To The Moon

Downturn in stock markets around the world including in Singapore since the start of 2022 might decrease our portfolio value, but on the flip side, it increases opportunities to “buy wonderful companies at a fair price”, to quote Warren Buffett, one of the greatest investors of our times.

How do we uncover such wonderful companies in Singapore, one might ask?

ROIC vs WACC

Well, Buffett uses Return On Invested Capital (ROIC) that looks at companies efficiency in allocating capital under their control to generate returns (see formula below):

ROIC Formula and Comparing ROIC – WACC of SGX (S68), Venture Corp (V03) and Yangzijiang Shipbuilding (BS6). Data source: GuruFocus

Next, compare ROIC with Weighted Average Cost of Capital (WACC), the average cost of capital from all sources, common stock, preferred stock, bonds, and debts, employed to generate returns. If ROIC for a company is greater than WACC by 2% (some say the legendary investor uses 20% to give greater margin of safety), the investment would likely be profitable, as the company is delivering high returns on capital, or in other words, uses invested capital efficiently.

Using freely available data from GuruFocus, I have checked the ROIC and WACC of all 30 constituents of the $Straits Times Index(STI.SI)$, as they are blue chips, and likely more stable for longer term investment in Singapore. The top 3 in terms of ROIC and WACC are shown in graph above.

As only $SINGAPORE EXCHANGE LIMITED(S68.SI)$ SGX ROIC s greater than WACC by more than 20% at 26.17%, meeting Buffett’s criteria, but not the other two, $VENTURE CORPORATION LIMITED(V03.SI)$ (10.24%) and $YANGZIJIANG SHIPBLDG HLDGS LTD(BS6.SI)$ (6.66%), I decided to focus only on SGX Fundamentals for this post.

For more on ROIC and WACC, I’ve written another post Psst! Do you know Buffett’s Investing ‘Secret Sauce’?

FUNDAMENTALS

After the initial shortlisting of companies such as using ROIC vs WACC, we could employ Buffett’s recipe to pick wonderful companies and determine fair price, condensed here into 4 steps:

Warren Buffett’s stock picking recipe. Source: via @TigerEvents

For posts from Tiger community on using the recipe, see @TigerEvents: Recommend a Stock to Warren Buffett

I will attempt to apply this recipe to determine if SGX, the company that runs the Singapore Exchange, could be recommended to friends, and dare I say, to Warren Buffett himself for investment…

1. Buy Businesses, not stocks

The first step is to understand the person leading the company. For SGX, Loh Boon Chye has been CEO of Singapore Exchange (SGX) since mid-July 2015, and has played a key role in the development of Southeast Asia’s capital markets.

CEO SGX Loh Boon Chye. Image credits: SGX

With close to 30 years of experience in the financial industry, his career journey brought him through Bank of America-Merrill Lynch, Deutsche Bank where he spent 17 years, Monetary Authority of Singapore (MAS) and Morgan Guaranty Trust Co, NY. Boon Chye currently sits on the boards of GIC, EDB Singapore, World Federation of Exchanges, and is a council member and Distinguished Fellow at the Institute of Banking & Finance Singapore.

Based on interviews and articles, he came across as a firm believer of mutual growth through international collaborations and partnerships between financial markets. Together with his team, his priority is to grow SGX into a leading global marketplace for equities, fixed income, currencies and commodities (FICC).

Thus, SGX looks like it is well-run, helmed by a CEO with not only the vision, but also pertinent expertise and extensive experience, to grow its intrinsic value over the longer term.

2. Companies must have sustainable competitive advantages

Next, we see if SGX has sustainable competitive advantages over its competitors. Its economic moat are in the following:

• Sole Exchange Operator in Singapore. As the only Exchange in the island state dating back 49 years, it has natural monopolistic advantage. With about 40% of its 665 companies (May 2022) and over 80% of listed bonds originating outside Singapore, SGX is Asia's most international and connected Exchange (with links to China, India, Japan, Asean, Nasdaq bourses). Even if Singapore financial regulator allows another exchange company to operate; there would be high barriers of entry; new entrants need efforts to build the extensive listing portfolios and time to produce the track records that engender trust by companies and investors alike.
• Baltic Exchange is the leading marketplace that provides real-time benchmark indexes for global rates to traders for settling physical and derivative shipping contracts. Established in London in the 18th century and acquired by SGX in 2016, it brings together Singapore and London’s complementary strength as global maritime freight centres.
• Energy Market Company, which SGX operates, is Singapore’s only wholesale electricity market for businesses and consumers.

SGX Group of companies and strategic investments. Source: SGX

SGX is also investing strategically in innovative and emerging range of products, platforms and partnerships, to strengthen its leading position as the multiple fixed income, currencies and commodities (FICC) asset classes Exchange in the region. These include:

• BidFX and MaxxTrader, specialised buyside and sellside trading platforms for global FX and its derivatives OTC markets
• Trumid XT, a US corporate bond e-trading platform
• Marketnode, a platform to issue and trade digital bonds through the use of smart contracts, ledger and tokenisation technologies
• Scientific Beta, a research and consultancy service that uses smart beta, or alternatives to market cap, to construct index funds. These include building funds that capture investment factors (or opportunities) ranging from volatility to liquidity, value to momentum, and inflation to ESG to climate impact
• Climate Impact X, a global carbon exchange and marketplace to buy and sell carbon credits, supporting institutions and companies in their carbon reduction and climate change mitigation initiatives.

Overall, SGX existing economic moat and its strategy of partnerships and investing in leading edge growth areas would keep SGX ahead of the competition from other Exchanges in the region, for the foreseeable future.

3. Focus on long-term intrinsic value, not short-term earnings

SGX’s 2021 performance has been mixed. While Revenue S$1.056b was comparable to 2020, its Operating, Net Profit, EPS and ROE decreased about 6% year on year (see graphic below).

SGX Business at a glance in FY 2021. Source: SGX Annual Report 2021

SGX main Revenue generator continued to be Equities (66%) but the FICC segment (20%) would be its future engine of growth, as shown by the company’s large capital expenditure through partnerships and acquisitions there. Despite this, SGX Dividend yield is a respectable 3.31%, and it has a healthy Payout ratio of 80.69%, returning significant portions of profit to investors.

SGX Dividend Yield TTM. Source: SGX / Tradingview

For longer term investment, how much Revenue, Profits, Debt and Cash flow the company could generate over time are more important metrics, rather than the yearly snapshot of performance.

SGX Income statement, Balance sheet and Cash flow. Source: SGX / Tradingview

From the past 5-year trend graphs (see above), SGX:

• Has steadily grown its Revenue, although it was flat for the last two years. Net income and Profit margin were also growing, although the higher capex in 2021 has eaten into its margin.
• Total assets value has consistently outweighed its Total liabilities. While it has used borrowings to fund increased in capex in the past two years, the Debt to assets ratio was maintained at manageable 53 to 54%.
• Has a healthy Operating Cash flow of above S$350m, and in the past two years, has increased this to the range of S$570 to S$638m.

All in all, SGX trend in Revenue, Income and Profit remain strong, Debt level is manageable and Cash flow is healthy. These point to a well-run business that generates longer term returns and add intrinsic value for the investors.

4. Demand a margin of safety

Based on the closing price of S68 at S$9.67 on 10 June 2022, we can see that it is 13.4% below fair value calculated using Discounted Cash Flow (DCF) estimates (see below). As Buffett would advise, it is better to buy companies when it is trading for less than its intrinsic value, to provide a greater margin of safety. SGX stock certainly fulfils this criteria currently.

SGX S68 Valuation using DCF estimates. Source: Simply Wall St

Despite the negative start to 2022, SGX (S68) is the best performing Exchange holding company versus its regional peers, where its stock price has risen +3.09% year to date (YTD). This is followed by Malaysia (BURSA) +1.55%. All the other major Exchanges in Asia and Oceania, Australia (ASX), Hong Kong (388) and Japan Exchanges (JPXGY) are underwater, with stock prices losing close to -15 to -30% (see graph below).

For comparison, Singapore benchmark index STI is also in positive territory, but at a modest +1.51%. This showed resilience in the stock price of SGX despite it being undervalued, and another plus point to consider for investing in the company.

YTD: SGX (S68) stock performance vs regional Exchanges: Malaysia (BURSA); Australia (ASX); Hong Kong (388), Japan (JPXGY)

Overall, SGX stock is undervalued, below its fair price, and with its relatively resilient share price, could provide solid longer term investment option.

TECHNICALS

Besides Fundamentals, we would like to review S68 stock price action over time, and relative to its fair value, when initiating long positions. If we are already invested and would like to find an exit, would this be the right time? This is where Technical analysis comes in handy.

From the Daily Chart of S68, we see its price has been consolidating in the range of $9 to $10, since a sharp drop from $12.13 (13-year high) post June 2021 earnings. This was after it reported higher capex expenditure to support growth initiatives, resulting in the drop of income and profits by 6%, shared earlier.

SGX (S68) Daily Chart

In the Daily chart, Fibonacci retracement from most recent high on 4 Aug 2021 to low on 30 Nov 2021 provides levels that we could target for long and short entries.

• Long entry could be to buy at last close price of $9.67, which is a confluence of 0.236 Fib, and 200 MA, and should provide strong support. At this level, it is undervalued as explained above by 13.4%. Short term target price is 0.382 Fib level of $10.15 (+4.89%) and medium term target is 0.5 Fib level of $10.53 (+8.95%). For longer term holdings such as what Buffett would do, the target is at least 0.618 Fib level of $10.91 (+12.82%) and in future, to reach fair value of $11.12 and exceed recent high of $12.13.
• Short entry. Supposed you are already holding S68 and would like to exit or close some positions, then possible exit is when price goes below support of $9.27 (-4.10%) or drops further than recent low of $8.93 (-7.48%).

Final Recommendation

My view is $SINGAPORE EXCHANGE LIMITED(S68.SI)$ is a stock I would recommend to go Long, based on longer term strong Fundamentals and current favourable Technical levels. 

Hope what I have shared would sufficiently pique friends and Mr. Buffett's interest in SGX...

Of course as Buffett would do, if SGX's Fundamentals were to weakened considerably in the future, it is also alright to exit one's holdings, and allocate capital to other STI companies that could utilise it for better investment returns, such as Venture Corp or Yangzijiang Shipbuilding.

@TigerStars