article 3 months old

Pressure Building On ASX Earnings

Australia | Jul 07 2020

This story features ASX LIMITED. For more info SHARE ANALYSIS: ASX

Pressure on ASX earnings is likely to build throughout FY21, with derivatives providing the main area of weakness.

-Decline in derivatives volume entirely driven by interest-rate futures
-Equities trading activity now starting to normalise
-Project expenditure likely to be elevated

 

By Eva Brocklehurst

Recent volatility has provided ASX Ltd ((ASX)) with substantial turnover in cash equities and capital raisings but this is unlikely to continue and brokers suspects pressure on earnings will build throughout FY21.

Citi assesses there are many headwinds developing, although expects a solid second half in FY20, supported by record levels of cash equities trading. However, derivatives trade is likely to slump further as the Reserve Bank of Australia maintains yield curve control.

Admittedly, some of the negative impact will be delayed amid recognition of capital raisings income over the medium term. Regardless, the record second half in cash equities trading is unlikely to be repeated.

Cash equity daily average turnover is up 45%, while capital raisings totalled $52.6bn in the second half. Still, the derivative segment is a key area of weakness and futures volumes dropped -12% in the second half.

Derivatives

Derivative volume declines were entirely driven by interest rate futures, as the targeting of low interest rates by the RBA for durations up to three years has meant reduced activity in the three-year futures market.

Credit Suisse believes the majority of the decline in interest rate volumes will come from principal traders rather than house clients, as house clients need to continue hedging their interest-rate risk.

So, as principal trader volumes are reduced, the level of discounting is likely to wind back and cushion the revenue impact. Revenue will also be supported by a change in the mix, as a result of declines in lower fee interest rate futures and increases in a higher fee electricity futures.

Commodity futures were the one bright spark, albeit these contribute less than 1% of total futures volumes. Commodity futures were up 65% in the second half and carry gross average fees of more than 15x gross fees on interest-rate products.

Interest Income

Macquarie expects interest income to decline throughout FY21 because of lower client charges for futures, lower investment spreads and cash rates. Interest margin income accounted for 13% of first half net profit.

Looking into the second half, the broker envisages the spread between the BBSW (bank bill swap rate) and cash rate will narrow significantly, noting since early April it has actually been negative.

Hence, earnings pressure is expected to extend across the second half of FY20 and FY21. Moreover, strong equities trading activity is now starting to normalise. UBS, too, considers it unlikely ASX will deliver a positive surprise over the next year.

Overvalued?

Given delays to the CHESS replacement platform, now intended for April 2022, project expenditure may be elevated and while ASX offers a defensive dividend yield of 2.6%, UBS finds the 12-month price/earnings ratio of 33.7x at odds with a more modest medium-term growth outlook, downgrading to Sell from Neutral.

This now takes the total to seven Sell ratings on FNArena's database and the consensus target is $72.20, which suggests -16.8% in downside to the last share price.

Annual listing fees account for 11% of ASX revenue and, Macquarie points out, for the first time in eight years ASX has decided not to raise its annual listing fee price. The broker agrees the stock is overvalued, trading at around 48% above the five-year average.

Capital markets are also not as strong as they seem at first glance. Secondary capital raisings in the second half were supported by a strengthening of corporate balance sheets but beyond the merger of TPG Telecom ((TPM)) and Vodafone, activity in IPOs (initial public offerings) was weak because of heightened levels of uncertainty.

However, as Citi highlights, with accounting standards requiring revenue to be smoothed over several years, the impact on the balance sheet over the short term is likely to be muted.

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms

CHARTS

ASX

For more info SHARE ANALYSIS: ASX - ASX LIMITED