Multi Commodity Exchange (Update) : Still a lot to play for. Maintain BUY :: HDFC Sec

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Still a lot to play for We organized investor interactions with the senior management of MCX. The management highlighted several potential regulatory tailwinds including (1) rationalization of the commodities transaction tax (CTT) (2) merger of the Securities Exchange Bureau of India (SEBI) and the Forward Markets Commission (FMC). Average daily traded volume (ADTV) is gradually improving as the company has started refocusing on its market development efforts. The company mentioned that future growth would be driven by contract launches in base metals and agri commodities such as cotton. We maintain our high-conviction positive stance on the company on account of (1) significant business operating leverage (2) potential for non-linear growth driven by conducive policy framework. We continue to value MCX at 25x FY17E EPS arriving at a target price of Rs 1,180. Below are key highlights of the investor interactions:  Regulatory triggers in the offing: MCX mentioned that the commodity exchanges, FMC, members (brokers) and industry associations have appealed to the government to do away with CTT. The government has netted just Rs 8.5bn in the last 18 months though the CTT and management reiterated that this tax makes Indian commodity exchanges extremely uncompetitive versus global exchanges (CME, LME etc), impeding the development of a commodity derivatives ecosystem. Considering the government’s ‘Make In India’ focus, MCX believes that the government could rationalize CTT and facilitate creation of a transparent marketplace for commodities.  The government is also considering a merger between SEBI and FMC. Such a move would result in an autonomous commodity derivatives regulator, which would have punitive power to crackdown on illegal Dabba trading (bucket shops). Management believes that this could result in improvement of exchange volumes (20-25% in year) as Dabba trading volumes could be as high as 10x exchange volumes.  Improving operating performance, base metals and cotton could be future growth areas: ADTV has improved to Rs 230-240bn, comparable to adjusted pre-crisis, post-CTT ADTV. MCX has resumed market outreach efforts to grow business. Deliverable base metal contracts and cotton could be future growth areas for the company. However, new contract success is fraught with challenges, such as contract standardization, warehousing capabilities, taxation etc.  Key investor concerns include MCX’s dependence on FTIL for software support. Additionally, lack of clarity on the use of surplus cash remains a sore point.

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