NSE: IEX
BSE: 540750
Incorporated in the year 2008, IEX is India’s largest energy exchange which provides, transparent trading & price discovery platform for physical delivery of electricity & renewable energy certificates.
Company operates in the short-term markets (another type: long-term contracts) which are near-term agreements between buyer/seller to purchase required electricity. Exchange facilities efficient & transparent price discovery by conducting double-sided anonymous bidding process.
Buyer of power: Industries (4400+) & distribution companies (55+)
Seller of electricity: power generator companies (500+) & Renewable energy entities.
Industry overview & Rise of Short term contracts:
India set up its first power plant in the year 1897 & since then we have made considerable progress & today our total installed capacity is 382 GW which makes us a power surplus nation & an exporting country.
In earlier times, India had a lot of uncertainty about power generation capacity & its transmission furthermore to mitigate that risk most state distributors & power generators used to sign long-term contracts (more than 20 yrs.).
But in today era with surplus capacity & transmission Infrastructure in place, long term contracts are becoming unfavorable as it keeps buyer lock-in for 20+ years to the same rate specified at the start of the agreement.
Although, long-term contracts have an 89% market penetration but slowly trend is shifting as many states are going for short-term contracts & canceling long-term commitments. In fact, since 2015, only 1 long term deal (20+ years) has been signed.
The other counterpart is short term market which provides efficient & better value to buyers & sellers, generator can sell surplus power & buyer can purchase at a lower price/unit according to current conditions.
Short term contracts have an 11.2% share of total consumptions & Includes major participates like:
1. Power exchange (like IEX & PXIL) holds a 6.1% market share. Exchange with its superior price discovery mechanism & transparent bidding process helps participate get lower price/unit & liquidity compare to other players.
2. Traders & bilateral holds the remaining market, but this share is diminishing as these contracts are customized contracts that don’t work on price discovery mechanism but rates decided by a group of traders and buyer has to agree upon that price. It also carries a counter-party default risk.
In last 10 years’ short-term contracts has seen popularity because it helps state distribution companies in cost savings towards power procurement as electricity is procured from cheapest source & therefore exchange as an alternative was able to gain dominant share from 20% in FY11 to 61% in FY21.
Key Product type & Market share:
IEX offers various customer-centric products like DAM, TAM, RTM, GTAM all these are different contract types with duration ranging from 1 hr to 11 days.
Platform works similar to the stock exchange where a buyer with a certain megawatt(MW) electricity requirement has to put in his bid price in allocated time-slot which, if equivalent to seller offer price then trade take place & agreed-upon rate is called Market clearing price (MCP).
Because of 4000+ participants, exchange provides much needed liquidity for sellers & low MCP for buyers which helps IEX gain more members & market share.
In most of the product category, company either has monopoly or above 90% market share which translate to huge sustainable revenues & profit growth for the company.
Key Revenue Segments:
1. Transaction Fees: For every executed trade, IEX charges a transaction fee of 0.02/kWh from both sides, i.e. minimum of ₹40/MW trade. IEX platform had an average daily volume of 2.1 lakhs MW in FY21 which makes transaction fees a major source of revenue & it forms about 80% of the total company’s revenue.
2. Admission & Annual fees: Remaining revenue comes from the admission fees & renewal segment. As a member, participate has to pay one-time admission fees & renew it annually. company charges ₹40lakhs/member.
Financials & Key Ratios:
Key highlights:
1. IEX has reported consistent growth & profit margins over the years as it has limited expenses compare to revenue & is reaping the benefits of its initial investment in new technologies & customers which will continue to contribute revenue growth in the future as well.
2. IEX is a debt-free business with a huge cash reserve which helps the company to diversify into new businesses like the recent launch of the Natural gas trading exchange i.e. IGX.
3. 3-year average ROCE & ROE are 51.8% & 45.4% which is well above sectoral average & possible because of monopolistic approach & high barriers of entry because of network & technology effect.
Investment Rationale to select IEX:
1. Under-penetrated & competitive advantage: India is under-penetrated in terms of exchange-traded electricity as compared to developed countries & firm with its virtual monopoly & competitive advantage is expected to gain market share.
At present, India has a 6% penetration which is expected to rise. It would be very difficult for a new firm to set-up a power business & gain market dominance against IEX because a new entrant may find it difficult to offer superior price/unit because of illiquidity & less market participation. Moreover, exchange members may not switch to other exchanges because of high initial membership fees (₹40 lakhs/participate).
For example, company’s closest competitor, Power exchange India Ltd.(PXIL) which started operation in 2008 still has less than 3% market share and a loss-making company. PXIL was on verge of a business shut-down in the year 2018 because of continuous losses.
2. Cross-border trading: In April 2021, IEX started cross-border trading with Nepal as the first country on board & it plans to include Bhutan, Bangladesh & Srilanka in the coming years. India being a power surplus nation plans to export electricity through exchange platform.
3. New product segments: till now contracts offered by IEX had a maximum range from 1hr to 11 days of electricity requirement but it plans to introduce a long duration contract(LDC) with a duration of up to 365 days which will help to gain market share.
4. New Business segment: Similar to electricity exchange, firm recently launched operations in natural gas trading through its subsidiary company Indian Gas Exchange(IGX). IGX is still at a nascent stage of the business cycle with a similar model to enable efficient & competitive price discovery for gas contracts & target market dominance of bilateral & off-market transactions.
Key Risk with IEX:
1. Regulatory changes: Electricity being an essential service has regulatory control. Rules for exchanges are formed by Central Electricity Regulatory commissions(CERC) which decided maximum transaction fees, contract type offered by the exchange. If the regulator tinkers with rules, then it could impact on company’s revenue & profits.
2. Change in Demand/supply matrix: Short-term contracts serve as backup for peak power requirement but when a particular state has a stable demand curve then it will rely more on long-term contracts rather than the exchange which could Impact IEX traded volume. Also, exchange has to ensure price stays stable in an optimal range of 2.5 to 2.8/kwh, too high or too low a rate per unit could impact exchange participation.
Summing up:
For the last 10 years’ market witness a 90% long-term & 10% short-term contract ratio, but developed market data suggest more scope for the short-term market. Would the ideal ratio will be (80-20) % or (70-30) % split?? That only time will tell but if it does happen then the big beneficiary will be a platform business like Indian Energy Exchange(IEX).
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