The company that I'm going to discuss today has an almost 95% monopoly in the sector it operates. On top of that, this company has technology as its core competency, so it is basically a technology company that has a 95% monopoly in the market. The company I'm going to discuss is the Indian Energy Exchange but is it really a multi-bagger? We will discuss this in this article. Dear friends, before proceeding further, I would like to clarify that this article is only for long-term investors, and I would request you to read this article till the end, as I am sure that the majority of you will not know much about the business of Indian energy exchange and this article is only for the educational purpose. In this article, we will try to understand, what exactly is IEX, and what is its business model? Then we will look at the product segment of the company along with the leadership profile. Then we will look at the competitive advantage of the company and try to understand, why Indian Energy Exchange enjoys a 95% monopoly in the business? And finally, we'll look at the megatrends in the energy sector in India that will drive the growth of the Indian Energy Exchange. At the last, we will discuss the key initiative from Indian Energy Exchange for future growth. Then we will discuss the key risk aspect of the company. And then we'll look at the financials of the company. And finally, we'll check the valuations to understand if the company is overvalued or undervalued. Then we will conclude if the Indian energy exchange is fundamentally strong or not. And if it is worth investing in the company or not. Alright, let's get started.
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IEX and its Business Model
Established in 2008, the Indian energy exchange is the first and the largest in India that provides an automated trading platform for physical delivery of electricity, renewable energy certificate, and energy-saving certificates. Okay, this might sound a bit complicated to many of you, as the energy exchange business is not common. So let me simplify the business model of Indian energy exchange. Think this way, when you want to buy a stock, you visit a broker's website. For example, let's visit ZERODHA. Now, you will submit your bid at a specific price. So let's say you want to buy 10 shares of HDFC Bank at rupees 1400. So, you will enter the buy quantity and the price at which you want to buy then there would be a seller on ZERODHA who would want to sell it. Now, you will only be able to buy 10 shares of HDFC Bank at rupees 1400 when the seller is willing to sell those 10 shares for rupees 1400, and where is the stock price decided it is decided at the exchange level that includes Bombay Stock Exchange and National Stock Exchange. These are the two biggest stock exchanges in India. So, they have a specific algorithm that decides the stock price. Similarly, you have an Indian energy exchange that provides a platform for buyers and sellers to buy and sell physical electricity via an online platform. Now here is the interesting part. When you buy stock ZERODHA is only a broker that facilitates the buying and selling process, it does not decide the price of the stock, it is decided at the exchange level that is at NSE and BSE. However, on Indian energy exchange worth buying and selling process, which is also known as order matching, along with price discovery happens at the exchange level. Just imagine NSE or BSE doing their job, as well as providing a platform for buyers and sellers. In that case, you won't need ZERODHA. Now, once the bidding and price discovery happen, the buyer will be able to buy electricity and the seller will be able to sell the electricity. Until a few years ago India always had a power deficit. So there was no question about selling electricity. But today, India is a power surplus country with a large installed generation base of 382 Gigawatt and a peak demand of about 185 Gigawatt, India is a power surplus country, which means the additional electricity can be bought and sold. I hope now you're clear about the business model of the Indian energy exchange. And how does Indian energy exchange earn around 80% revenue of IEX is in the form of transaction fees, as it facilitates the buying and selling transaction of electricity. So it charges a transaction fee. As there would be more and more transactions of electricity in the future, it would increase the revenue for the company.
Product offerings of IEX
The day had to market
In Day had market participants transact electricity on a 15-minute block basis in 24 hours of the next day, starting from midnight. So if you need electricity tomorrow, you can trade that today on a 15-minute block basis.
Term Ahead market
In the Term Ahead market, buyers and sellers can trade electricity for up to 11 days ahead. It enables participants to purchase electricity for the same day through intraday contracts, for the next day through day-ahead contingency, or daily for rolling seven days through daily contracts and weekly through weekly contracts to manage their electricity portfolio for a different duration.
Real-time market
The real-time market is a new market segment launched on 1 June 2020. It features a new auction session every half an hour with power to be delivered after an hour after the gate closure of the auction, which means energy can be bought and sold in almost real-time within an hour.
Renewable Energy Certificates (REC)
Various industries have the obligation to use a minimum amount of renewable energy. And if they don't use renewable energy, then they can purchase the Renewable Energy Certificates from the renewable energy generator on the exchange. This basically helps renewable energy generators to recover their cost.
Energy Saving Certificate
Again, the energy-saving certificate is an interesting product of IEX. So the Ministry of Power launched a program to increase the energy efficiency of various industries. For example, by using the LED light or by using an advanced machine that consumed lower energy. So these industries were given targets for reducing their energy consumption. Now, some industries can overachieve the target, whereas some can't achieve it, even industry or achieve the target, it can convert it into a tradable Energy Saving Certificate at the end of the target idea that it can sell to the one that could not achieve the target Indian Energy Exchange, also facilitate this process. I hope now you understand the various products segment of the Indian Energy Exchange.
Today, more than 6700 participants are registered on IEX, out of the participants registered to trade electricity contracts include more than 15 distribution companies, over 500 electricity generators, and over 4200 open access consumers. Open Access consumers belong to various industries such as textile, metal, chemical, automobile, cement, etc.
IEX Leadership
If you look at the leadership of the company, Mr. Satyanarayan Goel is the Executive Chairman and Managing Director of the company since February 19, 2021. He has over 40 years of rich experience in different areas of the power sector. He was also actively involved in various reform initiatives of the government of India. He was also associated with NTPC limited for 29 years and retired as an Executive Director. Overall, the company has a very unique business model of operating as an energy exchange platform, and it has various products in the category. The leadership of the company has a rich experience. However, the original promoter of the company was Mr. Jignesh Shah, and he was involved in financial fraud and in 2014, the control was taken over from him. Although IEX's current management is clean, its promoter was involved in unethical practices in the past. Hence, on the company and its business and its leadership, I would rate it 8 on 10.
Competitive Advantage and the monopoly
The biggest advantage of the Indian Energy Exchange is its technology. The company is continuously innovating launching new product and services and it is all set to encash the Digital Trends in the future. Indian Energy Exchange is even working towards automating its market operation process using Robotic Process Automation and Artificial Intelligence to improve the forecasting models and optimize the buying pattern. Now, let's try to understand the reason for the monopoly of the Indian Energy Exchange in the energy exchange market. So, Indian energy exchange has about 95% monopoly in the energy exchange platform, which means 95% of energy exchange happens on IndianEnergy Exchange, which's a lot of power. So, think this way, if you want to buy energy, which platform would you use, you would use the platform that has more sellers, so that you can get a competitive rate. Hence, you will join IEX as there are more sellers. And if you want to sell electricity, which platform will you use, where you can find more buyers hence you will join IEX.
Due to this, IEX has a monopoly in the market, while everything looks perfect for this company with great business, great monopoly, and so on. There is one major factor that drives the future of this company. So just like banks are regulated by RBI, the Stock market is regulated by SEBI, this energy exchange is regulated by Central Electricity Regulatory Commission, which is CERC. For example, CERC regulates the pricing structure of IEX, where CERC decides the price per transaction for IEX. We discuss further how CERC can impact IEX growth and monopoly in the risk aspect. Another player in energy exchange in India is PXIL that was around 4 to 5% market share. So, as of today, IEX has a strong monopoly in the sector it operates, and hence, on competitive advantage, I would rate 10 on 10.
Mega Trends in Energy Sector
Before we try to understand the future growth of IEX, it is important to look at the megatrends that are shaping the growth of the energy sector in India.
Decarbonization
The first megatrend is decarbonization trends. Dear friends, there is a strong focus on renewable energy in India. In fact, if you look at power production in the year 2020, thermal is the biggest contributor with 62% share, the remaining share is with hydro, wind, solar, etc. But going forward solar energy share is going to increase rapidly from 9% to 20% to 36% by 2030. Wind power would increase from 10% to 17%. Thermal Power would reduce from 62% to 35% by 2030. Just to give you an idea, the current installed renewable energy capacity stood at 90.39 Gigawatts, and the government plans to establish a renewable energy capacity of 500 Gigawatts by 2030. That's more than 5 times in the next 10 years. Now, you can imagine the growth of the renewable energy sector in India.
Decentralization
The second megatrend is decentralization. Earlier, power generation was mainly done by large companies like NTPC. This was then transmitted and distributed to the end consumer, but now the big trend is decentralization, where electricity generation and transmission would happen all over the country. For example, due to the installation of rooftop solar panels, many small players are also generating electricity, they can use the exchange platforms to trade electricity.
Digitalization
The third megatrend is digitalization, decarbonization and decentralization will require increased focus on automation and technology to optimize the entire end-to-end supply chain across generation, transmission, and distribution. The addition of intelligent system controls and internet-enabled software can enable the optimization of power plants and grids. In addition, large-scale up-gradation to smart metering, IoT-based application, and smart grid technologies are driving the digitization of power distribution.
Democratization
The final megatrend is democratization. In the future, the end consumer would have more power. For example, you can choose an electricity supplier in the future. Even in Budget 2021, the government has mentioned that they will come up with a framework where an end consumer can choose the electricity provider. This would establish energy as a service concept in the country. the electricity consumption in India is still 1/3 of the global average. The Per Capital electricity consumption in India is 1181 kilowatt-hours as compared to Brazil, which is 2601 kilowatt-hour energy consumption, and China has 3927-kilowatt hour consumption, and the global average is 3127-kilowatt hours. So, Per Capital consumption in India is expected to double in the next 5 to 6 years. This is mainly due to factors like increasing manufacturing activity in India, government initiatives like make-in India Atamanirbhar Bharat, etc. Rising urban population and government focus to provide last mile connectivity where even the remotest villages can get access to electricity.
With growing trends like digitization, where you have smart meters, IoT devices, and smart grid technology, you would need a technology-based marketplace to create the energy with growing decentralization that is local manufacturing of power and growing democratization. That is the power to consumers to choose among the electricity supplier, you would need a marketplace to trade your energy, and that's where Indian energy exchange comes into the picture, where you can trade physical electricity at the best rate using our digital platform.
Strategic growth plan
Now, let us look at some strategic growth plants of Indian energy exchange. The first plan is
New Product Launches
As we discussed, the Indian energy exchange has many product segments where you can trade electricity for the next day or up to 11 days or even in real-time, then you can also trade renewable energy certificates and energy saving certificates. Indian energy exchange is continuously launching new products to widen its reach and increase penetration. For example, the Indian Energy Exchange has recently launched cross-border trade, where neighboring countries in the South Asian region can trade electricity on this platform. So it is increased its reach to the entire South Asian region. The company is also planning to introduce a green market where it will enable the trading of renewable energy on the platform. If it gets approved by CERC, then it would generate additional revenue for the company and renewable energy is the future.
Better rates from exchange
The second plan better rates from an exchange. One of the major reasons for the adoption of energy exchanges would be the cost-saving factor. Since anyone can come and bid for the electricity in real-time. This provides a great opportunity to buy electricity when it is available at lower rates. For example, during the lockdown in March and April 2020 electricity was available at a very low rate on the Indian energy exchange. In one of the reports the alignment it mentioned that companies saved crores of rupees by trading electricity on the IEX platform. In other news, Maharashtra's income which is electricity distributors started buying energy from IEX and save a lot of money.
Lunch of IGX
Next is the launch of IGX. IEX has also launched a platform, called IGX which is the Indian Gas Exchange, it is the first gas exchange platform in India it will facilitate the trading of physical gas. If you look at the exchange market as a percentage of total demand power market in developed countries is in the range of 30 to 50% whereas, in India, it is only 5%. On top of that, the share of exchange in short-term trade is just 5.2%. So, currently, there is a very low usage of exchange platforms for power trading. This is mainly because there is a long-term contract between power companies like NTPC and distributors, it could be as long as 25 years. However, Government is planning to introduce MBED which is Market Based Electricity Dispatch, where the power generators and distributors would have to come to the exchange platform to trade. If that happens, it would boost the growth of power exchange in India to almost 8 to 10 times in the next few years.
Key Risk
So far we discussed the growth prospects and positive side of the company but now let's discuss the key risk. The biggest risk for Indian Energy Exchange is the risk of losing its monopoly. How can IEX lose its monopoly? As we have discussed earlier, IEX is regulated by the Central Electricity Regulatory Commission (CERC). Now CERC is concerned with the monopoly of IEX in the country, obviously, a monopoly is not good in any market. You need competition for the overall market to thrive. Hence, CERC has recently introduced 'Market coupling' in spot power trading, please read it very carefully.
We already discussed the business model of IEX where we learn that the Indian Energy Exchange facilitates order matching, where buyers' and sellers' bits are matched, as well as price discovery, where the IEX algorithm decides the right price based on supply and demand both happen on the platform. However, with market coupling, this order matching, and price discovery would be done by a third party. Hence, after 'Market coupling' buyers from other platforms would be able to buy from sellers on the IEX platform. Likewise, buyers on the IEX platform can buy from sellers on another platform. As of today, IEX had the monopoly because it had the maximum number of buyers and sellers, and it was able to provide electricity at a competitive rate, but after 'Market coupling' it would lose this monopoly. As there won't be any cost incentive for buyers and sellers to use the IEX platform. This would also open up the market for other players to enter and IEX would lose its monopoly but since the overall size of the energy exchange market is expected to grow, IEX would benefit from it. So, even though the pie size of IEX in the market would reduce due to 'Market coupling' the overall pie of the market would increase. Hence, on future growth prospects, it is a mix of both growth for the company, but at the same time, there is a risk of losing the monopoly. So on future growth, I would rate 8 on 10.
Financials
Now let us look at the financials of IEX.
Revenue
If you look at the revenue growth since March 2011, IEX revenues have grown from rupees 36 crores to the level of 291 crores by December 2020 that's a growth of 25.8%. the profits have grown from rupees 19 crores to 197 crores at a CAGR of 27%. Overall, the historical growth has been fantastic. Hence, on the growth ratio, I would rate 10 on 10.
Operating Profit Margin
If you look at the operating margin of the company, it is exceptional. It is consistently above 50%. In fact, the recent operating margin is 80%. This clearly suggests the lean structure of the company and its core competency as a technology-based solution provider that reduced the cost and hence a brilliant operating margin of 80%.
ROE and ROCE
Its ROE and ROCE for the last 10 years are consistently great. The recent ROE and ROCE stood at 41% and 53.8% respectively, which is simply brilliant. Hence on profitability, I would rate 10 on 10.
Debt to equity ratio
If you look at the debt to equity ratio company has zero debt which makes it a debt-free company. Hence on debt to equity, I would rate 10 on 10.
Reserves
The reserves of the company have increased from 48 crores to rupees 451 crores, which is great. Overall the company is looking financially very strong.
Shareholding pattern
If you look at the promoter shareholding of IEX, the first thing you would have noticed is that there is no promoter, the entire shareholding is between FIIs, DIIs, and retail investors. Although FIIs have increased their stake in IEX significantly from 9.91% to 36.81% in the last 3 years. DIIs have kept the shareholding in the range of 30s but recently they have reduced the shareholding from 36.6% to 27.9%. looks like DII have sold the shares and FIIs have purchased them in March 2021 quarter, but overall both DIIs and FIIs have a good amount of shareholding in the company. The recent why IEX does not have any promoter is because initially IEX was promoted, that company called financial technology India Limited (FTIL), which had 26% stake in the company but its founder Jignesh Shah was involved in a scam of around 5000 crores and hence was forced to step down, and shares of FTIL were purchased by some other group.
Valuation
If you look at the share price movement of IEX, its IPO was in the price band of Rs 1650 in October 2017, later its share split from 1:10, so it was trading at around 165 rupees, and since then it is currently trading at Rs 370. The PE ratio of the company is currently around 57, which is higher than the median PE of 32 which looks overvalued to me.
Read also: Why are IEX shares falling?
Conclusion
Overall if you conclude IEX has a business of power exchange, where it provides a platform to buy and sell electricity. It has an experienced team of leaders. Since it is a technology-based company, it has a very lean structure and high profitability. Currently, it enjoys a monopoly in the energy exchange market. The future growth of the company looks promising. However, the company is highly regulated by Central Electricity Regulatory Commission (CERC), which even controls the pricing for IEX. Moreover, CERC is planning to launch 'Market coupling' that could end the monopoly of IEX in the market. The current valuation of the company is on the higher side. Hence, I would suggest investing cautiously in the stock.
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