MCX Ltd – Commodity Exchange Monopoly
Updated: Jan 13
Company Name – Multi Commodity Exchange of India Limited (MCX)
Current Share Price – INR 1,509 (January 12, 2023)
Market Cap – INR 7,694 cr
1. What is interesting about the stock?
Multi Commodity Exchange of India Limited (MCX) is a leading commodities exchange based on the value of commodity futures contracts traded in India with a 97% market share during Q2FY23. The Company is a de-mutualized exchange and received permanent recognition from the Government of India in September 2003, to facilitate nationwide online trading, clearing, and settlement operations of commodities futures transactions. The exchange started operations in November 2003. MCX offers trading in varied commodity futures and options contracts across segments including precious metals (bullion), base metals, energy, and agricultural commodities. MCX has a national reach, with ~600 registered members and ~51,500 authorized persons with its presence in around ~850 cities and towns across India as of Sep 2022.
Some history of MCX – Jignesh Shah launched MCX in 2003. He started his career at the Bombay Stock Exchange in 1990, rising to head its automation function and work on its BSE Online Trading Project. Shah left the BSE in 1995 to start Financial Technologies India Ltd (FTIL). FTIL incubated MCX. He also launched NSEL, the country's first electronic spot exchange for commodities, in 2008. His empire unraveled in July 2013 when National Spot Exchange (NSEL) defaulted on payments to its investors, and it came to light that customers of certain favored NSEL brokers had been allowed to take long-term, 30-to-40-day forward contracts in commodities like sugar and wheat despite the exchange being allowed only to handle spot contracts. Management changes happened in MCX in 2014 with Kotak Mahindra Bank taking a 15% stake.
MCX is like a monopoly business with a 97% market share. Investing in a monopoly is a very attractive thing for an investor as they necessarily tend to make for wonderful businesses. Businesses that are highly protected from competition (in MCX's case by sheer market share and resultant network effects) exhibit pricing power. Businesses whose prices are decoupled from their costs, and thus their margins can be as large as the market will bear. These are the business characteristics Warren Buffett likes (and you should, too). Hence, MCX is an interesting investment opportunity.
Revenue mix for FY21 is:
Transaction income – 66%. Transaction income depends on turnover (both the number of contracts and the value of each contract)
Treasury income – 21%
Other income (including income on margin money) – 13%
Commodity-wise turnover mix for H1FY23 is:
Precious metals – 41% (Silver and Gold)
Energy – 43% (Natural Gas and Crude Oil)
Base metals – 15% (Copper, Zinc, Aluminum)
MCX has ~100% market share in precious metals, energy, and base metals commodities.
Why invest in MCX – Investment Thesis?
Monopoly with 97% market share in commodities trading exchange - Even after granting permission to BSE and NSE, MCX has held up ~100% market share in commodities like precious metals, energy, and base metals. NCDEX is a distant competitor with 3% in market share. Depth, liquidity, and impact cost are the most critical factors for a trader – so it becomes difficult to move volume from one exchange to other.
Regulatory clarity may be finally emerging – SEBI became the regulator for the commodities market in 2015. In the last 3 years, MCX turnover has been impacted by the flux of regulatory changes like compulsory delivery in Base Metals (FY20), discontinuation of mini contracts (FY19/FY20) in base metal, high margin requirement in Crude (FY21), and Peak Margin Rules (FY21/22). Peak margin rules have impacted the financials in FY22, leading to lower turnover. However, all these changes have improved the regulatory environment and sustainability of the commodity trading business in India.
Unlike global commodity exchanges, MCX’s transaction income depends on turnover. So, the surge in commodity prices like precious metals, energy, and base metals could provide a tailwind to the business.
We, as Indians, love to trade and speculate. In the bull market since March 2020, the volumes shifted to the equity market. With Fed tightening in the corner and high sideways movement/volatility in the equity market, the retail volume could move to commodity trading.
MCX has a dependency on 63 Moons Technologies (erstwhile Financial Technologies) for trading software, which is charged based on transaction income (~10%) in addition to a fixed monthly cost. MCX is working with TCS to develop a new trading software for which the first drop has been delivered. The second and third drops should be delivered subsequently. Management was expecting to go live with the platform in December 2022 or January 2023. However, MCX has extended the contract with the current vendor for another 6 months beginning January 1, 2023, at a higher cost - we can expect an impact on profitability for the next couple of quarters.
MCX is not attracting big industrial houses, which have huge capacities to trade as the liquidity that MCX is providing is not sufficient, and they require far-month contracts to be very liquid. MCX doesn't have much depth now. MCX is focusing bottom-up on MSMEs and smaller players, who can not go overseas for trading/hedging, to build up the volumes. On having the critical mass, it will start to attract bigger players.
2. Key Historical Financials
The last tranche of peak margin rules (move from 75% level to 100% level) was implemented in September 2021. This led to future average daily turnover falling from INR 32,500 cr in Q3 FY21 to INR 24,500 cr in Q3 FY22 thereby impacting the financials. The quarterly profitability of the company has fallen from INR 60-70 cr in FY20/21 to INR 35-40 cr in FY22 and Q1FY23. However, the profitability improved in Q2FY23.
Part of the futures turnover decline has been compensated by an increase in options turnover (from INR 800 cr of notional average daily turnover in Q3 FY21 to INR 31,381 cr in Q2FY23). Options have contributed ~55% of total trading in Q2FY23 which is higher than management expectations of 50%. MCX has also started charging for options trade in Q3 FY22
3. What is my view on company valuation?
The share price has fallen ~10% in the last 1 year (1) reflecting the fall in the company’s profitability and (2) in line with other mid/small cap stocks.
MCX currently trades at a P/E (TTM) multiple of 40x vs its 5-year average of 31x and other monopolistic/duopolistic plays like CDSL, IEX, and CAMS trading at 38x, 42x, and 40x respectively.
Business looks very interesting to invest in from the long-term perspective. But the valuation is still expensive and investors should evaluate entering the stock around its long-term average P/E multiple of 30-35x.
4. What are the risks to the investment analysis?
Risks to the analysis are:
Adverse regulatory and policy decision
The movement to a new trading platform would come with inherent transition risk – new software will take time to stabilize and MCX could lose volume during this period
Increase in competition – MCX got a reprieve in the last 3/4 years with management changes happening at NSE. We can expect an increase in competitive pressures going forward with SEBI allowing the trading of commodity derivatives and other segments of the securities market on a single exchange
About the Author
I have over 17 years of experience in venture capital, private equity, and investment banking in India and the Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in the Middle East, to look after investments, M&A, and venture capital. I have prior experience in India with Tata Capital (Private Equity), Merrill Lynch (Investment Banking or IB), and Ambit Corporate Finance (IB). I bring the long-term ownership mindset to the analysis.
I graduated from the MBA program of the Indian Institute of Management Lucknow (2005) after completing the Bachelor of Technology program at the Indian Institute of Technology, Kharagpur (2002).
I am an Insignificant Investor in the public market and co-founder of SocInvest.
I have no stock, option, or similar derivative position in any of the companies mentioned in the last 30 days, and shall not initiate any such positions within the next 5 days. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from SocInvest). I have no business relationship with any company whose stock is mentioned in this article.
I am not a SEBI registered advisor. This article is purely for educational purposes and is not to be construed as investment advice. Please consult your financial advisor before acting on it.
I have used publicly available information while writing this article.