Jse Ltd (JSEJY) CEO Nicky Newton-King on Q2 2018 Results - Earnings Call Transcript

Jse Ltd (OTC:JSEJY) Q2 2018 Results Earnings Conference Call August 2, 2018 3:00 AM ET

Executives

Nicky Newton-King - Chief Executive Officer

Aarti Takoordeen - Chief Financial Officer

Analysts

Harry Botha - Avior Capital Markets

Chris Blaine - African Alliance

Operator

Good morning, ladies and gentlemen, and welcome to the JSE Limited Interim Results for 2018. All participants will be in listen-only mode. [Operator Instructions] Please note that this conference is being recorded.

I'd now like to hand over to Ms. Nicky Newton-King. Please go ahead, ma'am.

Nicky Newton-King

Thank you very much. Good morning, everybody. Just to clarify, can everybody hear this line very well because it feels on our side very scratchy and inconsistent. Okay, I'm assuming that everybody can hear, so we're going to carry on, and, but please speak up if you feel that you, that it isn't good enough. So it's a pleasure to speak to you this morning. As you can see from our results, the first half of the year was relatively unpredictable with, as one of the [indiscernible] a tale of 2 quarters. The first quarter barely traded up significantly over the comparable period last year and flowing somewhat in the second quarter. But all of that activity has translated into significant increases across all of our drivers.

As you will see from the presentation on the website, equitable, billable equity value traded up 11%; the number of IPOs up 2 to 10 IPOs; Equity Derivatives up 4%; interest rate derivative contracts up 26%; commodities up 11%; currency 7%; and the bond nominal value traded up. So all the key drivers of JSE are up in the right direction. And this, as you know, from reading the things, translated into operating revenue up 7%. We did this time last year announce our fundamental restructuring of our business, and you can see that impacting the cost line this half. Our operating expenses down 5%. Not only made up of the headcount reduction or where you can see the significant headcount reduction in depth and its impact on operating expenses but also very well controlled tech cost.

As we say in the fins announcement, we are tracking on target with our commitment to reduce our cost by ZAR170 million by the end of next year. That's something that we are quite pleased with. The remaining portions of the costs are going to be targeted to come from the renegotiation of some of our very large contracts, but we are on track with that. That revenue increase together with the operating expense reduction translated to, and this ZAR31 million one-off tax credit, which for those of you with long memory, the tax credit is a result of us challenging the tax treatment of the impairment of the technology project at the beginning of 2012.

So that translated into the net profit after tax up 34%, 34%, which we think is a strong performance this year. We have continued to make strong investments in our infrastructure, so the ZAR42 million capital investment is primarily directed at the ITaC, which is in the closing stages of delivery. We have just delivered the pilot phase of the government ETP. And we will be putting in the final, mostly quick government bond at the end of this month, and then that project will come to a close, also something that we're having taken 10 years to get to the stage where we are pleased to have been able to deliver it in good partnership with all of our clients.

I'll ask Aarti to take us through the financials in a little bit more detail, and then we can take questions.

Aarti Takoordeen

Thanks, Nicky. So as Nicky said, the earnings growth for the first half is largely a combination of better revenue, remembering that last year's base effect was extremely low because the lull in volatility we experienced for us last year. And in addition to that, the lower headcount than we'd like as well as the headcount reductions that we saw concerning half 1 and the cost reductions that we've made on the technology costs. So the combination of that landed us on the highest EBIT margin we've reported, we've ever recorded at 49%. So that is, and the quality of that 49% EBIT margin is really coming from the cost reductions because this is not necessarily the highest-recorded revenue in any first half. 2016 was a better revenue year for us in terms of half 1.

And then included in the net finance income is ZAR5 million of interest income that relates to the once off far credit that Nicky referred to. So that far credit is split into ZAR5 million finance income earned, and the balance is against the tax charge as a credit. And so you'll see that we also grew in terms of the share profit from our Associates Street, and that's on the back of increased activity. So that landed us on, at an NPAT margin of the highest recorded NPAT margin that we've seen in any half 1 as well at 47%. So that's on the high end, but generally, half 1 is higher than half 2 NPAT margin but also significantly higher than any other margin recorded in the past. But as I said, it's because of the combination of the cost reductions and then the tax credit coming through, which is reducing significantly on our effective tax charge.

I think I want to just talk about the cash position. Very, very strong cash position as you will have seen, closing on ZAR2.35 billion. That is very positive for the group and correlated to our cost reductions and our earnings growth. And they will be having conversations with the end of the year around sharing with you ideas in terms of the cash, the employment of our financial resources.

And then surely we'll have lots of conversations and a later one-on-one around that. And then, that's it, Nicky. I don't want to point anything else out.

Nicky Newton-King

Sure. Just looking ahead to pick up the major focus point going forward, we are completing ITaC, targeting to complete ITaC at the end of this year. There are some, still some quite significant checkpoints we need to get through to make sure that clients are already and that all of our systems are ready, but we're at the pointy end of that project. When it comes to growth, as we have discussed with a number of you, as a major growth area in the future is targeted to come out of information services, we might be slightly slower. We're getting that going and we had, wanted to. But in the first, in this mix part of this year, we are completing the transition of our bond suite, bond index suite to FTSE. That will enable us to roll out more credible bonding agencies. And I'm certainly having government bond index, government bonds trading on the electronic platform will provide some good transparency there.

Our focus on cost control. I talked about the fact that we have completely, we've really taken a very hard look at this. And you can see from the slide on technology cost that the reduction in the technology cost comes across all the, almost all of the elements of tech cost from software maintenance and licenses to contractors, to connectivity and the like. And as I say, the remaining parts of that reduction are going to, are targeted to come from our major tech providers, vendors in our suite. And then we have made extremely good progress with operational resilience. We've put in nearly ZAR30 million with, of our spend this year has gone towards and upgrading the operational aspect of critical parts of our business, particularly in close trade to make sure that, as we bring in new and robust technology in the derivatives suite, our processes internally are able to handle that.

I think perhaps we haven't mentioned BDA. And just to make the point that we think BDA will be around for some time still. Although as we migrate towards the implementation of an equity CCP, an equity central counterparty, and move that clearing business into our independent clearinghouse, then how we use a back-office service like BDA will need to change. And so we are starting conversations about the design of that type of back-office service. And I'm sure that in a while but not in the immediate future, when I say a while, in great South African terms, that's probably in a couple of years just now as [indiscernible] says. We will have, we will we having conversations with vendors about what is possible to provide to us in that space.

We are not, from a technology perspective, as many of you know, inclined to be leading-edge each leaders. In our technology, we really prefer to be fast followers. So the base about the coring settlement and blockchain and the use of blockchain technology is something we follow, but we have no intent, plans in that regard at the moment. Our settlement, our scope and clearly looking at blockchain possibilities in, for its settlement, so which is, as you know, really are use cases around the world, particularly in Australia in that regard because it's low-volume, high-value transactions don't need very high latency. They're very first technologies, and blockchain might well be suited to that.

Just before I end the final parties on colocation, we have, in fact, now just commissioned further colocation space because we are first colocation space is fully sold. As we go live with the Integrated Trading and Clearing platform for derivatives, we fully expect to see more derivative clients come into that and to trade from colocation. As you know, in the equity space, the use of colocation has been extremely valuable to us, roundabout 30% of our trades come out of a colocation environment. And we would expect to see our derivative clients using that substantially as well.

So with those core comments, let me just pause and see if anybody has any questions in the meantime, and we're happy to take them on.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Harry Botha of Avior Capital Markets.

Harry Botha

I just wanted to maybe get some more detail on the investment going forward, potentially after the fact that project is coming to end fairly soon. Do you expect to embark in any other major projects? Are we still kind of going to see the upgrade all the other products with the same trading and clearing systems like ITaC has done?

Nicky Newton-King

Sure. Harry, thanks for that question. We do want to move the other, the remaining derivative products onto ITaC because that will enable us to decommission the FTC product's technology and consolidations are trading all on a couple of technology suites and that will basically make that technology better. There are a number of technology things that we will need to do. I for instance have spoken about and include develop the back-office system. There are continuous improvements in our environment, but this is the lumpy technology that we can see, lumpy investment that we can see this particular phase of ITaC.

We expect that the rest of the technology investments that we can see at the moment are perfectly digestible within our current, within our sort of current free cash flow, and that does then link to the issue of the point that we have significant cash and whether or not we are going to essentially return that to shareholders. So what we will do, I mean, we're busy working through alternatives at the moment. And what we will do is communicate those thoughts very clearly at the beginning of next year when we release the results. But as you know, our policy is not to, now that we have got sufficient capital to meet our regulatory and economic capital requirements, if we haven't got an extremely good use for that, then it needs to go back to the shareholders, and we will maintain that policy.

Operator

The next question comes from Chris Blaine, African Alliance.

Chris Blaine

Just a couple of questions. Maybe we can go through them one at a time. So I wanted to understand, with BDA set to stay on for a while, can you maintain BDA? Because I keep hearing that there's no software developers left or at least they're very close to retirement?

Nicky Newton-King

Yes. Chris, we can. I mean, BDA's stable. It can do what it needs to do. But as we've consistently said, we will need to evolve it into new technology. But we are not planning, it is not in our contemplation to try and do a complete replace of BDA. We made 2 functionality that it has that is relevant to maintain in the context of a CCP, an equity CCP, and we will vote for that functionality, I think. But we haven't, we're a way away from being able to give you any decent guidance on that. But for the moment, yes, we're comfortable that BDA is stable and able to be maintained.

Aarti Takoordeen

This is Aarti. If I can just add, in terms of the BDA maintenance, we have a couple of things, so we commission our vendors to look after the mainframe infrastructure and support the infrastructure. Last year, we renegotiated with this vendor and managed to bring the cost of that support and maintenance down in terms of mainframe maintenance. And then on top of that, we have a different vendor who will provide support and maintenance on the code of the software, the actual coding in BDA in terms of upgrade, bug fixes and, what you call it, like a call center type of support. So there's 2 things that you need to consider in maintaining BDA: one is the infrastructure, and the other one is the support and maintenance associated with software.

Nicky Newton-King

And both of those, we're quite comfortable with where they are for the moment.

Chris Blaine

Like I say, so you're comfortable that, that is even with all the, I guess, [indiscernible] languages is robust against, say, some sort of digital tech resumption?

Nicky Newton-King

Yes. When you're talking about fiber, it's not just a BDA issue. We are, we spend an enormous of time, energy and money on making sure that we are as cyber-resilient as it is possible to be, and I suppose if you spoke to any CEO, they will tell you that in their dark nights, they worry about the fact that there's somebody in somebody's basement able to do something that we haven't been able to think about yet. But we certainly are connected with all of the, our peers in relation to cyber resilience and as up to date with the cybersecurity environment that we can possibly be.

Chris Blaine

Okay. That was my one concern with reducing your technology cost, which sound good but it might be good as a headline but the problem is then that you are reducing or maybe several levels from your service providers or your, as you say, your level of rigorousness when it comes to maintaining your systems. It doesn't sound like you're doing that, though, so that's good. Is that technology [indiscernible] rand or foreign currency? And I ask because it seems like the country is in a difficult place, so the rand might be quite volatile.

Nicky Newton-King

So BDA is still local cost. In terms of the foreign, foreign-denominated support and maintenance, that's associated with our trading engine and our clearing system. That is, as is typical, we've got a significant number of dollar-based billings, and that provides a natural hedge against the creditors that we have on our books. And the revenue that we bill in USD exceeds, far exceeds the outgoing in foreign-denominated costs.

Chris Blaine

Okay. Good. And then the government bonds, that sounds like it's coming along quite well. Are you in a position to talk yet about what effect that will have on, say, your revenue?

Nicky Newton-King

It will have a very, very minimal effect on both revenue and cost. We, at the moment, that's sort of 11 or 12 trades a day, ZAR200 million was the first day. It's a very, it's trading between the primary dealers only. [indiscernible] of the illiquid bonds. When [indiscernible] comes on, I think that will change quite a lot. But our entire business case for the government bond market has been to build a central order book at a very, very low margin at a very low cost, too, so that we get the transparency on which we can then build the interest rate derivative market, and then that's a completely different animal.

Chris Blaine

So if you, it sounds like a few years before we get to the point where you've got those value-added products?

Nicky Newton-King

No, we already have an interest rate derivative market, and it's growing nicely, but it's small. And so I think it's a few years before you will, we can start to talk about the sparked market activity in ETP in percentage terms of the revenue in any significant percentage terms from a group revenue perspective.

Chris Blaine

Okay. And I guess linked to that, and it's a couple of different points with competition, is that caps the model for the equity market as well where you, I guess, are there fees that you could maybe make minimal or reduce further and rather then shift the business to more, more of the focus on these value-added products like their selling data and news-driven products, and that's something which is unique to JSE?

Nicky Newton-King

Yes. Chris, it's a good question. I mean, we, the equity market trading, equity trading component of our group revenue is nearly 60%, so it's a very significant part. Trending that to a very low price point would have a lesser impact on the income statement. And what you want to do is to trend prices in all of our products, including equities, down to a sustainable level while you are growing the value-added stock. So we are doing both of those. But I really don't think, well, I don't see a world in which we run equity trading at lower margins as we can as the ETP. Because, yes, I just, I think it's too important a component of how the South African ecosystem works at the moment for that to be a necessary and be a viable option for us. But we do need to grow the alternative products and, so hence, the investment in derivatives, hence the investment in data and the like.

Chris Blaine

So that's perhaps where these competitors will continue attacking you so on that rands cost basis?

Nicky Newton-King

That is where their approach is at the moment. It has not made a significant impact. But ultimately, it's important for clients to recognize that it's not only the invoice from the JSE that is the cost of the trade. It's also the question of the quality of execution, and if you look at the quality of execution, that's a function of the bid office [indiscernible] to bid and the liquidity, all of which are based on the JSE.

Chris Blaine

And you're comfortable that those compared to the advantages are, are sustainable, at least in the medium term?

Nicky Newton-King

Yes. Basically, if we continue to offer services and technology which gets our clients to do what they want and pricing that encourages them do more with us, which is what our new tiered billing model does. The more they do with us, the higher up the tier they go, the cheaper the price is.

Operator

[Operator Instructions] No, we don't have any questions in the queue at this stage.

Nicky Newton-King

Okay. Well, thank you very much, everybody. I appreciate it. I know we're going to see many of you at the lunches and in one-on-ones. We look forward to that. We're always available for any questions and appreciate the many analyst reports already out. Thank you.

Operator

Thank you. On behalf of the JSE, that concludes this morning's conference. Thank you for joining. You may now disconnect your lines. Thank you.