The China Trading Tollbooth

Erik@YWR on Hong Kong Exchanges & Clearing Ltd. (388-HKG | hongkongexch)

5/4/2025

Summary

HK Exchange and Clearing's (HKEX) trading volumes and earnings will grow significantly through 2028 as the Chinese economy recovers, the stock market gains, derivative volumes grow, and investors globally increase their China and HK allocations from low levels. Investors will underestimate, as they did in the previous bull market from 2002-2007, the earnings upside in HKEX as this multi-year trend unfolds. Earnings are expected to grow at a 17% CAGR from 2024-2028. The price target for year end 2027 is HK$ 425/share which is 27x the estimated 2027 EPS of HK 15.4/share. In addition HKEX typically pays out over 80% of earnings as dividends as the business does not require much additional capital to grow.

Thesis

HKEX is the best way to play a recover in China's economy and its capital markets. Since 2021 China has suffered a series of economic shocks from COVID to a property development crisis. As a result stock market valuations are near all time lows, and investors have minimal allocation to the Chinese market despite it being the second largest economy in the world. Government stimulus, low valuations and lack of investor exposure to China are the set up for a strong rally in Chinese capital markets. In addition it is now Chinese government policy to encourage speculation in the stock market rather than property. Chinese stock market rallies can have a surprisingly powerful effect on the earnings of HKEX, the primary global stock exchange for trading Hong Kong shares and China H-Shares (mainland Chinese stocks listed in HK). In the previous bull market from 2002-2007 HKEX's earnings surged 9x from HK 0.57 to HK$ 5.78. Investor expectations are currently conservative with consensus EPS expectations of just 7% p.a from 2024-2027. In a bull market HKEX will benefit from growing cash equity trading volumes, derivative volumes, listing volumes and back office settlement fees. Since costs are relatively fixed and grow at 5%/year, there is tremendous earnings leverage. As a result earnings growth of 17% p.a through 2028 is more likely. In addition to the cyclical benefit of a recovery in Chinese capital markets, HKEX is also building its position as the gateway to trading in China. Revenues from Southbound Connect (mainland Chinese trading in Hong Kong) together with Northbound Connect (HK and global investors trading on mainland Chinese exchanges) were 12% of group revenues in 2024, up from 11% in 2023. In addition to cash equities (42% of revenues), equity derivatives (28% of revenues), data revenues (10% of revenues) and other items (8% of revenues), HKEX also earns 12% of revenues from commodity trading. HKEX purchased the London Metals Exchange in 2012 and has been growing the mainland Chinese commodity contracts.

Risks

Earnings at HKEX are highly cyclical and based on trading volumes which are hard to predict. The HKEX share price is highly correlated to the movement of the HK stock market and will decline if there is a sell off in the market. It is possible in an extreme scenario that the Chinese regulators could decide they want to make Shanghai the financial capital of China and move trading volumes to Shanghai, or shut down the Southbound Connect and Northbound Connect trading links. Any capital controls on the HK$ would also make it impossible for Hong Kong to operate as a financial center.

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