Investment bankers may have managed to extract high valuations for the Indian Energy Exchange Ltd (IEX) initial public offering. But the stock is feeling the after-effects. After a lacklustre listing, the stock continues to trail the broader markets.

This is despite the company delivering a steady performance. “We believe IEX is in a sweet spot as it benefits from the rise in short-term traded volumes," Jefferies India Pvt. Ltd said in a March quarter results review note.

Sure, easing transmission congestion and growing awareness among state utilities do offer immense scope for growth. But the opportunity is less rosy than it is sometimes made out to be. Growth is occurring at a rather pedestrian rate, a drawback for a stock trading at premium valuations.

Revenues during the March quarter are up 7%. For the full year they are up 10%, out of step with the stock’s rich valuation of 31 times fiscal year 2019 earnings estimates.

At the core of the optimism are the spot electricity trading volumes, which include day ahead and term ahead contracts. Volumes during the quarter and full year are up in the range of 13-14%. Jefferies India estimates overall volumes at IEX to grow at an average annual pace of 15% till FY20, helping the company expand the profit by 16% annually.

But weighing on investor sentiment is the rather gradual expansion of the short-term power market. According to Jefferies India, in the first 11 months of FY18, the short-term power market increased to just 10.6% of the power market in India from 10.3%.

Ratings agency Crisil Ltd estimates that this short-term market will expand rapidly. But the complex realities of the Indian power sector stand in the way. Wary of losing lucrative non-residential customers, state electricity boards (SEBs) impose open access charges, keeping them away from the spot electricity markets. The second problem is the government monitored platform for shorter duration power procurement contracts, which drives some volumes away.

The other set of challenges emanate from SEBs. Given that SEBs have more than adequate longer duration power purchasing agreements, the first preference is to fully utilize them. The incremental demand is tactfully met through short-term markets such as IEX.

But with demand expanding at a pedestrian pace—total power generation is up just 4% in FY18—the scope for large-scale purchases is rather limited and this is being reflected in the slow pace of expansion of the total short- term power market. In short, the valuation-growth mismatch is a key overhang for IEX and the recent stock performance is testimony to it.

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