Why IEX Just Got Two Back-To-Back ‘Sells’

Spark Capital and Axis Capital downgraded the stock to ‘Sell’. The other 10 brokerages that track the company recommend ‘Buy’.

That comes when IEX has surged more than 37% year-to-date, beating most power sector peers and benchmarks. The Sensex fell 1.7% and the BSE Power Index has tumbled 17.2% during the period.

The exchange allows distribution companies to buy power to meet the seasonal shortfall and benefit from lower tariffs. It has a near-monopoly in the business. And short-term power trading has grown in India at an annualised rate of 8% in the past decade to 138 billion units in 2019-20.

Yet, Spark Capital is no longer bullish. As monopolistic state electricity boards control power purchases, the brokerage does not expect an efficient wholesale electricity market where power exchanges can play a dominant role, according to its report. Chances of a significant change in the power sector are low despite upcoming reforms, it said.

IEX's major volumes come from day-ahead market (DAM), which thrives on weak power demand, it said, anticipating moderate annualised growth in volumes in the next five years.

According to Axis Capital, the stock's recent outperformance, high valuations already capture the upsides of the new product launches.

The valuations are at a premium to the global exchange companies compared to a discount historically, Abhishek Puri, executive director– capital goods, power & infrastructure at the brokerage wrote in a report. Also, there will be higher competitive risks due to the draft power market regulations that could hit IEX’s monopoly status, he said.

Moreover, according to Axis Capital, there seems to be a weak correlation between power demand and exchange volumes—with power demand picking, the volume growth is likely to taper.

Business Model

IEX earns its revenue from transaction fees, annual subscription, admission charges, interest income, gains on the sale of investments. Its revenue and net income grew at an annualised rate of at 8% and 8.6% between 2016 and 2020.

It’s a negative net debt company, implying it has more cash than its financial obligations. But's IEX's dividend yield of 1.3%—or what it pays shareholders from every Rs 100 of profit—is lower than the average of 3.3% for BSE Power Index and nearly in line with 1.1% for BSE Sensex.

The stock trades at 28.6 times its FY22 estimated earnings compared with a three-year average of 28.7. The average 12-month price target tracked by Bloomberg suggests upside of 8.5%.

And the majority of the brokerages are bullish.

Most Brokerages Bullish

Equirus Securities said IEX is likely to be a key beneficiary as the short-term power trading market is gaining ground due to the improvement in power availability and the decongestion of transmission lines. The shift towards the short-term market is also driven by the increasing preference of discoms to cut power procurement costs, it said.

According to Motilal Oswal, active market participation and new product launches will help IEX maintain its market share. The exchange has launched a real-time market to conduct power auctions every 30 minutes, Green TAM for renewable energy generators to sell power. Cross-border contracts, delivery-based long-duration contracts and power derivatives are in the pipeline.

Edelweiss Securities estimates that the new product launches will double IEX’s target market opportunity to 120 billion units.

New Products

IEX, majority-owned by institutions after the regulator forced Financial Technologies Of India Ltd. to divest stake, has diversified into gas trading as it sees opportunity in India’s plan to more than double the share of gas in the nation’s energy mix to 15% by 2022. Plans to rationalise tariffs, bring gas under GST, and set up a national gas transmission corridor are in the pipeline.

IGX, a wholly-owned subsidiary of IEX, will facilitate trade in the physical delivery of gas from designated hubs. If reforms are pushed through, Edelweiss said, it will boost liquidity and create exponential growth for IEX.

IEX faces one potential threat to its monopoly, as pointed out by Axis Capital.

Threat To Monopoly

A possible regulatory change may dilute its dominance in the power trading market. The Central Electricity Regulatory Commission in July published a draft paper that suggests a market coupling authority for order matching and price discovery.

It proposes to shift the entire volume of the power sold in the country onto an exchange that includes long-term power purchase agreements to help cut costs and improve efficiency. The objective is to reduce overreliance on exchanges for order matching and price discovery on only exchanges.

According to a note by Candor Investing, this change, if it materialises, can impair the intrinsic of IEX.