SGX recorded a 38.9% y-o-y decline in net profit (excluding the $34m distribution from SGX-DT compensation fund in the previous period) to $74.7m in 2Q09. Earning weakness deepened during the quarter as reflected in the 12% q-o-q drop in earnings underpinned by weaker revenues from all business segments.

Despite a surge in volume (+22% q-o-q), securities market revenue tumbled 6.5% q-o-q to $1.03bn as a result of steep decline in securities prices. The ADT trend is in line with our $1.1bn ADT estimate for the full year 2009. Stable revenue fell 20% y-o-y led by reduced corporate action and lower initial listing fees with only 2 IPOs listed during the quarter.

SGX was not spared from the global reduction in derivatives trading activity. Its derivatives revenue slide 7% q-o-q led by a 12.4% decline in futures volume and a 34% drop in structured warrants volume. In particular, the Nifty futures contract dip 47% due to declining foreign institutional investor interest in India. Despite the set back, the management sees encouraging signs from the healthy year-end open interest for the Nifty contract at 25% market share and escalating trading value of structured warrants on foreign underlying securities.

The adverse market conditions did not hinder SGX’s commitment to strengthen its monopolistic status. They plan to launch the extended settlement contracts to attract more retail investors and intend to launch options on the MSCI Singapore by 3Q09. Its new OTC clearing business – Asia Clear has successfully attracted 260 counterparty accounts. Recent measures to facilitate secondary fund raising by listed companies are also a timely move to bolster trading activities.

We believe the share price underperformance in FY08 (-62% versus a 50% dip in STI) justifies its earnings vulnerability in the current downturn. SGX’s commitment to pay an annual base dividend of 14 cents, coupled with strengthening fundamentals as an Asian gateway will mitigate price downside. As the stock approaches our fair valuation of S$4.90, we are upgrading it to a HOLD.