Local stock exchange operator Bursa Malaysia (RM8.10) is slated to announce its earnings results for the first quarter of 2011 on Tuesday. We expect the company’s net profit to be better than the RM29.8 million it made in 4Q10, on the back of higher trading volume for both equities and derivatives during this period.

Global stock markets started 2011 on a strong footing. Despite having chalked up hefty gains — from the lows during the worst of the global financial crisis — investor confidence in the continuation of the rally was underpinned by evidence that the global economic recovery was gaining traction as well as ample liquidity.

On the local bourse, the benchmark index, the FBM KLCI, rose to an all-time high of 1,577 points in the first week of trading in the new year. In particular, retail participation in the local bourse picked up strength as lower liners saw rejuvenated interest. Retail investors accounted for about 27% of the daily average trading value in 1Q11, up from 26% in 2010.

Sentiment on the local stock market was further buoyed by expectations of increasing economic activities from the rash of infrastructure and construction projects announced under the various government initiatives, including Budget 2011, 10th Malaysia Plan and Economic Transformation Programme (ETP).

The securities daily trading volume averaged at roughly two billion shares in January-February 2011 — about double the average number of shares transacted daily in 2010. Trading activities slowed in March with sentiment buffeted by the massive earthquake in Japan and its aftermath as well as the growing political unrest in the Middle East and North Africa (Mena). The number of shares traded daily for the month dipped to about 1.3 billion shares on average.

Nonetheless, daily trading value still averaged at RM2.23 billion — compared with RM2 billion in 4Q10 and well above the RM1.53 billion recorded in 1Q10 — suggesting better securities trading revenue for Bursa.

Increased volatility in commodity prices boosts derivatives trading
We also expect stronger derivatives trading revenue for 1Q11. The total number of derivatives contracts traded was sharply higher — averaging some 36,785 daily compared with 27,776 and 23,889 in 4Q10 and 1Q10 respectively.

The robust volume was attributed to increased hedging activities amid heightened volatility in global commodity prices. Trading in the futures crude palm oil (FCPO) was brisk as CPO prices surged as high as RM3,970 per tonne in early February before giving back some gains.

Fresh uncertainties may keep some investors sidelined
Looking ahead though, at least for 2Q11, securities trading volume — and by extension, Bursa’s revenue — appear likely to be pared back in view of prevailing external uncertainties.

If the drop in equity trading volume in March is any guide, at least some investors are moving to the sidelines pending greater clarity on the global economic outlook.

The earthquake-tsunami and resulting power outages in Japan are expected to cause disruption in the global supply chain for the next few months. This would affect production output and damp economic growth. Positively, spending on reconstruction should provide a fillip to the country’s economy later in the year and going into 2012.

Meanwhile, political unrest in Mena has driven crude oil prices higher, causing additional problems for countries already grappling with rising inflationary pressures from high commodity prices.

Food prices have been on an uptrend and show little signs of reversal. Crude oil futures traded on the New York Mercantile Exchange are currently hovering at the highest levels since the onset of the financial crisis, reaching US$113 (RM341.26) per barrel early this week — well above the price of US$91 per barrel at end-2010.

Rising prices will eat into consumer disposable incomes and hurt spending. Tighter monetary policies by governments — in attempts to cool inflation — would have a further dampening effect on growth.

On a positive note, the US economy appears to be recovering nicely, supported by the Federal Reserve’s extremely loose monetary policy. Short-term interest rates remain near zero. Consumer spending is on the mend on the back of encouraging signs of improvement in the employment market.

On the other hand, the Fed’s US$600 billion quantitative easing plan is slated to end in June. It is uncertain how the reversal in liquidity and a gradual rise in interest rates from thereon will affect the US recovery and more significantly, prices for global stocks. Thus far, cheap money has found its way into stocks and commodities in search of higher returns.

Hence, we are inclined to assume that securities trading volume on the local bourse will be lower for the rest of the year on average, compared with that recorded in 1Q11 — at least for now.

Derivatives growth to strengthen
Outlook for the derivatives market appears clearer at this point. We estimate a 20% volume growth for derivatives this year.

It is uncertain how big a part the migration to Globex has on the sharply higher trading volume in 1Q11. But as global investors gain in familiarity with our products, especially the FCPO, volume should rise.

Bursa expects its derivatives trade volume to double by 2013. To cater to future growth, the company will be implementing a new clearing system by 4Q11. It is also working closely with the CME Group on new products to enhance the existing range.

Longer term plans to remain competitive
Going forward, Bursa is planning on various measures to keep the local bourse a competitive listing destination as well as an attractive investing place for investors.

For starters, a positive outlook for the domestic economy over the next few years, underpinned by the government’s ETP, bodes well for corporate earnings growth.

One of the measures to improve market velocity is to attract greater — and sustained — retail participation, especially given the nation’s relatively high savings rate.

In this respect, Bursa is undertaking nationwide roadshows to educate the investing public. Programmes such as the CBRS Scheme that provides free analyst reports and “In the Spotlight @ Bursa Malaysia” are aimed at raising the profile of under-researched companies.

These measures could also help improve investors’ perception of foreign companies listed on the local bourse. So far, many of the China-based companies listed here have not fared so well. This could be attributed, in part, to the lack of familiarity with their products and businesses.

Bursa hopes that with time, earnings track record and better information flow, local investors will gain greater confidence in these stocks. It does expect a few more foreign company IPOs this year.

To further enhance the breadth and depth of its product range, the company is exploring the possibility of facilitating the trading of select foreign-listed companies on the local bourse in the ringgit currency. This would ease the process for local funds to diversify their investments overseas.

Against the backdrop of mergers and acquisitions (M&A) for stock exchange operators around the world, Bursa is working with six other regional bourses to create a bigger “Asean marketplace” — aimed at boosting the region’s visibility, product range and liquidity, which would, in turn, be more attractive to foreign funds.

The collaboration will create an electronic trading link between the different markets to facilitate and enhance accessibility for cross border trading.

Under the first phase, Bursa targets to link up with the Stock Exchange of Thailand and the Singapore Stock Exchange (SGX) by end-2011. This will be followed by links with the Hanoi Stock Exchange, the Hochiminh Stock Exchange, Indonesia Stock Exchange and the Philippine Stock Exchange.

For the moment, there are no concrete plans to take things further, in terms of M&A with other foreign stock exchange operators. The failure of the SGX-Australian Securities Exchange (ASX) merger proposal highlights the fact that for the sale of such key assets, the issue of “national interest” remains a major stumbling block.

Nonetheless, the pressure to merge may intensify in the long run. Ongoing M&A deals — such as the London Stock Exchange-Toronto Stock Exchange and Deutsche Boerse-NYSE Euronext — will create bigger exchanges with wider reach and economies of scale that would pose increasingly stiff competition for investor dollars.  

Fairly valued but pays decent yields
Whilst there remain uncertainties on the global economic outlook going forward, investor sentiment is likely to stay relatively upbeat, underpinned by a resilient domestic economy. Thus, we estimate trading volume for securities and derivatives for the year to average higher going forward.

Net profit is estimated at RM122.7 million, up 9% this year, and to expand further to RM133.9 million in 2012.

That prices Bursa’s shares at 35.1 and 32.1 times our estimated earnings for the two years, respectively. Whilst its valuations appear on the high side, we believe the stock will continue to attract interest as a proxy for our economy.

Capital expenditure (capex) is estimated at around RM30 million to RM40 million for the current year, including capex for the new derivatives clearing system and general maintenance. Bursa had some RM512 million in available financial resources at end-2010.

The company’s balance sheet and cash flow from operations can support its high dividend payout. Assuming the same level of profits payout as that in 2010, dividends are estimated to total 21.7 sen and 23.7 sen per share for 2011-2012 respectively. That will earn investors fairly decent net yields of 2.7%-2.9% at the prevailing share price.

Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.

This article appeared in The Edge Financial Daily, April 15, 2011.