MCX – Commodity Exchange Monopoly

Updated: Feb 28


Company Name – Multi Commodity Exchange of India Limited (MCX)


Current Share Price – INR 1,293 (February 23, 2022)


Market Cap – INR 6,597 cr


 

1. What is interesting about the stock?

Multi Commodity Exchange of India Limited (MCX) is a leading commodities exchange based on value of commodity futures and options contracts traded in India with 93% market share during Apr – Dec 2021 (YTD FY22). The company is a de-mutualised 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. 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 ~50,000 authorized persons with its presence in around ~1,100 cities and towns across India as of December 2021.


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 changed happened in MCX in 2014 with Kotak Mahindra Bank taking 15% stake.


MCX is like a monopoly business with 93% market share. Investing in a monopoly is a very attractive thing for an investor as they necessarily tend to make for wonderful businesses. Businesses which are highly protected from competition (in MCX case by sheer market share and resultant network effects) and 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 number of contracts and value of each contract)

  • Treasury income – 21%

  • Other income (including income on margin money) – 13%

Commodity-wise turnover mix for Apr – Dec 21 (YTD FY22) is:

  • Precious metals – 39% (Silver and Gold)

  • Energy – 35% (Natural Gas and Crude Oil)

  • Base metals – 22% (Copper, Nickel, Zinc, Aluminum)

MCX has ~100% market share in precious metals, energy and base metals commodities.


Why invest in MCX – Investment Thesis?

  • Monopoly with 93% 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 7% 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 regulator for the commodities market in 2015. In the last 3 , MCX turnover has been impacted by 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 as it has led to lower turnover. However, all these changes have improved the regulatory environment and sustainability of commodity trading business in India.

  • Unlike global commodity exchanges, MCX’s transaction income depends on turnover. So, the surge in commodity price like precious metal, 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 dependency on 63 Moons Technologies (erstwhile Financial Technologies) for trading software, which is charged on the basis of 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 expects to go live with the platform from September 2022. Shift to new trading platform is expected to result in cost savings.

MCX is not attracting big industrial houses, who 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 such 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

  • Last tranche of peak margin rules (move from 75% level to 100% level) was implemented in September 2021. This led to futures average daily turnover to fall from INR 32,500 cr in Q3 FY21 to INR 24,500 cr in Q3 FY22 thereby impacting the financials. Quarterly profitability of the company has fallen from INR 60-70 cr in FY20/21 to INR 35-40 cr in the last 4 quarters

  • Part of the futures turnover decline has been compensated by increase in options turnover (from INR 800 cr of notional average daily turnover in Q3 FY21 to INR 8,600 cr in Q3 FY22). Options contribute 25% in average daily turnover and rest is futures, management expects in few years to reach 50-50%. MCX has also started charging for options trade in Q3 FY22

3. What is my view on company valuation?


Share price has fallen ~35% since mid October (1) reflecting the fall in company’s profitability and (2) in line with other mid/small cap stocks.


MCX currently trades at P/E (TTM) multiple of 45x vs its 5 year average of 31x and other monopolistic/duopolistic plays like CDSL, IEX and CAMS trading at 51x, 66x and 41x respectively.


Business looks very interesting to invest 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

  • 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 reprieve in last 3/4 years with management changes happening at NSE. We can expect increase in competitive pressures going forward with SEBI allowing trading of commodity derivatives and other segments of securities market on a single exchange

 

About the Author


I have over 15 years of experience in venture capital, private equity and investment banking in India and Middle East across a wide variety of sectors. I was last working with Majid Al Futtaim Holding (MAF), a leading conglomerate in 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.


Disclosure


I have no stock, option or similar derivative position in any of the companies mentioned since 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 purpose and not to be construed as an investment advice. Please consult your financial advisor before acting on it.


I have used publicly available information while writing this article.




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