HKXCF - Hong Kong Exchanges: It's About Turnover And IPOs

2024-01-08 06:48:02 ET

Summary

• The Average Daily Turnover for Hong Kong Exchanges contracted by -17% YoY last month, but there are expectations of a ramp-up in Hong Kong IPO fund raising activity for 2024.
• The market currently values HKEX at a forward P/E multiple of 27.9 times, which I deem to be unattractive on both an absolute and a historical basis.
• My rating for Hong Kong Exchanges stays as a Hold, after I reviewed HKEX's valuations and the company's prospects pertaining to ADT and IPOs.

Elevator Pitch

Hong Kong Exchanges and Clearing Limited (HKXCF) [388:HK], or HKEX, is rated as a Hold. HKEX describes itself as "one of the world's major exchange groups" that "operates a range of equity, commodity, fixed income and currency markets" which includes "Hong Kong's only securities and derivatives exchange" on its website .

I previously performed a review of HKEX's financial performance for the first half of 2021 with my prior update written on August 13, 2021. With this latest article, I evaluate HKEX's outlook relating to ADT (Average Daily Turnover) and public listings.

The company's prospects for the long run are promising taking into account the long-term potential of China's capital markets, but a significant improvement in ADT for the short term is less likely. Separately, there are expectations of an increase in the number of Hong Kong IPOs this year, but the undemanding valuations of Hong Kong-listed companies have most probably deterred other businesses from contemplating a potential IPO in Hong Kong. Also, HKEX's valuation discount relative to its historical average isn't sufficiently large to warrant a Buy rating. In that respect, I stick to a Hold rating for HKEX.

Readers should be aware that they can buy and sell HKEX's shares on both the Over-The-Counter Market and the Hong Kong Stock Exchange. The average daily trading value for HKEX's OTC shares in the past three months was around $50,000 (source: S&P Capital IQ ), while the three-month mean daily trading value for the company's Hong Kong-listed shares was relatively higher at $140 million. HKEX's Hong Kong shares can be traded with US stockbrokers, which provide foreign equity trading services like Interactive Brokers.

Average Daily Turnover

HKEX's Average Daily Turnover or ADT decreased by -17% YoY from HK$135.5 billion in December 2022 to HK$98.6 billion for the final month of last year. The full-year 2023 ADT for HKEX was HK$105.0 billion which represented a -16% decline as compared to its 2022 ADT of HK$124.9 billion .

Mainland Chinese stockbroker CMB International published a research report on December 30, 2019, which indicated that there was a "72% correlation" between HKEX's stock price and its ADT for the 2014-2019 time period. As such, it is unsurprising that HKEX's shares have performed poorly in recent times, taking into account the ADT contraction. HKEX's OTC shares and Hong Kong-listed shares fell by -28.9% and -30.3%, respectively, in the past year.

On its corporate website , HKEX emphasized that the company's target is to become the "go-to international market for capturing China-related flows and opportunities" by virtue of Hong Kong being "the most international city in China and the most Chinese city outside of the Mainland." Therefore, it is reasonable to assume that HKEX's ADT is heavily influenced by investor sentiment towards China.

In the long run, the prospects of China's capital markets are good. Specifically, HKEX estimates that the size of capital markets in China could potentially triple to $100 trillion in the coming 10 years. A key supporting factor for this forecast is that the current foreign ownership of Chinese A-shares (which HKEX provides an avenue for international investors to invest in via the Stock Connect program ) is low, at approximately 5%.

In the very near term, I don't expect HKEX's ADT (and share price) to recover in a meaningful way for two key reasons.

Firstly, geopolitical tensions between the US and China could weigh on market sentiment in Hong Kong following the January 13, 2024 Taiwanese presidential election. A January 2, 2024 Bloomberg news article noted that the "US-friendly" Democratic Progressive Party candidate "Lai Ching-te was the frontrunner" in the Taiwanese presidential election according to the latest polls, which is potentially "a setback to President Xi Jinping's efforts to bring the island (Taiwan) closer to Beijing."

Secondly, recent statistics suggest that it will take a longer than expected period of time for the Mainland Chinese property market to return to positive sales growth. According to a January 2, 2024 Reuters article , "China's average daily home sales" dropped by -26% "during the three-day New Year holiday in 40 cities." Considering the disappointing property sales figures, it is hard to be optimistic about Mainland China's economic outlook for the short term.

Initial Public Offerings

In the company's November 2019 investor presentation slides , HKEX highlighted that "Hong Kong is consistently the world's largest IPO market." HKEX didn't live up to its billing in 2023, as the number of Hong Kong IPOs declined by -19% to 73 for the previous year. The funds raised from HKEX's IPOs in the prior year was roughly HK$46.3 billion, and this was equivalent to a -56% fall vis-à-vis last year.

2024 is expected to be a better year for HKEX in terms of IPOs. Auditing firm PricewaterhouseCoopers or PWC has forecasted that the number of IPOs and funds raised from IPOs in Hong Kong will increase to 80 and in excess of HK$100 billion, respectively this year. Recent news flow provides support for PWC's bullish projections. Alibaba ( BABA ) and JD.com ( JD ) are expected to spin off their logistics and industrial businesses, Cainiao and JD Industrials , respectively for listings in Hong Kong this year.

On the flip side, HKEX has failed to attract other big-name Chinese companies with substantial international business operations to list in Hong Kong, and one notable example is fast-fashion retailer Shein which has opted for a US listing. In my opinion, the Hong Kong market's low valuations should have been a major factor that deterred specific businesses from considering a public listing in Hong Kong. As per data sourced from CEIC , the current P/E multiple for Hong Kong's benchmark index, the Hang Seng Index, is approximately 10 times. In contrast, the S&P 500's P/E ratio is above 25 times now.

To sum things up, HKEX faces a chicken-and-egg problem, notwithstanding the positive IPO outlook for 2024. On one hand, the exchange operator needs high-quality IPOs to enhance investor sentiment and trading interest, which will in turn provide support for the valuations of Hong Kong-listed companies. On the other hand, Hong Kong stocks' depressed valuations in general make it tough for HKEX to attract new public listings.

Final Thoughts

HKEX is now trading at a consensus forward the next twelve months' normalized P/E multiple of 27.9 times as per S&P Capital IQ data, and this represents a modest 12% discount to the stock's historical 15-year mean P/E ratio of 31.9 times. My opinion is that HKEX's valuations will be more appealing if and when the stock trades at a wider 20%-25% discount to the historical average P/E. As such, I take the view that HKEX's shares are at a fair valuation considering both the positives and negatives associated with its ADT growth outlook and IPO market prospects.

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