Long on IEX and India’s energy infra

Noise on creation of market coupling operator by CERC needs to be closely watched.

IEX is India’s first and largest energy exchange, with 90% plus market share for traded electricity. It serves as a platform for physical delivery of electricity, Renewable Energy Certificates (RECs) and Energy Saving Certificates (ESCs). IEX is one of two such exchanges in the country, the other being Power Exchange India Limited (PXIL).

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Policy tailwinds bode well for infra development

GOI has been emphasizing development of energy infra. The Union Budget 2021 allocated an outlay of INR22Kcr to the energy sector with a concessional tax rate regime for GENCOs. Budget 2022 has announced a INR3Lcr plus financial package to capitalize DISCOMs.

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Energy trading seems aligned onto a similar trajectory

Broader energy sector outlook stays positive with production expected to grow by 17% CAGR for FY20-22 and consumption by 26% CAGR over the same period. Only 4% of all generation was priced through exchanges as of 2018, showcasing significant under-penetration. Exchanges offer efficient price discovery (vs. long-term/bilateral contracts) but cross-subsidy surcharges/additional charges by states have held them back. The Central Electricity Regulatory Commission (CERC) has created an enabling framework for a range of short-term contracts such as Real Time Market (RTM) segment, allowing participants to accommodate differences between day-ahead forecasts of conditions and actual real time conditions, leading to an increase in overall trading volumes. CERC has also notified new rules governing cross border electricity trading. Price deregulation and opening DISCOMs to private competition, as proposed in Electricity Amendment Bill, 2020, are expected to enhance the number of players while increasing volumes further.

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Focus is on expansion of addressable market

IEX aims 3x growth of its addressable market with plans to expand duration of electricity delivery up to 365 days – presently confined between 2.5 hours and 11 days. A new revenue sharing licensing agreement with MCX for trading of electricity derivatives linked to IEX spot prices on the MCX should help. REC trading is expected to pick up in FY22 after non-trading in FY21. IEX is the holding company of Indian Gas Exchange (IGX), a one of its kind natural gas trading platform. It recently entered strategic partnerships with Adani Gas, Torrent Gas & GAIL which have acquired a 5% stake (each) in IGX.

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Steady growth and sound balance sheet de-risk the investment profile

Revenue/EBITDA has seen a CAGR of 10%/13% during FY16-20 helping the company deliver a lofty 62% ROCE and 48% ROE on average. IEX maintained stable margins with EBITDA at 90% and operating margin at 75% on average. Operations are debt free. Cash flow generation looks strong with FCF of INR157cr in FY20. The company announced Q3 2021 results with 9M revenue at INR224cr, a 19% Y-o-Y increase. Trading volume in Q3 2021 grew by 62% on Y-o-Y. Further, spot market grew by 47% and Day-Ahead Market by 17% in Jan 20 on Y-o-Y basis.

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Valuation on absolute terms looks fairly attractive

IEX currently trades at 37.46x P/E and 29.30x EV/EBITDA on FY22F. Being the only listed energy exchange there are no direct comps but exchanges like MCX (NSE: MCX) trade at P/E of 28.55x and EV/EBITDA of 30.30x; BSE (NSE: BSE) at 21.22x and 9.81x on FY22F. Not apples-to-apples but IEX’s premium may be driven by higher earnings growth outlook due to under-penetration and lower competition. Majority shareholders are institutional (66.24%). Increased competition (e.g. entry of PTC, BSE, ICICI backed Pranurja, currently under regulatory approval), change in market design (“market coupling” reforms), and potential price caps remain notable risk factors.

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Our Position

We are LONG. Noise on creation of market coupling operator by CERC needs to be closely watched.