Stock Call. Why investment in MCX is a good bet over the long run

In April, we recommended to ‘hold’ on MCX (at the price of ₹1,072) when the stock was plummeting in the aftermath of a controversy in the crude oil contract. The exchange settled open positions in crude oil April month futures at a negative price as a WTI (West Texas Intermediate) contract in NYMEX price moved into the red.

Investors in the crude futures contract of MCX ended up making huge losses and resultantly the interest in crude futures on the exchange dropped.

As the crude oil contract is volume churner for MCX, the development had worried investors in the stock. Besides, given that the MCX’s trading platform didn’t have a facility to accept a negative price quote, investors were worried over how traders will continue on the contract if WTI moves into the negative terrain again.

Over the last two months, however, a lot of positive developments, including the sharp rally in the price of gold, have helped the MCX stock gain strong traction, more than recoup its losses and rise to a lifetime high.

At the current market price of ₹1,672, the stock discounts its earnings for FY21 by 37 times.

Its average PE ratio in the last three years on one-year forward earnings was about 24 times.

While high earnings visibility and absence of competition in the bullion and energy futures market make MCX a good investment bet over the long run, pricey valuations may limit the upside in the near term.

Hence, investors can continue to hold the stock. Market corrections, if any, should be an opportunity to accumulate the stock.

Positives

In the June 2020 quarter, MCX recorded a 14 per cent drop (y-o-y) in operational income. But since June, volumes have picked up sharply on higher interest in trading in bullion futures. Thus, the September 2020 quarter looks promising.

The main drag on the stock — the absence of a provision for negative price quotation in the software — is not a worry any more.

MCX has modified its software to accept negative price and has done a test run, too. So, there may not be any issue for the exchange to attract traders back to its fold. However, since this is a recent development, one has to wait and watch if volumes come back in crude oil futures or not.

The current average daily turnover in crude oil futures on MCX is ₹3,000 crore. In March — before the fiasco in the crude contract — the average daily turnover in the contract was about ₹11,000 crore. That said, the loss in volumes in the crude contract have been offset by higher turnover in gold and silver futures.

The Covid-19 pandemic has led investors across the globe to invest aggressively in safe havens — gold and silver. Since June, as prices of gold and silver started to climb new peaks, speculative interest in gold and silver futures contracts on commodity bourses have been going up.

The average daily turnover in gold and silver put together is ₹23,000 crore now; in March, it was ₹ 16,000 crore.

There has also been an increase in the number of traded contracts on the exchange.

In July, the overall turnover at the exchange, including trade in metals, bullion, energy and agri contracts, was ₹8.5-lakh crore.

This is sharply higher than that in April when volumes were at ₹2.8-lakh crore.

The medium-term outlook for the stock is positive. The exchange is all set to introduce index futures on metals and bullion. Further, with mutual funds that run gold exchange-traded funds (ETFs) also considering buying gold futures with the SEBI’s nod, volumes will rise further. The launch of options in goods in gold mini (100 grams) contract is also expected to add to volumes as it will bring more traders (retail investors) and hedgers to the exchange (with costs relatively lower).

The other positive news is that MCX has entered into an MoU with B2B e-commerce company Mjunction to explore setting up of a coal exchange.

While BSE and NSE have been trying to establish themselves in the commodity derivatives space, there has not been much success. In options in in gold, one has to see if BSE is able to sustain the good volumes that it is seeing.

Cost control

MCX’s June quarter performance was marred by a drop in the turnover od crude oil contracts and restricted work timing in April due to the Covid-19 lockdown. (Between March 30 and April 22, the commodity market was functioning only between 9 am and 5 pm. In normal days, it functions till 11.30 pm.)

The revenue from operation in the quarter was ₹73.01 crore, down 14 per cent from the same quarter last year. However, lower employee costs and a drop in other operating expenses, along with an increase in other income, helped the company record a 29 per cent growth in net profit at ₹56 crore. The operating profit margin in the June quarter was 62 per cent versus 53 per cent last year.

In the next few months, as prices of gold and silver remain elevated, margins could be strong for the company. But salaries of employees in the Assistant VP level, which was cut by 10 per cent, once restored from this month, could impact some of the costs savings.