Options approval good, but MCX valuations ignore ground realities
Shares of Multi Commodity Exchange of India Ltd (MCX) have risen by around 27% in the past seven trading sessions. Investors have been excited about the Securities and Exchange Board of India’s (Sebi’s) plans to allow commodity exchanges launch options contracts; this was eventually approved on Wednesday. Besides, MCX suddenly raised its transaction fees by around 25% for futures contracts this week. Analysts at Edelweiss Securities Ltd say this can boost earnings by 19% in fiscal 2017-18.
Thanks to the recent rally, MCX shares are now 12% higher than end-February 2013 levels, or just before its woes under the previous management had begun. On 28 February 2013, the government announced a commodity transaction tax, which resulted in a massive drop in traded volumes. And later that year, the National Spot Exchange Ltd scam came to light, which led to restrictions on commodity futures markets as well.
It can be argued that under a new management, many of MCX’s earlier troubles are behind it. But the numbers tell a different story. Average daily turnover on the exchange stood at Rs21,923 crore in FY16, 55% lower than in FY13. And profits are now about 60% lower compared to FY13 levels. The fact that the company’s market capitalization is now higher than end-February 2013 levels means that valuations have risen massively. MCX trades at nearly 44 times Edelweiss’s revised earnings estimate for FY17.
While it’s true that the exchange’s prospects look good, a willingness to pay over 40 times forward earnings means investors are pricing in this expected improvement and much more. Besides, they are brushing concerns related to the commodity segment under the carpet.
Although Sebi now regulates both the equity and commodity derivatives markets, it’s clear that the latter is treated as a lesser sibling. Now and then, it clamps down on certain commodity contracts—imposing higher margins at times, or even banning contracts in extreme cases. Also, as pointed out earlier in this column, Sebi hasn’t moved quickly enough to bring commodity exchanges on a par with their counterparts in the equity segment. See bit.ly/29bpIMB.
Sebi’s algorithmic trading guidelines for the commodity markets are vastly different from those that apply in the equity derivatives segment. For instance, commodity exchanges can’t provide co-location facilities or allow members using algorithmic trading systems to post immediate or cancel orders, among other restrictions. If similar limitations were applied to members of equity exchanges, turnover would reduce materially, especially in the options segment.
In any case, a look at the growth in the National Stock Exchange’s (NSE’s) transaction fees in the past seven years should temper investors’ excitement. The bourse has had enormous success in the equity derivatives platform. While its average daily turnover rose at an impressive pace of 28.5% between FY09 and FY16, revenue earned from transaction fee has risen by only 10.8% annually during this period.
NSE may well decide to enter the commodity space directly, which can increase competition. On the other hand, MCX may target other segments such as currency, but this can result in cash burn, keeping in mind NSE and BSE already have a high share of the market.
Having said all this, if reports of CME Group Inc.’s interest in buying a 15% stake in MCX are true, investors may continue valuing the bourse at high multiples. But as things stand, the stock is unduly pricey.