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Morningstar | ASX Still Looks Expensive Despite Strong First-Half Capital Raisings. See Updated Analyst Note from 07 Jan 2019

Wide-moat-rated ASX continues to look expensive despite strong growth in equity capital raisings in the first half of fiscal 2019. ASX data for December 2018 indicates that AUD 62 billion in equity capital was raised in the first half, up 38% on the prior comparable period, most of it explained by the AUD 16 billion Coles demerger from Wesfarmers. However, since the local bull market peaked last August, capital-raising conditions have deteriorated, causing initial public offerings like PEXA to be cancelled in the second quarter of fiscal 2019. We expect capital raisings to normalise in the second half, in addition to the usual seasonal slowdown, and don’t believe first-half growth will be repeated.

We maintain our near-term earnings forecasts but have increased our long-term annual earnings growth forecast to 4% from 3%, which better aligns with our forecast EPS compound annual growth rate of 4.7% over the next decade. This has increased our fair value estimate by 6% to AUD 52 per share. However, at the current market price of AUD 61.88, we continue to believe the shares are overvalued. The market price implies a fiscal 2019 price/earnings multiple of 25 versus 21 at our fair value estimate and just 14 for the S&P/ASX 200 index. Over the past decade, ASX’s P/E has gradually increased, trading between a low of 12 and the recent high of 27. ASX’s market-implied dividend yield is 3.7%, or 5.3% including franking, but would be 4.4%, or 6.3% with franking, at our fair value estimate.

Despite strong capital-raising activity, the number of stocks listed on the ASX fell slightly in December and is up only 0.4% on the prior year, in line with the CAGR over the past decade. Although ASX hopes to increase listings, particularly in the overseas technology sector, we remain sceptical about its ability to do so.

The ASX has historically comprised mainly Australian companies with a high proportion of small and speculative resource companies. If anything, this situation will worsen as new high-quality technology companies chase broader and deeper investor pools on U.S., European, and Asian markets. ASX’s intention to tighten listing rules is also likely to reduce the number of small, low-quality, overseas companies on the market.

While the ASX share price has increased 54% over the past three years versus 12% for the S&P/ASX 200 index, the one-year forward P/E ratio has risen to 24 from 18, versus the ASX 200 P/E falling to 14 from 15. Although it’s justifiable that ASX trades at a P/E multiple premium to the market, the increase in the premium to around 70% currently, from 20% in 2016, looks excessive. Looked at another way, ASX now has an EPS yield of around 4% versus 7% for the ASX 200 index, although earnings growth rates are likely to be similar for both.

To justify its relatively high P/E multiple, ASX needs to increase its earnings growth prospects beyond the mid-single-digit EPS growth generated by its Australian listed securities businesses. Management hopes growth will partly come from the planned distributed ledger technology, or DLT, which will replace the Clearing House Electronic Subregister System. However, although the DLT system has the potential to create new revenue streams, the project still has many hoops to jump through and no details have been provided regarding potential monetisation of the technology. At a minimum, however, we expect the company to maintain its existing clearing and settlement revenue, which combined constitute around 12% of group revenue. We await further progress with the DLT project before potentially incorporating more upside into our revenue forecasts.