Stock Call. Why you should hold on to MCX stock

We initiated a buy on MCX in November 2018. That was when NSE and BSE had flagged their first commodity contracts and waived transaction charges for members.

We expected the Multi Commodity Exchange of India to soak up most volumes in the commodity market, even after the entry of two other players, given the exchange’s long history in commodity market and its connect with physical market participants.

Also, we were confident that the regulatory changes brought about by SEBI could help increase participation in commodity market.

In over a year since the call, the two bourses, NSE and BSE, have negligible presence in the commodity derivatives market.

In base metals, energy and precious metals, MCX is still the market leader with over 98 per cent market share. Commodity derivatives market volumes have also increased since then, thanks to increased participation by corporates and widening of the exchange’s client base and members.

From ₹699 in November 2018, the stock price is now at ₹1,072.

At the current market price, it discounts its estimated earnings for 2020-21 by 21 times. In the past few years it has traded in the PE band of 21-23 times on one-year forward earnings.

Investors in MCX can hold on to the stock. Given the risks in the broader market, additional exposure to this small-cap stock is not advisable.

While the negative settlement price in the MCX crude oil futures contract for April created a controversy, it lost its fizz as it was done as per the rule book.

The MCX Clearing Corporation has already settled the obligations on the crude oil contract that expired on April 20 (by using member deposits, without touching the Settlement Guarantee Fund).

That said, with crude oil futures being the largest volume contributors for the exchange, one needs to watch out if the exchange is able to sustain the interest of the traders in the contract as crude prices may continue to slide, over the near future; the possibility of a negative price on WTI (West Texas Intermediate) in the current month contract can also not be ruled out.

However, long-term (next five years) prospects look good for MCX. The exchange is awaiting SEBI’s approval to launch commodity index futures.Also, as mutual funds and PMS (portfolio management services) begin trading on the exchange (regulatory nod has already come), it will increase volumes.

Going ahead, if MCX is able to build its leadership (internally) and technology capability, it can be ahead of the competition and will continue to generate value for shareholders.

So far so good

In 2018, MCX saw the total traded turnover jump 27 per cent; in 2019, the turnover increase was 21 per cent. This year, it has not been bad, so far, for the exchange. The average daily turnover was around ₹38,000-39,000 crore in January, February and March. In April, however, the reduced trading hours during the lockdown (cut to eight hours from 14 hours earlier) have seen volumes drop — the average daily turnover was ₹13,000 crore till April 22.

From April 23, as normal market hours resumed, volumes have been inching up. The average daily turnover on April 23 and April 24 was about ₹20,000 crore.

The increase in volatility in commodity prices has helped boost interest in trading.

The Covid-19-triggered global market crisis, plus developments in the OPEC and the West, have all been reasons for higher volatility in commodity prices, especially crude oil and gold contracts, helping increase in volumes at the exchange. Further, in gold and silver, the rally in prices,too, has helped.

Going ahead, as uncertainty persists in the global financial market, commodity derivatives market volumes may continue to stay upbeat.

However, one needs to be watchful about the volumes in the crude oil contracts of the exchange as it is based on the WTI crude futures contract at NYMEX.

This contract is deliverable only at the Cushing hub, Oklahoma, and the place is running out of storage space. Buyers of this contract last week refused to take delivery of their open contracts and this pushed the contract price to minus $37.63/barrel on April 20.

Thus, MCX, too, had to settle its April crude oil futures contract at a negative price, and traders who had long positions open, ended making a huge loss (April 20 being the expiry day of the contract for the MCX contract).

Now, traders who burnt their fingers may think twice before coming back.

Financials

In the nine months ended December 2019, MCX reported a 21 per cent increase in income from operations (₹268 crore). The operating profit growth for the period was up 60 per cent due to better containment of operational expenses. Operating profit margin was 42.45 per cent, up from 31 per cent in the same period last year, thanks to lower technology and other expenses.

The high-margin scenario may sustain for some more time as volumes remain robust and with no additional costs expected.

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