23 April 2013 Asia Pacific/Japan Equity Research Brokerage (Brokerage & Asset Managers (Japan)) / OVERWEIGHT Japan Exchange Group (8697.T) Rating NEUTRAL* [V] INITIATION Price (22 Apr 13, ¥) 11,850 Target price (¥) 11,500¹ Chg to TP (%) -3.0 Valuation reliant on market for now, expansion Market cap. (¥ bn) 650.65 (US$ 6.52) of exchange offerings over the medium term Enterprise value (¥ bn) 650.65 Number of shares (mn) 54.91 ■ Initiate at NEUTRAL: We initiate coverage of Japan Exchange Group (JPX) Free float (%) 54.8 with a NEUTRAL rating and ¥11,500 target price. The market rebound of 52-week price range 12,190 - 3,885 *Stock ratings are relative to the coverage universe in each late 2012 has led to increased trading of both cash equities and derivatives, analyst's or each team's respective sector. which has fuelled raised expectations of operating revenue growth that are ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix). currently driving the stock. Integration of the TSE and OSE platforms is proceeding, but we think the share price currently reflects trends in the Research Analysts markets. Valuations have not changed much since before the merger, and Takehito Yamanaka the stock presently trades at 18x prospective FY3/14 P/E. Equities trading 81 3 4550 9150 [email protected] value has recently topped ¥3tn on some days but, given that we view this as historically atypical, we see further upside as limited. ■ Investment case: We believe the stock could be positively re-rated over the medium term if JPX can boost the proportion of high-growth offerings in its line-up by strengthening alliances with overseas exchanges or expanding the range of instruments, such as derivatives, that it offers. In addition, expanding derivatives operations as a share of overall business could help stabilize earnings during periods of elevated market volatility. ■ Risks: Brisker trading of cash equities or derivatives would be positive for earnings and the share price, but the converse would also apply. ■ Valuation: Our ¥11,500 TP is based on 1Q FY3/14E annualized ROE of 27.85% and a discount rate of 6.5%, implying a P/B of 4.28x and P/E of 14x (annualized) 1Q projected EPS of ¥205.8. We think trading value for cash equities and derivatives are the key drivers of the stock at present. We would expect the persistence of these conditions to support the share price at current levels. Share price performance Financial and valuation metrics Year 3/12A 3/13E 3/14E 3/15E Price (LHS) Rebased Rel (RHS) Revenue (¥ bn) 75.5 81.4 121.1 112.9 12000 400 Operating profit (¥ bn) 17.5 23.4 60.7 57.3 300 7000 200 Recurring profit (¥ bn) 20.1 26.5 63.5 60.4 100 Net profit (¥ bn) 11.8 14.2 37.2 36.4 2000 0 EPS (¥) 214.6 258.6 677.5 662.9 1-13 Change from previous EPS (%) n.a. The price relative chart measures performance against the IBES Consensus EPS (¥) n.a. 314.5 334.9 414.1 TOPIX which closed at 1145.6 on 22/04/13 EPS growth (%) n.a. 20.5 162.0 -2.2 On 22/04/13 the spot exchange rate was ¥99.72/US$1 P/E (x) — 45.8 17.5 17.9 Dividend yield (%) — 0.7 1.7 1.7 Performance Over 1M 3M 12M BPS (¥) 2,470.1 2,476.6 3,145.0 3,808.0 Absolute (%) 45.9 119.4 — P/B (x) — 4.8 3.8 3.1 Relative (%) 35.6 90.4 — ROE(%) 6.5 9.0 24.1 19.1 Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates. DISCLOSURE APPENDIX CONTAINS ANALYST CERTIFICATIONS AND THE STATUS OF NON US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 23 April 2013 Table of contents Investment case 3 Initiating coverage at NEUTRAL with ¥11,500 TP 3 Share price will likely depend on trading volume in the near term 4 Diversification offers potential route to additional underpinning of stock valuation 4 Valuation 7 Only three months of trading history as JPX 7 Valuation level could rise with more derivatives-rich revenue base 8 Earnings forecasts, merger effects 9 Earnings have rebounded sharply on rally in equities 9 Plan sets market assumption-based earnings targets 10 Domestic competition 13 A growing settlement business 13 Future issues 14 International comparisons 14 Company outline and establishment of JPX in 2012 16 Japan Exchange Group (8697.T) 2 23 April 2013 Investment case Initiating coverage at NEUTRAL with ¥11,500 TP The rally in Japanese equities since November 2012 has helped revive the performance of JPX and boost its share price. The stock wavered momentarily after the formal listing of JPX on 4 January as brokers that had owned stock in the TSE disposed of JPX shares (as evidenced by several listed securities firms disclosing gains on the disposal of securities in January). JPX stock has since risen sharply, however, buoyed by higher equities trading volumes and market expectations that the rally in Japanese shares is set to extend. Figure 1: JPX outperformed TOPIX: Relative performance Figure 2: Both cash & derivative trading expanding vs. TOPIX recently 250 (¥tn) (Thousand trading unit) 6.0 2,500 Spot trading stocks (RHS) Jan 4, 2013=100 200 5.0 Nikkei 225 futures Nikkei 225 minii 2,000 4.0 Nikkei 225 options 150 Topix sector index futures 1,500 10-year JGB futures 3.0 100 1,000 2.0 500 50 1.0 0.0 0 0 11/30/2012 12/10/2012 03/10/2013 10/01/2012 10/11/2012 10/21/2012 10/31/2012 11/10/2012 11/20/2012 12/20/2012 12/30/2012 01/09/2013 01/19/2013 01/29/2013 02/08/2013 02/18/2013 02/28/2013 03/20/2013 03/30/2013 04/09/2013 01/09/2007 05/29/2008 04/02/2004 12/11/2004 08/21/2005 05/01/2006 09/19/2007 02/06/2009 10/17/2009 06/27/2010 03/07/2011 11/15/2011 07/25/2012 04/04/2013 Source: Thomson Reuters Source: TSE, OSE, Bloomberg We forecast RP of ¥26.5bn and NP of ¥14.2bn for JPX in FY3/13, based on assumptions JPX shares have already outlined below and calculating these earnings as simple aggregates for TSE and OSE. priced in elevated activity in According to the company’s disclosure based accounting, its RP was ¥22.8bn and NP cash equities and ¥12.2bn. For FY3/14, we forecast RP of ¥63.5bn and NP of ¥37.2bn. We calculate our derivatives markets ¥11,500 TP using a theoretical P/B and ROE annualized from quarterly data. Based on end-1Q FY3/14E BPS of ¥2,682.4, 1Q annualized ROE of 27.9% and a discount rate of 6.5% (using a risk-free rate of 1%, a 5.5% equity risk premium and beta of 1.0), our TP implies a P/B of 4.29x and a P/E of 14x projected 1Q annualized earnings. Average daily trading value for cash equities has recently exceeded ¥3tn. For trading volume to rise further, not only expectations of economic recovery but also solid evidence that the recovery is entrenched will likely be necessary. We initiate coverage with a NEUTRAL rating. Japan Exchange Group (8697.T) 3 23 April 2013 Figure 3: Daily trading value of spot-trading stocks (¥tn) 6.0 5.0 4.0 3.0 2.0 1.0 0.0 1/07 1/91 1/92 1/93 1/94 1/95 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05 1/06 1/08 1/09 1/10 1/11 1/12 1/13 1/90 Note: Spot trading stocks trading value total = TSE 1st section, 2nd section + Mothers + OSE 1st section, 2nd section + JASDAQ Source: TSE, OSE, Bloomberg Share price will likely depend on trading volume in the near term JPX shares have continued to rally because the surge in trading value has transformed earnings prospects. Management released an outline of its latest medium-term business plan along with 3Q FY3/13 results. Since the LDP regained power, Japanese equities have rallied on hopes of economic recovery and an escape from deflation. The so-called “new dimension” in monetary easing by the BoJ has supplied a further boost. Such short- term market dynamics are guiding the shares of highly market-sensitive financials such as JPX and the brokerages. We see trading value, which are the principal variable affecting operating revenues, as the primary near-term share price driver. Diversification offers potential route to additional underpinning of stock valuation Exchanges that generate more earnings from derivatives trading typically command higher Valuation multiple could rise valuations. From its listing until December 2012, OSE shares traded in a P/E range of 9– with higher ratio of 40x, with an average multiple of 18.6x. JPX shares have traded on a P/E of about 20x derivative fees or expansion since the TSE merger in January.