Blue: Capital Expenditure. Source: Corp website
Dividends Track Record
The annual dividend had grown from HK$4.25 in 2016 to HK$6.71 in 2019.
HKEX adopts a policy of providing shareholders with dividends amounting to 90% of the group’s annual profit.
Strengths and Opportunities
The biggest strength of HKEX is its status as the sole owner and operator of the Hong Kong stock exchange. A stock exchange is a business of scale. The larger the scale, the more capital it will attract and the more active equity trading is. It is highly unlikely that we will see another stock exchange in Hong Kong that challenges the incumbent. The monopolistic position gives HKEX a strong economic moat.
While Hong Kong was rocked by the social protest in 2019, its fundamentals as one of the top three financial centres in the world are still intact. As a fundraising hub, it was the number one IPO venue globally last year, a title it held in 6 out of the last 10 years. In my opinion, I feel that the social movement will impact Hong Kong’s economy and employment, but it would not affect its attractiveness as a capital market.
Furthermore, as China’s only financial hub well-plugged into the international market, HKEX can benefit from the liberalisation of China’s financial market. The Shanghai and Shenzhen Stock Connect implemented a few years ago boosted trading volume between international capital and China equities. China’s A-share inclusion into the emerging market indices will attract more capital into China equities via Hong Kong.
HKEX is facing strong competition from the Shanghai stock exchange which is receiving a strong push from the Chinese government to evolve into an international financial centre. Shanghai’s A-share features many large local companies that thrive on China’s domestic consumption upgrade. It has also launched the Science and Technology Innovation Board (STAR) that seeks to attract listings of technology start-ups.
The group may also engage in the acquisition of other bourse operators for inorganic growth. These are often large bids that cost huge sums which may run into lengthy integration processes that could drag financial performance. For example, HKEX’s attempt to take over the London Stock Exchange in a whopping US$36.6 billion deal met with resistance from stakeholders and eventually failed. Investors need to be aware of such future risks.
Hong Kong’s status as a key financial hub that connects China’s burgeoning economy with the world is the driving force behind HKEX’s highly successful business.
HKEX’s management also leveraged the trend of internationalisation of China’s financial market, which made HKEX an established company with steady revenue and earnings growth, consistent cash flow, high return on equity, and an increasing dividend.
I think Hong Kong still holds an important role in the rise of China, and its position as a fund-raising and capital hub remains intact, despite the ongoing social unrest.
Investors who have the same opinions may consider HKEX for their portfolio as a stable blue-chip stock.