Stock Fundamentals

Why IEX is a good long-term bet despite falling power demand

Vivek Ananth | Updated on May 17, 2020 Published on May 16, 2020

Discoms are preferring cheaper electricity available on the exchange to long-term purchase agreements with power producers

The power sector is in doldrums because the demand has fallen sharply. The decline in demand in the aftermath of the nationwide lockdown is led by the industrial segment that accounts for a big chunk of the electricity demand.

Despite this, the Indian Energy Exchange (IEX) by virtue of its near monopoly in the power exchange business holds promise for investors.

For one, State power distribution companies (discoms), which are already under distress, are likely to gradually shift towards power exchanges to procure electricity which is visibly cheaper than their existing long-term agreements with power producers. With hardly any new long-term power purchase agreements being signed now, the move may happen faster.

Even though the government has unveiled a ₹90,000-crore liquidity package to rescue discoms, this won’t reverse the trend of discoms using IEX to service their peak demand.

Two, large quantities of sell bids in IEX’s day-ahead market (for next-day delivery) led to the spot price touch a three-year low of 60 paise per unit on March 25 (the day the lockdown was imposed). The low price per unit of electricity available on IEX’s power trading platform makes it attractive for discoms and otherconsumers (with open access).

Three, in April, the first full month of lockdown, IEX’s volumes fell by 6.6 per cent year-on-year, as against India’s peak power demand that fell 25 per cent during the month.

The volumes in the day-ahead market fell by nearly 8 per cent year-on-year, but volumes in the term-ahead market rose 8.4 per cent. This suggests that many discoms could be leaning on the term-ahead market to fulfil their power needs. In the first two weeks of May, volumes have picked up, the management said in its recent earnings conference call. In March, the company’s stock fell considerably. From the peak of ₹193 in February, the stock has lost about 17 per cent as of now.

 

 

 

While the stock could be under pressure in the near term, a slew of factors, such as robust operating margins, decent volumes even in adverse market conditions, dominant position in the power exchange business and likely recovery (when industrial activity picks up) bode well for its earnings in the long run. The IEX stock now trades at around 28 times its 12-month trailing earnings compared with its 30-month average of around 33 times.

Investors with a high risk appetite (given the smaller market capitalisation of a little over ₹4,800 crore) can consider accumulating the stock in declines.

Volumes pick up

Before the lockdown came into force , IEX saw volumes traded on its platform rise from January to March by nearly 39 per cent in the day-ahead market. Volumes, however, tapered at the end of March.

The term-ahead market (contracts for delivery of electricity up to 11 days) also showed a phenomenal jump of nearly 90 per cent year-on-year during the period, coinciding with a mild pick-up in industrial activity before the pandemic-induced lockdown.

This suggests that when industrial activity picks up after lifting of the lockdown, IEX could see a corresponding rise in the volumes in the term-ahead market as well.

The rise in the volumes in the term-ahead market in the January-March period bodes well for IEX as many State discoms seem to be leaning on this segment to meet some of their demand.

This also suggests that when IEX finally launches long-term products (for delivery of electricity up to a year), there could be adequate demand for it.

As of now, IEX addresses only 4 per cent of the total power demand in the Indian market.

When looked at from the perspective of the short-term power market (of which power exchanges are a part), IEX accounts for nearly 40 per cent in India.

The short-term power market is 11 per cent of the entire power market in India.

Also, the increasing share of renewable energy in India’s power generation basket means there will be intermittent power production. This augurs well for platforms such as IEX as power generation can be matched with demand whenever it arises.

Add to this, the real-time market that IEX will launch on June 1 will aid many renewable power producers due to the intermittent nature of renewable power.

Financials

IEX’s high EBITDA margin has been a key positive. The company has enjoyed consolidated operating margin of nearly 80 per cent for the past couple of quarters. The firm recorded tepid numbers in the quarter ended December 31, 2019.

The volumes spiked in the quarter ended March 31, 2020, before the lockdown was imposed, and this helped the company end the financial year 2019-20 with decent numbers.

The consolidated net profit for the quarter ended March 31, 2020, was up 20.5 per cent year-on-year to ₹46 crore, while revenues, helped by a volume spike, rose 17.3 per cent to ₹80 crore.

Risks

The launch of the company’s long-term products is stuck due to a dispute between SEBI and the Central Electricity Regulatory Commission (CERC).

The regulators have agreed to split the jurisdiction of electricity derivative contracts between them. They were also to withdraw their petitions pending in the Supreme Court.

The lockdown has thrown the timeline out of gear because the court has been prioritising more pressing cases than IEX’s.

Once the hurdle of the pending litigation is cleared, the IEX management would be ready to launch long-term contracts in the current fiscal.

Published on May 16, 2020

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