Shares in securities exchange operator ASX Ltd (ASX: ASX) are up almost 20% over the past 12 months and are nearing their 52-week high of $55.07.
The share price rise has been impressive considering the company increased revenue and statutory net profit by just 2.4% and 1.9% respectively in FY2017 and currently trades on a relatively high trailing P/E of 24x.
Companies that trade at a premium to the market are usually higher-growth stocks, rather than mature, stable, slow-growers like ASX.
However, the ASX is essentially an infrastructure asset with defensive characteristics; including having much smaller competitors in terms of equities trading and a monopoly on clearing and settlements. With such a stranglehold on these critical investment functions, ASX's earnings will continue ticking over even during periods of slow economic growth.
ASX's operating revenue has increased at a compound annual growth rate of 5.5% since FY2013, with most of the company's revenue lines achieving low-single-digit growth in that time.
The Trading Services segment has been the strongest performer, with a growth rate of 7.4% since FY2013. I expect this trending growth to continue given the rising popularity of Exchange Traded Funds (ETFs).
These investment vehicles inherently increase trading activity as they must periodically re-balance or reconstitute holdings in order to match the index they are designed to track.
ASX's operating expenses have remained largely stable since FY2013, with the exception of staff costs that have increased each year.
ASX spent $50 million on capital expenditures in FY2017, mainly on new technology and a similar amount is expected for FY2018. In the coming years I believe staff costs will stabilise as the organisation becomes more automated and technology-dependent.
Management has previously indicated its intent to pay around 90% of earnings as dividends to shareholders, and this looks set to continue as the company had no interest-bearing debt and held cash at call of more than $500 million at the start of FY2018.
ASX's dividend yield has fallen due to the strong share price gains of late, but remains a healthy 3.70%, fully-franked.
In addition to defensive earnings, a strong balance sheet and solid dividend, another contributing factor in ASX's price premium could be that the company is a potential takeover or merger target. In 2011, the then Gillard government blocked a proposed AUD$8 billion bid by the Singapore Exchange.
Foolish takeaway
Despite ASX's relatively high price and low-single-digit growth, I doubt the share price will fall below $50 until interest rates in Australia are expected to rise.
That could be the re-pricing catalyst for several "bond-proxy" stocks like ASX, that currently trade on relatively high earnings multiples due their defensive characteristics and stable income. I have enjoyed ASX's steadily growing dividends to date, but I won't add to my holdings at current prices.
