The ASX is currently at a crossroads. The business is well established, generates a strong return on capital, and faces limited competition.
Strategically, cost growth continues the multi-year trend of running ahead of revenue, whilst new revenue opportunities appear to be some way off. Recent CEO and CFO appointments (2022), and relatively new Chairman (2021), leave ASX with a refreshed management team to address current challenges.
Regulatory risks have risen following the failed CHESS replacement program in 2022. There remains a risk that the monopoly ASX has on clearing activities is broken - either by forced structural separation or the introduction of new competition. This would significantly weaken ASX’s pricing power, and result in a further share price de-rating.
ASX is undertaking a wholesale review of capital expenditure. Further reinvestment is likely across both OPEX and CAPEX. CAPEX spending has been running well ahead of global peers for several years. Execution risks remain elevated given the poor major project performance in recent years. In our view CHESS 2.0 costs are likely to surprise on the upside in late 2023.
Catalysts | April: ASX response to ASIC/RBA CHESS review; 6 June: ASX Strategy Day, 2Q24: CHESS 2.0 program update
Investment View
We rate the ASX a Hold. ASX’s earnings multiple has de-rated by a third since the beginning of 2022. Despite the improved valuation appeal, ASX trades at a premium to global peers whilst offering mid-single digit earnings growth, well below the growth of global exchange rate peers.
Uncertainty around the regulatory environment and ASX’s free-cash flow profile leave the ASX with an unusually high-level earnings risk.
We see limited ability for the ASX to be part of any potential global exchange consolidation, given the ‘national icon’ status view from Australian regulators.
A positive stance on the ASX would require; 1) evidence of improved Futures volumes from currently depressed levels (20% of revenue); 2) a refreshed, credible CHESS 2.0 program; 3) clarity on regulatory and structural separation concerns; and 4) improvement in volumes – particularly IPO activity.
Share Price Catalysts
End of April: ASX response to ASIC/RBA CHESS suitability request. We expect the ASX will highlight there are no material functional issues for the current CHESS system from a market capacity and integrity review.
6 June: ASX Strategy Day. First strategy day in several years. We expect new CEO Helen Lofthouse will more clearly define where the ASX is headed. We struggle to see significant new areas for revenue growth and anticipate cost growth is likely to remain elevated into FY24E. CHESS 2.0 guidance will be limited.
August 2023: FY Results. Expect first guidance for FY24 on cost growth, which we expect is likely to running harder than markets current estimates of ~4%.
4Q 2023: CHESS replacement program update. We expect the ASX will flag additional spending on CHESS 2.0 over a +3-year period. Following comments at 1H23 Results, we anticipate the technology solution will be a bespoke solution. We see upside risks to market cost estimates.
ASX Overview
The ASX is an Australian multi-asset exchange that provides services such as listings, trading, clearing, settlements, information technology services as well as data servicing. ASX controls the dominant position within the Australian market holding the largest market share in cash equities, whilst in many other areas including settlement, the ASX is effectively a monopoly.
The ASX commands a privileged position in Australian financials system being the sole integrated exchange in the market.
Whilst ASX has four main arms of regulatory oversight (APRA ASIC, RBA, Treasury), this has traditionally provided the ASX with an element of “protected” status in the eyes of government and regulators. This has allowed the ASX to generate a return on equity averaging well ahead of its cost of capital since listing in 1988.
In 2011, the Federal Treasurer as part of the Foreign Investment Review Board (FIRB) process knocked back a takeover offer from the Singapore Exchange (SGX).
In 2011 regulators allows the introduction of competition for cash equities trading, with Chi-X establishing a rival exchange. Chi-X was subsequently purchased by US-listed exchange CBOE Global Markets (CBOE.US) in 2021.
The introduction of competition has had only a modest impact on ASX’s profitability and status as an exchange (the benefit of being a natural monopoly). CBOE Australia’s market share in cash equities has been flat at ~20% since 2016.
Following a series of operational failures in 2017-2019 which forced the exchange to unexpectedly remain closed, and the failure of the CHESS replacement program in 2022, the ASX finds itself at the crossroads of an extensive review of its operations, and the regulatory framework under which it operates. The outcomes of this process will likely be known by the end of 2023.
The most damaging outcome would be the potential for forced structural separation of the ASX’s monopoly clearing operations. This function contributes ~22% of ASX’s revenue. The loss of clearing would significantly weaken ASX’s position within the financial system and allow make it easier for competitors to come in and would like dimmish ASX pricing power. We would anticipate the ASX to trade a materially lower PER multiple if this were happened.
All major global exchanges combine trading activities and clearing, so we think risks of forced separation are low.
Figure 1: ASX product mix by revenue type
Figure 2: ASX product line-up versus global exchanges
Figure 3: ASX has maintained 80% cash equities market share since introduction of competition in 2012
Valuation Considerations
The ASX has typically traded at premium to the market given its monopoly like status, and persistence of cash flow generation. This is also the case globally, where investors recognise the value of monopoly like assets and the inbuild growth profile they contain. Returns on equity are typically well ahead of cost of capital across the business cycle.
For this reason, exchanges typically trade at a premium to their host index. In recent years, this premium has also been supported by consolidation and M&A at a global level.
Figure 12: ASX Return On Equity Has Improved Over Time
Historically, the ASX has traded at a premium valuation compared to global exchanges. However, over the past year, concerns surrounding capital expenditure and governance have caused this premium to collapse, which has put downward pressure on the share price over 2022.
Furthermore, the earnings outlook for the ASX appears to be relatively subdued, with a projected 3% 3-year EPS compound annual growth rate (CAGR).
In contrast, global exchange peers are expected to grow earnings by 6-7% over the same period. The derating in the earnings multiple has can also be partially attributed to the lower earnings growth outlook of the ASX vs peers.
Figure 13: Global exchange valuation
Figure 14: Global exchanges: earnings growth vs valuation.
Figure 15: ASX dividend payout ratio has remained ~90% over the past 20 years. This level of payout can be maintained going forward.
Risks to Investment View
Figure 16: ASX PER has fallen since 2020, now close to the long-term average
Figure 17: ASX PER Rel vs market remains elevated
Figure 18: ASX FY1 dividend yield remains below market
Figure 19: ASX EPS growth expected to average low-mid single digit growth into FY25e
