A small-cap stock that is a good long-term play in the power industry is Indian Energy Exchange (IEX). The company operates in the short-term market, where generators and buyers come on the exchange platform to buy and sell power. The short-term power exchange market comprises distribution companies, producers and consumers (captive players).
IEX has 98 per cent share in the electricity traded on power exchanges in India. Currently, the short-term power market makes up 11 per cent of the total power generated in India.
IEX makes up 36 per cent of this short-term market. Overall, volumes traded at IEX make up 4 per cent of the power generated in India (as of 2018-19). As is evident, while IEX enjoys near-monopoly status in the energy trading segment, in relation to the overall power generated in the country, the trading volumes are still low. It is this limited volume play that has been a dampener for the stock.
The stock has had a bumpy ride since its listing last January. For one, the asking price for the IPO — at a steep 44 times its trailing 12-month earnings then — was a spoiler. Despite the stock split (1:10) last year and buyback at ₹185 at the beginning of this year, the stock has been under pressure owing to its weak June 2019 quarter results.
That said, IEX is the country’s largest energy exchange and there is immense scope for growth in volumes.
The Centre’s stated objective is one nation, one grid. It works well for IEX because it will reduce the congestion on transmission networks and give discoms and other power consumers easy access to fulfil their short-term power requirements.
The increasing use of renewable energy in India and future electrification of cars will continue to raise India’s power demand in the long- term. As India’s per capita power consumption catches up with that in the rest of the world, the volumes traded on the exchanges, over the long run, will rise, benefiting players such as IEX.
Also, in India, derivatives on energy are not available currently. But talks are under way for the process to get kick-started, and this could fuel volumes.
All these benefits are likely to come over the long run, and short-term sluggishness in volumes cannot be ruled out. Hence, investors with a long-term horizon and wanting a piece of the action in the power sector can buy the stock. At the current price of ₹125, the stock trades at 22 times its trailing 12-month earnings, far lower than the valuation at the time of the IPO, which was a dampener.
Financial metrics
In the June 2019 quarter, revenues fell 10 per cent Y-o-Y to ₹60 crore, while net profit fell 5.5 per cent. IEX’s EBITDA margin at the end of June 2019 quarter was at 84 per cent against 83 per cent in the same quarter last year.
In the June quarter, on account of the general elections, state power distribution companies had signed up short-term bilateral agreements with power generators, to ensure smooth supply of power to consumers. This took away a lot of the volume that would have otherwise been traded at the exchange. From 2015-16 to 2018-19, electricity traded on IEX grew 15 per cent CAGR to 52.19 billion units. During the same period, revenues grew at a CAGR of 13.2 per cent to ₹254 crore and profit by 18.2 per cent CAGR. The company’s return on equity in FY19 stood at 50.5 per cent.
Risks
The power sector being a regulated business, any change in government policies will impact the company’s business. Power exchanges were introduced as part of Electricity Act 2003 to create a robust short-term power market. Currently, a major chunk of IEX’s revenues come from the transaction fees on traded volumes in the day ahead market (for use the next day) and the rest from term ahead market (for use up to 11 days.)
A regulatory kerfuffle has kept derivatives trading off the table as a revenue source for IEX. Markets regulator SEBI claimed it had jurisdiction on derivatives while power watchdog CERC (Central Electricity Regulatory Commission) allowed IEX to offer it as a product. The matter has reached the Supreme Court.
In February 2019, a government committee told both the regulators to fix individual responsibility — forward contracts for delivery will be regulated by CERC and financial derivatives by SEBI. The process is still on, and if this issue is resolved quickly, it could boost volumes for IEX.
Captive power producers and other generators feed in power into the short-term market through open access. State governments, not keen on allowing full open access in the power market, have been imposing cross-subsidy and open access charges. The Centre says these issues will have to be resolved to ensure 24x7 power to all. Unless these structural issues are addressed, there could be some pain for IEX in the near term.