Multi Commodity Exchange (Initiating Coverage) : Crouching tiger. BUY :: HDFC Sec, report

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Crouching tiger We initiate coverage on Multi Commodity Exchange of India (MCX), a world-class oligopoly which has weathered a ‘promoter shock’ and emerged with unscathed operations and business franchise. Our conviction is driven by the fact that the commodity exchanges business is at its infancy in India. MCX is thus poised for non-linear growth with progressive policy evolution. MCX is a persistent leader among Indian commodity exchanges despite cyclically poor trading volumes in its key commodities. Post the recent rationalisation of fixed costs (lower software and service costs), the co is poised to derive operating leverage as volumes resurface. The recent business development drive will help. At 18x FY17E EPS (implying PEG ~0.4x), MCX’s strong franchise and longer term growth prospects look attractively valued. We value MCX at 25x FY17E EPS arriving at a target price of Rs 1,180.  Globally, commodity exchanges are profitable, capital light oligopolies that gain franchise as they grow. We think MCX will be no different, given India’s position as the third largest global economy in PPP terms.  The commodity futures business is severely underpenetrated in India, especially when compared to the size of the corresponding physical markets in the country. This is mostly because institutions have been barred from trading commodity futures in India. The business may see non-linear growth (if, and) when the policy framework is corrected.  We see the CTT imposition in Jul-13 as a retrograde step worthy of reversal. A historically socialist mindset has led to poor government perception of the commodity futures business. We think this may change as India’s economic policy framework begins to lean towards the right in the foreseeable future.  MCX’s business enjoys significant operating leverage as gross margins are high (~90% during FY12-H1FY15). We believe that MCX can achieve revenue growth without almost any incremental IT investments while focusing on business development efforts. Incremental EBITDA margins over FY15-17 can be as high as 81%.  MCX has survived a triple shock (promoter change, CTT and cyclically low volumes) and actually emerged stronger. It is aggressively launching new products, which bodes well in the context of the underpenetrated nature of its business.  Key risks : (1) MCX continues to rely on the software platform of Financial Technologies India Limited, it’s erstwhile troubled promoter. FTIL could slip on support if there is any adverse outcome of judicial probes that it faces (2) Regulatory risks (3) Competition.

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http://www.hdfcsec.com/Share-Market-Research/Research-Details/StockReports/3011182