Singapore Exchange is a demutualised and integrated securities and derivatives exchange, offering an array of securities products including equities, bonds, debentures and loan stock, exchange traded funds, warrants and structured warrants, depository receipts, and real estate investment trusts. Derivatives products consist of short- and long-term interest rate futures and options on futures, equity index futures and options on futures, single stock futures, and energy futures.

We rate SGX Sell/Low Risk rating, with a target price of S$4.70. There are several fundamental positives about SGX - management have proactively diversified its revenue streams and deepened existing ones, running with the bulls of the past four years yet maintaining a lean and mean cost base, plus almost all of annual earnings have been distributed as dividends. Unfortunately, history suggests SGX may slide further until the present bear market reaches its trough. Profit expectations are still largely dependent on (volatile) securities market turnover, which we view will continue to wane until the bear market comes to an end.

Our target price for SGX is S$4.70. Our target price is derived assuming a FY09E ROAE of 30%, a dividend payout of 90%, cost of equity of 11.3% and long-term growth of 6.9%, deriving a FY09E fair value P/E of 20.5x. We use a dividend discount model as our primary valuation tool, because given SGX's inherently cyclical profit profile, the market needs to focus on what is a sustainable level of dividends to provide a core valuation for the stock. SGX's current dividend policy is to pay a minimum net cash dividend of the higher of S$0.14/share or 80% of annual net profit, but for the FY08 results declared a 91% payout. Using a P/E cycle analysis (based on consensus earnings), SGX has traded in a range of 14.4x at the trough and 24.6x at the peak (based on a +/-1SD band), with a mean of 19.5x for the period since listing. Our target price is based on a target multiple which is just above the mean cycle P/E.

We rate Singapore Exchange as Low Risk, in line with our quantitative risk-rating system. Key upside and downside risks to our target price: [a] SGX acts as a leveraged proxy to the Singapore market (STI). Upside could come from an improved economic outlook or a more benign global interest rate outlook, while further news of slowdown implies downside; [b] Volatile turnover: Market volumes could fall off sharply (negative), or conversely exceed our current forecast assumptions (positive); [c] Global sector re-rating/M&A: Our current view is that a cross-border M&A re-rating is unlikely to be realized in Asia, but SGX management's position is that it remains open to talks on M&A, although this depends on 23% shareholder MAS; [d] Capital management: With June 2008 liquid assets of over S$500m (S$0.47/share) capital management through special dividends is possible.