Last weekend we highlighted a note [8] out of Deutsche Bank where analysts hiked their target on shares of Hong Kong Exchanges and Clearing. HKEx is running at “full throttle” DB said, thanks to inflows from the mainland (attributable to new regulations in China which allow mutual funds to invest in Hong Kong-listed shares and to investors hunting for “bargains” outside of the Shanghai bubble mania) and things can only get better from here what with “sustained interest from Chinese investors focused on discounted Hshares, and potential growth in scale and scope of Stock Connect.”
As it turns out, DB made a good call here as the only thing more exciting than betting on the continuation of a margin-fueled, self-feeding domestic mania is betting on the exchange where the maniacs are trading, which is why, as Reuters reports [9], shares of HKEx are up 40% in just the past 6 trading days and is now the world’s largest exchange operator with a P/E ratio that’s double that of CME. Here’s more:
Shares in Hong Kong Exchanges and Clearing Ltd (HKEx) have risen about 40 percent in the past six days on an unprecedented flood of mainland investment in Hong Kong stocks. Average daily turnover hit a record HK$291 billion ($37.54 billion) last Thursday, nearly three times the historical average.
The HKEx is now the world's biggest bourse operator with a $43 billion market value, ahead of rival CME Group Inc. Its price-to-earnings (P/E) ratio has jumped to 45 times, while CME trades at a P/E of 23. No company in the Hang Seng Index matches that.
The P/E estimate is based on increased daily turnover flowing through the rest of the year. A Reuters poll of six analysts estimated average daily turnover of HK$103 billion for the rest of 2015 versus HK$86 billion in the first quarter...
HKEx, which derives two-thirds of its profits from equity trades, is well placed to benefit from more initiatives such as the planned Shenzhen-Hong Kong connect scheme, and as investment quotas for the Hong Kong-Shanghai pipeline are increased.
As we showed a few days back, market turnover is now above the levels seen in 2007 and average turnover from March 30 to April 10 was 120% greater than average turnover from January 1 to March 27.
But as Citi will tell, you, there may be a long way to go before we reach peak absurdity in Asia because the indexed average turnover shows that we’re only about half way there in terms of duplicating the surge in turnover that took place in 2006-2007 (and remember, whether it’s EV/EBITDA levels, CDO issuance, subprime lending, or record tight credit spreads, it’s all about getting back to 2006 or, in other words, completely reflating the bubble). Here’s Citi:
The bull run in 2007 suggests turnover rises in stages and by 10x in its full course. Given a different cyclical backdrop and structural drivers ahead, we believe recent turnover rise is likely the start of a secular uptrend. We raise our 15E-17E EPS forecast by 39-42% (33-36% above consensus) and roll our TP to HK$400 (42x mid-2016 P/E), based on HK$150bn daily stock turnover.
Reminiscent of 2007? We are probably just at mid-point
From 2006 to the market peak in late 2007, stock turnover (we use two-week moving avg.) rose by c.10x from HK$16bn to HK$170bn. Meanwhile, since 2014, stock turnover has risen by <5x from HK$48bn to currently HK$230bn. If 2006-2007 is a guidepost, current turnover uptrend is just half way done, and may reach c.HK$500bn over time.
We emphasize the turnover rally (of 10x) in 2007 took place in the absence of actual launch of "through-train". This time, the SH-HK Connect has kick-started, and liquidity flow to HK is bound to rise over time (e.g. raising quota of SH-HK Connect; launch of Shenzhen-HK Connect; fund flow through China banks). We also stress that China has huge savings (e.g. Rmb120trn of deposits) and institutional funds (e.g. Rmb5trn of mutual funds; Rmb11trn of insurance assets), vs merely HK$30trn of HK stock market cap.
So Citi is looking for 42% EPS upside and a 42X multiple, and why not? Because as we pointed out earlier this month [10], Chinese retail investors opened enough stock trading accounts in March for every man, woman, and child in Los Angeles and when we checked the data from the China Securities Depository and Clearing Co., we were not at all surprised to learn that there were 3.2 million more accounts opened in just the first two weeks of April meaning this month is on pace to beat last month by 63%.
The easier China makes it for this new money to find its way due south, the crazier things are likely to get in Hong Kong and that means that the investment thesis for the exchange makes some measure of sense. However, this has thus far been a self-fulfilling prophecy of sorts. That is, gains beget more gains as no one wants to miss the boat and as we've noted on a few occasions lately, it doesn't matter how much you overpay, as long as someone else is willing to pay more and in that type of envirornment, where a rising tide lifts all boats, it's easy to overlook the fact that these very same "investors" will have the very same herd mentality when the tide goes out, meaning that if something shakes their collective confidence, the whole is likely to crumble in spectacular fashion.
We'll leave you with the following chart showing the "interstellar" (to quote Reuters) move in shares of HKEx.
