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Morningstar | ASX 1H Result in Line With Expectations but Interest Income Surprisingly Strong

Wide-moat-rated ASX’s first-half result was broadly in line with our expectations, although net interest income was much stronger than we expected. However, we have maintained our fair value estimate at AUD 52.00 per share and, at the current price of AUD 68.82 per share, continue to believe the stock is overvalued.

We continue to forecast mid-single-digit annual underlying EPS growth over the next decade, as was achieved over the past decade. The strong share price performance in recent years has outpaced the EPS growth outlook, resulting in price/earnings ratio expansion. The current price implies a fiscal 2019 dividend yield of 3.4%, or 4.9% with franking, versus 4.6%, or 6.5% with franking, at our fair value. The federal Labor party’s plan to abolish cash refunds of franking credits to nontax payers could cause share price weakness should Labor win the federal election this year.

The result was the first to incorporate the new AASB 15 accounting standard which reduced Listings revenue by about 12% and group revenue by 3%. This meant the result was not comparable with the first half of fiscal 2018 and management provided like-for-like growth rates to better illustrate the underlying performance of the business. We have adjusted our forecasts to incorporate the new accounting standard, but the change does not impact our fair value estimate.

First-half net interest growth of 51% was much higher than our 5% full-year forecast and the average annual increase of 5% over the past 10 years. Management attributed the increase to the 16% increase in collateral balances, relating to growth in open futures positions, and an increase in investment spreads in the first half. We have increased our full-year interest forecast but don’t expect the strong first-half growth to be sustained in later years.

The first-half result was solid across the divisions, with like-for-like group revenue up 6.5% but EBITDA rising just 2.1% due to expenses growth of 9.4%, relating to reinvestment in the business. Management maintained their 9% full-year expenses growth guidance which is in line with our forecast. We expect expenses growth to fall to mid-single-digit rates from fiscal 2021 and management confirmed this was also their expectation. Divisional revenue growth rates were reasonably consistent with the mid-single-digit rates achieved in prior recent periods and with our forecasts. Capital expenditure guidance of AUD 70 to 75 million was maintained and is also in line with our forecast.

The key challenge facing ASX continues to be to increase earnings growth beyond the mid-single-digit EPS growth generated by its Australian listed securities businesses. The main initiative in this regard continues to be the implementation of distributed ledger technology, or DLT, to replace the Clearing House Electronic Sub Register System, or CHESS. Management believes the DLT system has the potential to create new revenue streams, but the project still has many hoops to jump through and no details have been provided regarding monetisation of the technology. At a minimum, however, we expect the company to maintain its existing clearing and settlement revenue, which combined comprise about 12% of group revenue.

ASX also hopes to create a real estate conveyancing platform via its investment in Sympli, a joint venture with real estate software provider ATI. However, we don’t include earnings from this business in our forecasts at this stage due to the early stage of the business and limited visibility of its ultimate success. In addition, Sympli will need to compete with PEXA which was created by Australian state governments and the major banks, among others, and appears to be rapidly building a network effect and strengthen its monopoly in the electronic conveyancing market.

From a balance sheet perspective, ASX remains extremely strong with no debt, AUD 7.3 billion in participants’ margin commitments, and AUD 1.1 billion in ASX-owned cash, of which AUD 202 million is free to use. Although expenses growth and capital expenditures will be relatively high in fiscal 2019, we are comfortable regarding the sustainability of fully franked dividends.