Is ASX Ltd the best share on the ASX?

Credit: Spyros Papaspyropoulos

Formed in 2006 following a merger between the Australian Stock Exchange and Sydney Futures Exchange, share market operator ASX Ltd (ASX: ASX) operates a monopoly over Australia’s stock market functions.

With very little competition in its core securities issuance, clearing and trading divisions, ASX is in a unique position to grow revenues without facing immense competition.

Although some of its segments feature competition from the likes of Computershare Limited (ASX: CPU), IRESS Ltd (ASX: IRE) and Link Administration Holdings (ASX: LNK), ASX’s vertically integrated structure makes it resilient to weakness in particular segments, allowing it to demonstrate defensive characteristics as a growth stock.

Accordingly, with the recent rebound in market sentiment, I believe now might be a good time to take advantage of any increased share market activity and buy this top-quality stock at a reasonable price.

Competitive landscape

ASX is the predominant stock exchange and derivatives market operator in Australia, only facing competition from recent entrant Chi-X Australia. Accounting for the bulk of stock market activity in Australia, ASX has pricing power in most of its operational segments, allowing it to protect its profitability against inflation. Whilst remaining cognisant of over-pricing its services, ASX commands high operating margins and generates high returns when market activity rises.

This is why the level of trading influences its earnings. ASX has a relatively fixed cost-base, meaning it can use its position as market leader to drive scale and profit when stock market activity flourishes.

This brings me to today.

Market sentiment

Global markets appear to be breathing a collective sigh of relief, with the S&P/ASX 200 Index (ASX: XJO) rising 200 points (approximately 4%) this week alone. The uptick is driven by positive earnings from some of our big corporates, as well as signs of stabilisation across the global economy. As a result, share trading volumes have gone up, meaning ASX is likely benefiting from increased trading activity.

Of course, things don’t always have to go well for ASX to profit. By controlling the share trading platform, whenever increased market activity occurs (in any direction), ASX should stand to benefit.

Its 2016 half-year results show just that.

Company fundamentals

ASX released its first-half results in February, reporting a 7.3% increase to net profit after tax, despite the index slumping over that period. Revenues were up across the board, with all bar its interest and dividend income reporting like-for-like growth. Group revenues grew 7.9% to $376.2 million, offset slightly by expenses which crept up marginally by 4.4% to $85.1 million. The uplift in expenses was driven largely by variable costs associated with increased market activity (such as the production and distribution of more CHESS holding statements), resulting in ASX forecasting full-year expenses to rise approximately 5.5% on prior year figures.

Foolish takeaway

Overall, the group provided a solid update placing it on a price-to-earnings of approximately 19.7 at current prices. Whilst not overly cheap, I believe ASX’s current share price can be justified by its defensive earnings quality and renewed market optimism. Trading on a trailing fully-franked dividend of 4.6% (6.6% grossed up), I believe ASX is a high-quality stock which offers significant growth potential and a decent income stream, making it one company to take note of on the ASX!

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Motley Fool contributor Rachit Dudhwala has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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