High growth potential, fair valuations

Like what the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) are for equities, MCX or Multi Commodity Exchange of India is synonymous in the commodities trading space with over 87 per cent market share in the country. However, unlike equities, the potential for commodities trading is high, given the low penetration — which is why the growth prospects of companies like MCX looks promising. That apart, given the cash in the books — besides a healthy business model — makes the offer attractive from a long-term perspective.

Cash cow
Typically, once an exchange and related infrastructure is set up, it starts generating revenues in the form of transaction fees among others with minimal need for capital (or increase in operating costs) even as the business scales up.

MCX, which is in the nascent stage and generating healthy cash, has been paying back almost a third of its profits to the shareholders in the form of dividends. Despite this, it is sitting on Rs 700 crore of cash and equivalent, which is fairly large for a company with a networth of Rs 1,100 crore. Globally too, exchanges generate high cash and return on equity (20.5 per cent in the case of MCX) and hence pay huge dividends like in the case of Hong Kong Exchange, which distributes almost 80-90 per cent of its profits in the form of dividends.
 

VITAL STATS
Price band (Rs)	860-1032
Opens on	22-Feb
Closes on	24-Feb
Size (Rs cr)	552R.80-663.30

CRISIL grading5/5 The entire issue is an offer for sale of 6.427 
million shares                                       Source: RHP  

LOOKING UP AGAIN
In Rs crore	FY09	FY10	FY11	9Mth FY12
Total income	365.8	493.7	447.5	474.5
Ebitda (%)	36.0	49.3	52.0	64.8
PAT	158.8	220.8	176.3	217.9
EPS (Rs)	31.5	43.2	34.5	42.7 *
* Non-annualised                                                                                  Source: RHP

Annuity business
Not surprisingly, investors thus see exchanges as more of an annuity investment or from a dividend yielding stock. This is also a reason that globally exchanges trade at an average 5 times their book value and 18-20 times earnings. In the case of MCX, at the upper price band of Rs 860-1,032, its shares are valued at 4.3 times annualised book value and 21 times annualised earnings, which looks fair, considering its business model, leadership and size of growth opportunity relative to its global peers, cash in the books and return profile. Also, some of MCX’s investments in other exchanges like MCX-SX, SME and MCX-CCL are in the nascent stage and could add value in future.

Growth strategy
MCX started its operation in 2003. Since then, its revenue and trading volumes have grown strongly. Though competition has also increased and there has been a key risk, the company still enjoys a leadership position on the back of its first mover advantage and technological support provided by its promoter company, Financial Technologies. The company continues to focus on increasing the number of members and terminals through geographical and product expansion. It already has 2,153 members, a total which is almost equal to the trading members in the equity segment of BSE and NSE put together.

So, while there may not be an exponential growth in members, future growth is likely to come from increase in trading terminals and clients. For instance, for the nine months to December 2011, while the company has added 34 new members, the terminal base has expanded by almost 100,000 to 296,896, which should reflect in higher trading volumes for the company.

Besides, the government has yet to pass a bill to amend the Forwards Contracts (Regulation) Act. “Once the regulatory changes are in place, trading in options and indices are expected to drive the volumes on the exchange in line with the global trend,” said a note on the company by Crisil, which has given the highest grading to the IPO. Globally, it is considered that options and indices (like Nifty in equity) account for a large chunk of volumes, which is yet to happen in India. To support this, the company has already developed the products and software. That apart, the rating agency also said that the government also been considering allowing foreign and domestic institutions and banks to participate in commodity futures trading. The entry of such participants, whenever permitted, is likely to be a positive for commodity exchanges like MCX, as it would help improve market liquidity. However, any delays (or rejection) of these proposals would lower growth expectation and thus, hurt stock valuations of MCX.