Hong Kong Exchanges and Clearing Limited: Warmth "fleeting", when is the next time?

After the Hong Kong stock market closed on August 21st Beijing time, HKEX.HK released its financial report for the second quarter of 2024. The overall performance is in line with expectations, but market sentiment weakened again starting in June, posing renewed pressure for the third quarter.

As most of the Hong Kong Exchanges and Clearing Limited (HKEX) revenue is related to market trading conditions, which are generally public information and disclosed monthly on the company's official website, the actual performance is usually not significantly different from expectations. With most positive and negative factors already priced in, there are not many points to be made solely based on the impact on valuation. The Dolphin mainly uses the financial report to further understand the actual market situation and delve into some significant changes within HKEX.

Specifically:

1. Overall Performance Mediocre: Here, "mediocre" means that compared to expectations, the second-quarter performance was not surprising, and even slightly below expectations. The trading volume in the Hong Kong stock market rebounded significantly compared to the first quarter, but this was an expected change. There was a slight gap from expectations in custody income and market data fee income.

Although operating profit seemed slightly above expectations, it was mainly due to a refund of legal fees related to the LME nickel market incident, and after excluding this impact, the actual performance was also average and did not exceed expectations.

2. Equity and Derivatives Expected to Rebound, but Marginal Weakness in Q3: 70% of HKEX's revenue comes from equity and derivatives market trading, so the rebound in these two markets in the second quarter drove the revenue growth rate to bounce back.

In terms of driving factors, the core lies in the increase in equity trading and derivatives trading volumes, with a combined average daily trading volume (ADV) exceeding HKD 120 billion, surpassing the Dolphin's key emotional line of HKD 100 billion.

However, starting from June, the market turned downwards again, performing poorly in July and August, with cold sentiment. Therefore, it can be anticipated that there will be considerable pressure in the third quarter. Now, the only hope lies in the beginning of an interest rate reduction cycle to increase liquidity and alleviate performance pressure.

3. Commodities Remain Strong: Additionally, the trading volume in the commodity market continues to remain strong, and under the "price increase" at the beginning of the year (raising trading and settlement fees), the simultaneous increase in volume and price has jointly driven accelerated revenue growth.

4. Investment Income Slows Down: The outstanding investment net income under high interest rates is expected to slow down year-on-year in the second quarter due to the decrease in market interest rates (HIBOR), with a negative growth on a quarter-on-quarter basis. Coupled with factors such as the decrease in margin scale after lowering the threshold and poor performance of the proprietary investment portfolio, it is expected to further decline in the second half of the year.

5. Overview of Financial Indicators

Dolphin's Viewpoint

The Hong Kong Stock Exchange operates on a "wait-and-see" basis. Unlike essential commodities like water, electricity, and coal (which have substitutability and the ability for funds to freely exit), being placed in the global capital market, it does not currently possess absolute advantages in terms of attractiveness. Therefore, the Hong Kong Stock Exchange does not have much room for adjustment. Under the circumstances of "revenue depending on market conditions and fixed expenses," the elasticity of profits mainly comes from the improvement of market sentiment. In other words, the investment opportunities for the Hong Kong Stock Exchange's performance and valuation resonance mainly lie in judging the turning point of market sentiment improvement.

In the short term, there is considerable pressure on third-quarter performance. On one hand, market sentiment is turning tepid again, with equity and derivative trading volumes rapidly declining. On the other hand, the mainstay of growth in trading-related income under pressure over the past year—investment income—will be more significantly affected in the third quarter due to the continued decline of HIBOR in mid to late July.

Currently, a possible turning point lies in substantial interest rate cuts in the United States in the fourth quarter, bringing some boost to Hong Kong stock liquidity, and a further improvement in market sentiment after valuation rebounds, leading to daily average securities trading volume exceeding HKD 100 billion.

Below is a detailed financial report analysis

1. Introduction to Hong Kong Stock Exchange Business

2. Overall Performance: Mediocre

In the second quarter, the Hong Kong Stock Exchange achieved a total of HKD 5.42 billion in revenue and other income, an 8% year-on-year increase, mainly driven by the recovery of stock and futures trading, as well as the continued strength of the commodity market.

Operating profit reached HKD 3.6 billion, a 9.3% year-on-year increase, with EBITDA at HKD 3.96 billion, an 8.4% year-on-year increase. Although it seems slightly above expectations, it was mainly due to a legal fee refund related to the LME nickel market incident. Excluding this impact, the actual performance was average and did not exceed expectations.

The expenses of the Hong Kong Stock Exchange are generally relatively fixed, but in the past year, due to system upgrades and executive layoffs, incentive compensation has temporarily increased overall expenses. This will have a more noticeable impact on profits when revenue is under pressure. Additionally, capital expenditures are still growing at a high rate, and the expected increase in expenses is unlikely to stop anytime soon.

From the perspective of revenue structure:

More than 50% of the Hong Kong Exchanges and Clearing Limited's revenue and other income are directly related to trading (trading fees, settlement fees), 7% comes from listing fees, which is also related to the current market sentiment. From the perspective of listed companies, they are more inclined to go public when the sentiment is high, boosting market capitalization.

In addition, there are investment gains benefiting from the high interest rate environment, which remained at historically high levels in the second quarter. However, due to the expectation of interest rate cuts and the decline in HIBOR, there has been a decrease compared to the first quarter.

3. Trading Fees: Benefiting from the May Recovery

In the second quarter, with the rise in interest rate cut expectations and the introduction of mainland real estate support policies, the extreme valuation of the first quarter was repaired in line with the trend, and the market trading sentiment improved, driving a 15% year-on-year increase in trading fees, a significant recovery compared to the first quarter.

The main markets where trading fees are charged are the equity market, derivatives market, and commodity market, and the following are the performances elaborated by Dolphin:

(1) Stock Market

In terms of trading volume, the average daily turnover (ADT) of stocks increased by 23% year-on-year, reaching HKD 118 billion per day, showing a significant improvement compared to the level of less than HKD 900 billion in the past four quarters.

It is worth mentioning that the proportion of mainland funds trading has significantly increased, with a 5% increase compared to the previous period. Conversely, the funds flowing from Hong Kong to the mainland market did not show a significant increase, and in fact, there was even a decrease compared to the previous period. This actually follows a fundamental investment logic:

During an interest rate cut cycle, as the US dollar depreciates relative to other currencies, capital market liquidity increases and will flow preferentially to emerging markets, especially those with low valuations and high-quality companies. Compared to the A-share market, the Hong Kong stock market has lower valuations and includes a large number of high-quality internet and technology companies, making it more favored by funds under this logic.

In the end, the stock market's trading fee revenue was HKD 770 million, a 12% year-on-year increase, with the significant recovery of trading fees in the Hong Kong market offsetting a small part of the impact of the decline in A-share trading fees.

However, as the largest component of detailed income, the trading sentiment from June to now may have a significant impact on third-quarter revenue. Looking at the monthly data, the average daily trading volume dropped below 900 billion again starting from June, and even decreased to 736 billion in July.

(2) Derivatives Market

In the derivatives market, the futures exchange and the stock options trading on the Hong Kong Stock Exchange are active, while warrants and bull-bear certificates are relatively subdued.

Although the number of contracts traded on the futures exchange and the number of stock options contracts traded on the Hong Kong Stock Exchange increased by 14% and 25% respectively compared to the same period last year, the trading volume of warrants and bull-bear certificates in the second quarter decreased by nearly 20% on a daily average basis. However, this does not mean that the trading activity is extremely thin. In terms of the number of transactions, it only slightly decreased by 3%.

Since most fees are charged based on the number of trading contracts, the situation of warrants and bull-bear certificates does not affect the overall rebound of the Hong Kong Stock Exchange's derivative trading fee income.

(3) Commodity Market

In the second quarter, although the nickel trading in the metal commodity market (LME) was suspended earlier and the natural repair cycle has passed, the high trading activity driven by significant fluctuations in commodity prices in the second quarter (first rising sharply and then falling sharply), combined with the price increase of trading fees at the beginning of this year, led to a simultaneous increase in trading fee income, continuing to grow strongly by 45%.

Looking at specific categories, all metal sectors saw different degrees of year-on-year growth, with nickel trading doubling directly year-on-year due to the introduction of a new product in the first half of the year.

However, starting from June, as the commodity market continued to adjust, it is expected that the trading volume in the third quarter will also decrease to some extent due to the lackluster market conditions.

4. Listing Fees: The number of new listings rebounds but there are also many delistings

In the second quarter, the number of new companies listed on the Hong Kong Stock Exchange reached 18, showing a certain rebound from the 12 companies in the first quarter. At the same time, 12 companies were delisted during the same period, maintaining short-term stability. As a result, the total number of listed companies at the end of the year basically maintained stable growth by 6 companies, reaching 2617 (including the main board and GEM).

Because the listing expenses are not only paid when the company goes public, but existing companies also have to pay a certain listing fee to the Hong Kong Stock Exchange every year, which often accounts for a larger proportion (75-80%). Therefore, overall listing expenses are still lower than the same period last year. However, due to three fewer delisted companies compared to last year, the year-on-year decline is also rapidly narrowing.

In the end, listing expenses in the second quarter decreased by 2% year-on-year, reaching 360 million, still at one of the lowest levels in nearly two years.

5. Decline in the marginal dividend of investment returns

In a high-interest environment, the performance of bonds, margins, and other income will be better, so when the stock market and derivatives market perform poorly due to the high-interest environment, they can provide some support. Conversely, with the arrival of an interest rate cut cycle, this income segment also faces marginal weakening.

In the second quarter, net investment income was 1.18 billion Hong Kong dollars, still at a historically high level, but there has been a certain decline compared to the previous quarter. With the further decline in the HIBOR interest rate in July, it is expected that investment income will come under significant pressure in the third quarter, directly decreasing year-on-year.