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Key beneficiary of global market volatility
* Total value of contracts traded on MCX increased strongly by ~44% YoY in 4QFY20. This was significantly ahead of our earlier estimate and largely led by heightened uncertainty and volatility in the global markets. Gold/silver/crude reported strong growth of ~120%/133%/60% YoY in traded value.
* Against the backdrop of COVID-19 outbreak, trading at MCX was truncated to eight hours (v/s 14 hours earlier), making it out of sync with the global commodity markets. This led to a sharp ~80% drop in traded value (v/s monthly average till 25th Mar’20). In our base case, we expect the restrictions to continue till end-Apr’20, materially impacting revenue growth/EBITDA margins (0%/16% QoQ contraction) for 1QFY21.
* Nevertheless, the medium-term prospects of MCX remain robust. Cues from the GFC period hint at increased interest in precious metals over a 2-3 year period following crisis/market volatility. COVID-19-led slowdown in global growth, soft interest rates and liquidity injections should be the key factors driving interest in gold/silver this time. Normalization of margin requirements in the crude segment is likely to drive continued strength in volume growth.
* Over FY21-22, we expect strong revenue growth of 14-18% and stable EBITDA margin of 42-44%, notwithstanding the COVID-19 impact on 1QFY21 operations. We upgrade our EPS estimate by 5-7% over FY21-22 to factor in the increase in volumes led by global market volatility. We continue liking the company for its near monopoly in the commodity exchanges segment in India. Reiterate Buy.
Global market volatility drives sharp increase in activity in Feb/Mar’20
Total value of contracts traded on MCX increased strongly by ~44% YoY in 4QFY20 (data considered only till 30th March 2020). This was significantly ahead of our earlier estimate and largely led by heightened uncertainty and volatility in the global markets. Precious metals like gold and silver reported a robust increase of ~120%/133% in total value of contracts traded. Volatility in crude prices led to a surge in speculation activity translating into ~60% YoY growth in traded value
During the quarter, while growth in traded value of gold and silver was more pronounced in Feb and March, it was more front ended for crude (toward Jan and Feb) due to the sharp fall in crude prices. Most of the base metals continued to show a trend of decline (YoY) due to the compulsory delivery rule, which impacted the interest levels of speculators and arbitrageurs.
Expect COVID-19 disruption in the near term
Against the backdrop of the three-week lockdown imposed in the country, trading at MCX is truncated to 8 hours per trading day (v/s 14 hours earlier) from 30th March to 14th April 2020. This makes the timings of the Indian commodity markets largely out of sync with those of the global commodity markets/news flows. Our interactions with commodity market experts suggest this limitation should have a material negative impact on speculation/investment appetite on MCX.Post this change, a look at the total contract value traded suggests a sharp ~80% drop (v/s monthly average till 25th March 2020). It was a broad-based decline across all important asset classes (84%/76%/80% drop in gold/silver/crude). In the base case, we expect the restrictions on trading hours to extend till the end of Apr’20. However, as trading returns to the normalized duration of 14 hours/day, we expect a recovery in volume growth.
Medium-term prospects robust
Recent volatility in global markets further underscores the need for diversification into alternate assets like gold and silver. Cues from the GFC period hint at an increased interest in precious metals over a 2-3 year period following the crisis/ market volatility. For instance, gold prices rallied ~170% in the three-year period (2009-12) subsequent to the GFC. COVID-19 led slowdown in global growth, soft interest rates across economies and massive liquidity injections by central banks should be the key factors driving the interest this time.
Over the previous two months, growth in traded value in crude decelerated (67%/87%/24% in Jan/Feb/Mar YoY). This was largely driven by the sharp decline in crude prices over this period. This price decline was accompanied by a strong increase in the margin requirements (~47-48% v/s 8-10% normally), further impacting volumes. Nevertheless, it is key to note that the traded value in Mar’20 still reported a robust growth of ~24% YoY. Normalization of margin requirements should drive continued strength in crude volume growth on MCX.
Base metals continue to report declines, largely led by the compulsory delivery rule, which impacted the interest levels of speculators and arbitrageurs. This was further complicated by the limitations on delivery capacity and shutdown of Vedanta’s copper complex which resulted in a shortage of the metal in the domestic market. Our interactions with the commodity market experts suggest this segment will take time to recover. Interest from SMEs, increase in delivery capacity for metals and liquidity concentration measures by the exchange (e.g. through single contract for each metal) should drive a recovery in this segment over the medium term.
Despite the one-off near-term impact on 1QFY21E (0% YoY revenue growth), we expect strong ~14%/18% revenue growth over FY21/22, primarily led by precious metals and crude. Notwithstanding the sharp EBITDA margin contraction expected in 1QFY21 (33% v/s 49% in 4QFY20E), we expect the EBITDA margins over the next two years to remain largely stable (in the range of ~42%-44%).
Valuation view: To be key beneficiary of global market volatility We upgraded our EPS estimate over FY21-22 by 5%-7% to factor in the increase in volumes led by the global market volatility. We continue liking the company for its near monopoly in the commodity exchanges segment in India. Over the course of its listed history, one-year forward P/E multiples averaged ~25x. Our target price implies 25x FY22E EPS. Reiterate Buy.
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