Analysts are split on the exchange's merit as it posts an unexpected 25 per cent earnings fall to $89 million Hong Kong Exchanges & Clearing (HKEx) has surprised the market with unexpectedly poor first-quarter results, which saw earnings fall 25 per cent year on year to $89 million. But analysts are divided on the merits of the stock which closed yesterday at $10. HKEx chairman Charles Lee Yeh-kwong said the profit fall was mainly due to a 14 per cent year-on-year drop in average daily turnover to $6.1 billion during the three months as the exchange relied on levy income and clearing fees on share transactions paid by investors. For many, HKEx's prospects in the medium-term correlate directly with the health of the Hong Kong market - and demand for initial public offerings and fund-raising activities is not strong in such bearish times. After the extreme disruptions of the Iraq war and Sars it is hard to imagine the economic climate getting any worse. A Thomson First Call survey of 16 brokers found a consensus 'buy' recommendation on the stock, despite a slight drop in earnings expectation by 1.75 per cent to 56 cents a share this year. 'Things can only get better,' said Phillip Securities research director Louis Wong Wai-kit, pointing out that HKEx's top and bottom lines were very much affected by the market turnover. 'Other than the exchange levy on the transactions, they also derive income from listing fees and information service provision. All are closely related to market performance,' he said. Mr Wong said one of HKEx's strengths was its sizeable cash reserve, which generates substantial interest income. 'That puts it in a rather safe position, in a sense [that] if anything goes wrong it still has a very sound financial position,' he said. Mr Wong said that compared with its international peers, HKEx's valuation was not excessive. The government's plan to hold a public consultation on whether to pass the frontline regulatory role of HKEx to the Securities and Futures Commission (SFC) could also see the exchange lose listing fees. What is certain is that the exchange will need to pay $20 million annually to the SFC under the dual filing arrangement as the cost of the commission sharing the vetting work with the exchange on listed companies' announcements. HKEx is trading at 13 times this year's expected earnings, compared with 20.81 times for the Singapore Exchange. Ultimately, however, Mr Wong's optimism on the stock stems from his expectation of a pick-up in market turnover in the second half of this year. 'With a US presidential election coming and the Iraq war over [this] should translate into a more bullish stock market,' he said. CLSA analyst Dominic Chan said fund managers' interest in HKEx depended on their individual 'investment horizons'. Mr Chan said the stock was a 'call to the market' and if an investor saw brighter times on the horizon then it was a worthwhile purchase because it would 'most likely outperform the market on the upside'. Mr Chan maintains a 'buy' recommendation for the stock but lowered his target price to $11.30 after the disappointing first-quarter results. But the revised objective still left a 15 per cent upside. Mr Wong said another reason to be positive about HKEx was its new chief executive, Paul Chow Man-yiu, who took the post on May 1. One change under Mr Chow is the scrapping of some of HKEx's less popular services. The exchange has said it would dump trading of futures and options on international stocks due to weak demand. Mr Wong said this was a move in the right direction. 'If it's not making money and is not profitable, the best thing to do is cut losses,' he said. But while most analysts are upbeat on the exchange's long-term prospects, others remain cautious. ABN Amro analyst Jeremy Sutch said he was 'sitting on the fence' as far as the stock was concerned because he was disappointed with the company's first-quarter results. He said the market's operating costs increased too much despite fixed-income gains. 'The problem with this business is that in order to remain competitive you've got to continue to invest in new technology, which means your information technology maintenance and computer costs for that particular item will continue to rise,' Mr Sutch said. He has set the stock's target price at $8.75, which is 14.2 per cent below yesterday's close. Celestial Asia Securities research head Herbert Lau Chung-kwan said the stock was 'not very attractive' in this economy. 'Because of Sars a lot of initial public offerings and fund-raising activities have been postponed or even cancelled,' he said. Mr Lau said HKEx's price was about 'fair value' and its growth prospects were limited given the confines of its business model.
