MCX Ltd: Best OPTION for the FUTURE

MCX has given great set of numbers for Sep-19 quarter results. Turnover 100 cr vs 71 cr last year (excluding other income), PBT excluding other income is 43 cr vs 19 cr and NP at 72 cr vs 36 cr. QOQ turnover is at 100 cr vs 79 cr and PBT excluding other income is at 43 cr vs 23 cr. There is big jump in daily average volumes traded at 34500 cr vs 25648 cr last year vs 27473 cr in June-19 quarter. The average daily volumes crossed 30000 cr first time since the imposition of CTT in 2013. So this is indeed are an awesome set of numbers and a strong catalyst for huge re-rating of the stock.

MCX has gone through some tough times as far as stock price is concerned (although its business was always doing fine in this period). 

We made first entry around 1000 in Sep-2016 (click here and here for earlier blog posts on MCX) and it touched 1700 shortly after that but then it was on a downward spiral after that and this year I have done some heavy buying at 700 levels to brought down my average to some 850. But I never had the doubts on its great future growth prospectus and have been continuously advising to buy more of this one at every fall to the email group of this blog.

Actually market got fearful after SEBI allowed universal stock exchanges in India paving the way for the likes of BSE/NSE to enter commodity trading and market feared that the likes of BSE/NSE would take the game from MCX by offering predatory pricing initially. So MCX was falling for quite a time.

But I always believed that predatory pricing is not the best strategy and history has proved this time and again. BSE tried hard to get the volume for derivative business from NSE by offering nil charges still it failed. When MCX was facing tough time due to NSEL scam in 2013, NCDEX (NSE Promoted) tried hard to fetch the volume by low charges but it failed miserably!!

Why this happened and why MCX will see strong growth in business:

1) This is due to “Impact cost” which is the cost buyers have to bear due to lack of liquidity in the market and this cost is way higher than the trading charges charged or foregone by the new exchanges. Like if you want to buy 1000 nos. of stock A at 100 but at this price only 500 shares are available. Next sell is at 102 so you have paid 1000 more for balance 500 shares. So taking the ideal price as the base, Impact cost here is 2% which is way higher than the normal trading charges. This is the main reason traders do not leave established exchanges with strong liquidity. This is the experience across the globe and MCX has more than 90% share in all major commodities. That’s why even after the start of commodity trading by BSE/NSE in later stages of 2018 still their impact on the business of MCX is just minimal.

But Impact cost is different from the impact of other factors like some news, any other fundamental factor effecting the business and its future. Here, the impact cost means the impact of low trading volume. Ideally at any given price and time, almost infinite trading volumes should be available for buying at any given price. Like one can buy huge quantity of ITC at NSE at any given price and in fact the constituents of BSE/NSE indexes are chosen based in the impact costs and the same should be almost nil.

So as we can see this “impact cost” is the another version of networking effects and this is one of the strongest entry barriers in nay business as we can see the same happening for long time in Naukri.com which is the undisputed leader in the segment for almost 2 decades and nobody has hit Naukri even after trying hard.

2) Also, if NSE/BSE can attack commodity trading then MCX can attack currency trading. Currency trading is a natural extension of commodity trading. Like, if I am hedging my import of Oil at MCX then I also need to hedge my currency exposure which at present I am doing at two exchanges. So MCX can target this area and chances of win are quite high.

3) Entry of Institutional players: One of the major growth catalysts is and will be the entry of Mutual funds and PMS (portfolio managers) as recently SEBI has allowed the participation of institutional investors such as Mutual Funds and PMS in commodity trading. This is the long awaited reform for Indian commodity market as institutional players can provide the much needed liquidity, research and price discovery to the Indian commodity market which is needed in order to attract the corporate houses (who need commodities for their businesses) to trade or hedge the commodities at Indian commodity exchanges.

Before the entry of these institutional players, the only players in Indian commodity trading was retail investors, small commodity traders (as large corporates trades abroad due to very high impact costs), small numbers of corporate clients and some other small speculators. So as we can see these third world traders can’t do any good for the commodity trading on their own, they need the support of much bigger and able players in the form of MF etc.

Investments into commodity markets will help MF to diversify their assets and risks as when equity markets are down they can invest more in commodities where the prices are more fundamentally derived because of the presence of ultimate users of the commodity in the trading channel which is not the case of stock market and this makes the stock market very volatile. But I think MF’s will first understand the commodity trading and volumes will build slowly over time. I think there must have been some material impact of the participation by the MF’s in the sep-19 results of MCX but the same will be much stronger in the times to come.

Actually the major function of a commodity market is the discovery of fair price; price is best discovered when there is sufficient volume and liquidity and there are INFORMED players in the market not mere speculators. The role of a powerful and able regulator is equally important as it is their responsibility to keep a watch and take necessary steps for the growth of the market.

At present banks are not allowed to trade in commodity exchanges but if allowed then Banks are going to be a major player in both agri and non-agri commodities as banks have huge exposure to commodities as they lend to commodity players like farmers/producers. Here, SEBI is in favour of the same but RBI is not but if allowed then the same is definitely be a great step for Indian commodity trading.

I am yet to analyse the data for Indian corporates doing their trading and hedging in Indian exchanges but I think this will also grow in the future. I’ll check the same and will post the analysis in another post.

4) Then the impact of Option trading. Option trading has been allowed by SEBI and options are cheaper than futures due to lower charges and low impact of taxes like CTT as compared to Futures as transaction value in case of options is very low at just premium paid (Not the strike price like in case of Futures). Also, downside is limited in options to option premium paid while the same is unlimited in Futures. So options are the real hedge products just like term insurance.

Also, hedging by Futures is very costly due to requirements of MTM and margin money which impact cash flow and working capital. So big corporates with tight working capital arrangements find hedging through Futures very costly and capital intensive. So Options are the answer for their needs.

But as options are cheap so in short term it hit the profits of MCX last year but volume growth was always the main catalyst and this is going to happen soon. Right now, i do not think that options volumes are that high and there may be issues related to pricing of options (more on this in the next post).

MCX is mainly focusing on developing options business and launching index options which are major volume growth drivers. Also option business is difficult for new players like NSE/BSE because SEBI has placed daily volume restrictions for exchanges to launch options like for Agri commodities the average daily turnover should be at least Rs 200 cr, for non-agri commodities, it is at Rs 1,000 cr. Building of this much of daily turnover won’t be easy for new players and MCX can build strong position in options by then.

5) Rationalization of Commodity transaction tax (CTT): This is another step which i am expecting from our government sooner or later and the same will happen when the entry of institutional players will have provided the much needed depth to the Indian commodity trading and the role of speculators/cartel will be minimal. Any such rationlization of CTT will be a big booster for the growth of commodity trading in india.

I have more to update on the various factors affecting the business of MCX but I’ll do the same in another post on this shortly with more detailed analysis because I think this is one story which is going to become very big in the near future and MCX can be the stock for next 5 years. NSE is scouting for acquiring a stake in MCX and I think Kotak was also looking to exit and as now it is back to strong growth so Kotak can now demand premium valuations from NSE and the deal may happen at much higher prices (may be at 2000).

At current market price of Rs. 1000 it is trading at PE ratio of just 20 (TTM) and forward PE ratio is just somewhere around 15 when it should command at least 40 keeping in view the fact that it commands more than 90% share of Indian commodity trading market. Its market capitalization is Rs. 5000 cr when NSE (Biggest stock exchange) is going to have a market capitalization of more than Rs. 50000 cr in upcoming IPO. For a perspective, commodity markets are way bigger than equity across the globe like in USA, commodity turnover is about 6 times the equity turnover, in china the figure is 2 times but in India commodity turnover is just 1/10th of the equity market.  This points toward the unexplored scope for high future growth for commodity trading and MCX in India. So I have no doubt that it is a very strong re-rating candidate and a must buy at any price around 1100-1200.

(Views are personal and should not be taken as a recommendation for buying or selling a stock. Stock markets are inherently risky so kindly do your Due Diligence before investing. I am not a certified Sebi Analyst and holding the shares discussed in this Post. Reach me at oscillationss@yahoo.in).