Indian Energy Exchange Ltd Price band

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1 IPO Review Rating matrix Rating : Subscribe (Apply) Issue Details Issue Opens Issue Closes Issue Size ( Crore) 9-Oct Oct crore Price Band ( ) No of Shares on Offer (lakh) 6.7 QIB (%) 5 Non-Institutional (%) 15 Retail (%) 35 Minimum lot size 9 shares and in multiples of thereof Objects of issue ( crore) The offer comprises an offer for sale of 6.7 lakh equity shares (~ 1 crore). The offer is entirely through an offer for sale and the Company will not receive any proceeds from the offer. Shareholding Pattern Pre-Issue Post-Issue Promoter & promoter group.%.% Public & Others 1.% 1.% Valuation Summary (at 165 ;upper price band) FY14 FY15 FY16 FY17 P/E EV/EBITDA P/B ROCE ROE Research Analyst Chirag J Shah shah.chirag@icicisecurities.com October 6, 217 Dominant player focused on future growth Indian Energy Exchange (IEX), incorporated in 28, is one of two power exchanges in India offering an electronic platform to trade electricity products. It has a dominant majority market share of 94.8% compared to its sole competitor. The company provides an automated platform for physical delivery of electricity. IEX enables efficient price discovery and offers participants opportunity to trade in a variety of energy products. Its exchange platform increases accessibility, transparency of the power market in India and enhances speed and efficiency of trade execution. It also offers settlement services, including electronic trade confirmation, access to clearing services & risk management functionality. Participants registered to trade electricity contracts include 5 distribution companies, over 4 electricity generators and over 3,9 open access consumers. In FY17, IEX recorded sales of 24 crore, EBITDA of 143 crore (EBITDA margin of 7%) & PAT of 113 crore. Investment Rationale Dominant energy exchange with wide brand recall The company was the first energy exchange in India, having commenced operations in June 28. IEX got an early mover advantage and created a strong brand among participants in the energy trading industry in India. The strong brand is also visible in the dominant market share it enjoys in short-term power trading in India. In the day-ahead market segment, it enjoyed 99.4% market share, in term-ahead market it recorded 67.9% market share while in renewable energy certificates, it has a 71.2% market share. In FY17, participants on the exchange traded and cleared billion kwh of power and 4.62 million RECs. Operational experience and scale of operations make it the largest energy exchange in India. Highly scalable technology with catalysts for growth IEX has a hugely scalable energy exchange platform. It currently caters to the entire country and plans to extend its trading facilities to neighbouring countries like Nepal, Bhutan and Bangladesh. Currently, India is divided into 13 price areas. Even after proposed expansion, this leaves plenty of scope for future growth. With technology support, the exchange can currently service up to 3 price areas. Expanding into such new geographic markets would allow IEX to increase the customer base and enhance the liquidity of electricity products available on the exchange. Priced at 44.1x FY17 P/E; recommend SUBSCRIBE At the upper price band of 1,65, IEX is priced at 44.1x FY17 P/E. This is on the back of an attractive cash yield of 4%, cash rich balance sheet, high profit margins, negative working capital cycle and superior return profile. We advise that investors SUBSCRIBE to the issue. Exhibit 1: Key Financials crore Net Sales other income Total Revenue EBITDA EBITDA Margins (%) Depreciation Interest PAT PAT Margins (%) EPS ( ) Indian Energy Exchange Ltd Price band

2 Company Background Indian Energy Exchange (IEX) is India s premier power trading platform. The company began operations in June 28. IEX is one of the two power exchanges in India that offers an electronic platform for trading short-term electricity products and has a dominant majority market share of 94.8% compared to its sole competitor. The exchange primarily brings together sellers of power like independent power producers, captive power plants, distribution companies, government owned power generation companies and buyers of power like distribution companies and industrial, commercial and institutional power consumers. It provides them with a transparent, neutral and automated platform for trading of electricity. IEX enables efficient price discovery and offers participants the opportunity to trade in a variety of energy products. The exchange platform increases the accessibility and transparency of the power market in India and enhances the speed and efficiency of trade execution. This has created a web of deserved trust among participants and resulted in increased liquidity. Over the years, the exchange has increased their offerings to provide settlement services, including electronic trade confirmation, access to clearing services and risk management functionality. This is a professionally managed company. IEX provides trading of several electricity products designed for shortterm markets over the firm s electronic trading platform providing physical delivery of electricity. 1. Electricity contracts in blocks of 15 minutes in the day-aheadmarket (DAM) 2. Electricity contracts for fixed terms in the future, such as intra-day contracts, day ahead contingency contracts and contracts up to 11 days ahead, known as the term-ahead-market (TAM) 3. Renewable energy certificates (RECs) by which the company provides a platform to trade renewable energy certificates. 4. In September 217, the company also commenced trading energy saving certificates Trading on the exchange is carried out by members on their own behalf and on behalf of their clients, together known as participants on the exchange. Trades with respect to electricity contracts traded in the DAM and TAM are physically settled. In other words, settlement is done through physical delivery of electricity itself. Around 3.5% of total energy generated in FY17 was traded on the power exchange. As of August 217, IEX had over 5,9 participants registered on the exchange of which over 3,2 participants were active. Over 4,3 registered participants were eligible to trade electricity contracts while over 4, registered participants were eligible to trade RECs. Participants registered to trade electricity contracts are located across 29 states and five union territories in India. Participants include 5 distribution companies, over 4 electricity generators and over 3,9 open access consumers. Page 2

3 IEX product profile Day-ahead market The day-ahead market was launched in June, 28. In this segment, participants transact electricity on a 15-minutes block basis, a day prior to the delivery of electricity. Both buyers and sellers submit their anonymous bids electronically during the market bid session while bids are matched on a double-sided auction mechanism with uniform market clearing price. The minimum allowable quantity to be bought and sold is.1 MW, with a minimum increment size of.1 MW of electricity. Congestion is managed through market splitting and an area clearing price (ACP) that is determined specific to an area. Risk management is adhered to through margin requirements, including any additional margin as specified for the respective trading segment or the type of contracts. Exhibit 2: Day-ahead market trading process es 1 am to 12 pm 12 am to 1 pm 1 pm to 2 pm 3 pm 5.3 pm 6 pm Bids for 15-min each for block bids can be placed. Market clearing price and volume is calculated. Corridor availability and funds verified. Final Area clearing price and volume calculated. Confirmation by NLDC Final schedule sent to RLDC for incorporation Source: Company, ICICIdirect.com Research Post confirmation by the National Load Development Centre (NLDC), the final schedule is sent to participants and regional load development centres for electricity delivery the next day. The DAM segment comprises a substantial majority of energy contracts traded on the exchange. Term-ahead market The term-ahead market (TAM) was launched in September 29. Contracts under TAM cover a range for buying/selling electricity for up to 11 days. It enables participants to purchase electricity for the same day through intra-day contracts, for the next day through day-ahead contingency, on a daily basis for rolling seven days through daily contracts, and on a weekly basis through weekly contracts to manage their electricity portfolio for different durations. Exchange enables trading in day-ahead contingency contracts, intra-day contracts, daily contracts through continuous trade methodology, i.e. on a real time basis with price and time priority as the matching criteria. The exchange enables trading in weekly contracts through a uniform price auction methodology. 1. Day-ahead contingency contracts: These are hourly contracts available for trading on day-ahead basis for : hours to 24: hours of the next day 2. Intra-day contracts: These are hourly contracts available for trading for the same day as the day of the trade. The intra-day contracts are one hour based rolling contracts and available for trading three hours prior to the start of delivery. Twenty hourly contracts are available for trading for delivery starting from 4: hours to 24: hours in a day 3. Daily contracts: Contracts available for trading on a rolling basis, i.e. for every trading day, seven daily contracts starting from the fifth day onwards are available. The duration of the contract can be for a specific time period, including for the entire day, peak time as well as off-peak times. Page 3

4 4. Weekly contracts: These contracts are traded in the subsequent week. Trading in weekly contracts is conducted for contracts of seven days at a stretch, commencing Monday to Sunday of every week Renewable energy certificates Trading of renewable energy certificate (REC) on the exchange commenced in February 211. Renewable purchase obligations are required to be met by obligated entities like distribution licensees, captive power plants and open access consumers by purchasing renewable energy, either by renewable energy generators or by purchasing RECs. Central Electricity Regulatory Commission (CERC) introduced the REC mechanism to ease the purchase of renewable energy by state utilities and obligated entities, including states that are not well endowed with renewable energy sources. The REC framework seeks to create a national level market for renewable generators to recover their cost. One REC represents 1 Mwhr of energy generated from renewable sources. RECs are market-based instruments, classified into solar RECs and nonsolar. These contracts are traded on the last Wednesday of a month. As per CERC regulations, RECs are only permitted to be traded through power exchanges. The floor and ceiling price of solar and non-solar RECs is periodically revised by CERC while the price discovered for RECs remains in between such floor and ceiling prices. Energy savings certificates The company received necessary regulatory and procedural approval for commencement of trading in Energy Savings Certification (ESCert). The ESCert is a market-based instrument created under the Perform Achieve Trade scheme that requires consumers in energy intensive industries while sectors are required to reduce their specific energy consumption in accordance with specified targets. Consumers achieving reductions above their targets are issued ESCerts, which is traded on the exchange. Consumers, who are unable to meet their targets, will have to buy the ESCerts to offset their shortfall. Consumers achieving reductions above their targets will also be able to bank their ESCerts for the next compliance period. The Bureau of Energy Efficiency (BEE) is empowered as administrator to notify the different compliance periods and designate consumers covered under that period, together with their respective targets. As per regulations issued by the CERC, ESCerts are only permitted to be traded through power exchanges. Page 4

5 crore % crore % crore crore Key financials: Story in charts Exhibit 3: Revenues grow at 13.9% CAGR in FY13-17 Exhibit 4: Topline bifurcation (FY17) Annual subscription fees, 25.2, 12% Admission, processing and transfer fees, 1., 1% 1 5 Transaction Fees, 177.8, 87% Exhibit 5: Topline main constituents sales trend (FY13-17) 25. Topline growth at IEX was driven by growth in trading volumes. Due to significant current investments, the company also reported 33.5 crore of other income. This drove the total revenue of the firm further Transaction fees Annual subscription fees Admission, processing and transfer fees Exhibit 6: EBITDA & EBITDA margins trend Exhibit 7: PAT & PAT margins trend EBITDA EBITDA Margins (%) PAT PAT Margins (%) IEX commanded consistently steady and high EBITDA margins of ~7-75% and PAT margins of ~48-5%. This coupled with high asset turnovers results in robust return ratios. Page 5

6 billion units % % par kwh Exhibit 8: Efficient price per unit discovered on exchanges est FY13 Electricity FY14 transacted FY15 through FY16 Traders FY17 Electricity transacted through Exchanges Source: CERC, ICICIdirect.com Research Exhibit 9: Dominant market share across platforms DAM TAM REC Exhibit 1: Rising traded volumes on exchanges Volumes through IEX Exchange volumes as a % of Electricity Generation Source: CERC, ICICIdirect.com Research Investment Rationale Efficient price discovery with wide range of product profile The exchange facilitates efficient price discovery and offers the participants flexibility to trade in a variety of electricity products. The company brings to the table all stakeholders involved like sellers of power, buyers of power and provides them an automated platform for trading of electricity. They also have a diverse participant base ensuring liquidity on its exchange. The primary focus of the exchange is on improved trade execution. The exchange also provides flexibility to the participants for buying and selling on the same day in different time blocks and thereby the ability to manage their requirements more efficiently. The participants can bid for a quantum as low as.1 MW to buy or sell through the Exchange, allowing flexibility in terms of quantum to be purchased or sold. In addition to trade execution for electricity contracts, the exchange offers trading in RECs, settlement services, including electronic trade confirmation, access to clearing services and risk management functionality. This entire gamut of products helps cater needs of any consumer in the short-term electricity market. Dominant energy exchange with strong brand recognition IEX is the largest power exchange for trading a range of electricity products in India, in terms of traded contract volumes in FY17. It was the first energy exchange in India, having commenced operations in June 28. The company got an early mover advantage and has since created a strong brand among participants in the energy trading industry in India. This is also visible through the dominant market shares it enjoys in shortterm power trading market in India. In the day-ahead market segment, the company enjoyed 99.4% market share. The term-ahead market recorded 67.9% market share while in REC, the company has a 71.2% market share. In FY17, participants on the exchange traded and cleared billion kwh of power and 4.62 million RECs. Operational experience and scale of operations make it the largest energy exchange in India, coupled with the growth expected in the short-term. Highly scalable technology with catalysts for growth in both domestic market and newer geographies According to CRIS, peak demand for power in India is expected to grow at ~7.3% CAGR in the next five years. This essentially means far more amount of power will be available that can be traded through energy exchanges. Further, the power generated in India is expected to grow 29.6% between FY17 and FY22. Energy exchanges have been gaining popularity as a platform for trading power due to the transparency of the trading process and efficient price discovery mechanism offered by such exchanges. The proportion of energy traded over power exchanges grew from 23.8% to 34.5% of the short-term market between FY13 and FY17. Government policy implementation like the Government of India s, UDAY scheme for the revival and financial turnaround of state owned electricity distribution companies in India. 24x7 Power for All. Make in India initiatives to encourage manufacturing, initiatives for augmentation in electricity transmission capacity and implementation of open access, are all catalysts expected to drive the demand for electricity and the market for electricity contracts trading in India. IEX has a hugely scalable energy exchange platform. It is currently catering to the entire country and plans to extend its trading facilities to neighbouring countries like Nepal, Bhutan and Bangladesh. Currently, India is divided into 13 price areas. Even after proposed expansion, this leaves plenty of scope for future growth. With technology support, the exchange can currently service up to 3 price areas. Expanding into such Page 6

7 % % new geographic markets would allow IEX to increase the customer base and enhance the liquidity of electricity products available on the exchange. Robust balance sheet & strong return ratios IEX possesses a robust balance sheet and is debt free. The company also benefits from negative working cycle due to participants paying to it in advance while payments by exchange are made later. Consequently, it realises robust return ratios considering the asset light nature of the business. In recent years, the company has been regularly paying out most of its earnings as dividends. This provides comfort and strength. Exhibit 11: Dividend payout e Exhibit 12: RoCE & RoE trend FY14 FY15 FY16 FY17 RoE RoCE s Page 7

8 Key risks and concerns Concentration of revenue sources remain a risk IEX has a relatively smaller number of participants. They account for a substantial portion of power traded on the exchange. According to the company s expectation, this concentration of participants would continue to remain high in the near future as well. Their top 1 clients contribute to almost 35% of revenue from DAM operations. Any loss of a major participant could have an adverse effect on the company s future volumes and, thus, revenues. Thus, this concentration remains a cause of concern for the company. Competition from existing and new players Though currently the company maintains a dominant market share among its peer, higher competition, going forward, cannot be ruled out. There are no barriers to setting up a power exchange. This may bring in newer players in the market. Competition may also arise in the form of competitive pricing, increased market liquidity, technological edge, a better trading platform efficiency and better reliability. Increased product offerings could also lead to participants switching over to competitors. Any response to adjust pricing by the company in retaliation to competition could adversely impact the company s profit margins. The short-term electricity market currently comprises 1.3% of the overall electricity generated. Over the next four to five years, this market is expected to double. Currently, 34.5% of short-term electricity contracts are traded on the exchanges. Their share is also expected to increase. Over the past five years, the short-term electricity market share over total electricity generated has remained in the range of 9-11%. Anticipated growth not playing out or remaining muted would result in a lower-thanexpected performance for the company. Within the short-term market competition for power traders, Power Exchange India and DEEP portal launched by the government may also keep growth of IEX in check. Any adverse ruling on perpetual license agreement The company has entered into a perpetual license agreement for acquiring exclusive rights to the source code (together with modification rights) for its trading software along with the transfer of 22 employees from 63 moons for an aggregate consideration of 13.6 crore. Currently, the order is under purview of NCLT. In case of any adverse ruling on the acquisition of exclusive rights to the source code for the trading software from 63 Moons, the Perpetual License Agreement may stand annulled or be repudiated. The company would lose exclusive rights to the source code though they could continue to use the software. However, the recovery of the consideration paid to 63 Moons under the Perpetual License Agreement may be subject to dispute. Technology or system limitations may impact future growth IEX operates using an electronic trading platform that may be subject to rapid technological change, change in usage patterns, change in user preferences, introduction of new products & services along with the emergence of new industry standards and practices. Any superior technology platform may result in the company s software being uncompetitive. Failure to keep up with new or advanced technology and respond to participant preferences may cause volume of trades on the exchange to decline. This may have an adverse effect and result in a loss of revenues. Further, supporting future growth will also be dependent on the ability to sustain the increased scale of operations i.e. ability to handle higher volumes efficiently. Any disruptions that may occur in DAM Page 8

9 segment, which accounts for a significant portion of the company s trading volumes, may adversely affect the company s reputation, business operations and also have a financial impact. Inability to innovate and introduce new products in the market place In order to grow their revenues in the future, the company needs to keep developing newer products catering to market participants that add value to them. The company continuously interacts with the CERC and government authorities to evaluate and test new electricity products. This is done since each new type of contract or product available for trade on the exchange must be reviewed and approved by the CERC. Thus, the company would need to spend substantial time and money developing new products and initiatives, which may or may not receive CERC approval. For example, the company applied to CERC for approvals to develop electricity products for the trading in renewable energy contracts on a day ahead basis, i.e. green day-ahead market. However the green day-ahead market energy contract was declined CERC approval, as the CERC determined that market conditions at present are not conducive for the introduction of such product. If in future also, such products and initiatives do not meet with success, the company may be unable to offset their costs, which may have an adverse effect on the company future scale of operations. Page 9

10 Valuations Indian Energy Exchange provides a comprehensive offering, enjoys a dominant market share and wide brand recall across the short-term electricity trading market. The company has delivered topline and bottomline growth of 14.5% and 14.4% CAGR, respectively, in FY IEX has a robust balance sheet with no debt and cash at around 3 crore. Further, with strong core profit margins, negative working capital cycle and superior return profile (average RoEs, RoCEs of 4.%, 48.%, respectively, in FY13-17), we believe IEX is a quality play and is on a strong footing. Exhibit 13: Peer comparison Listed peers Current PE FY18 FY19 MCX BSE ICE* IEX *estimates for calendar year Source: Bloomberg, ICICIdirect.com Research On the valuation front, based on FY17 numbers Indian Energy Exchange is available at a P/E of 44.1x valued at the upper price band. Since there is no listed peer, exchange, for a like-to-like comparison of the company, we have taken domestic as well as global exchanges for providing a background. On the back of an attractive cash yield of 4%, cash rich balance sheet, high profit margins, negative working capital cycle and superior return profile, we advise investors to SUBSCRIBE to IEX. Page 1

11 [ Financial summary Profit and loss statement Crore (Year-end March) Revenue Growth (%) Technology Expense Employee Cost Other Operaitng Expense Total Expenditure EBITDA Growth (%) Depreciation EBIT Interest Other Income Exceptional Items PBT Tax Reported PAT Growth (%) Cash flow statement Crore (Year-end March) Profit Before Tax Add: Depreciation Cash Profit other changes Increase/(Decrease) in CL (Increase)/Decrease in CA CF from Operating Activities Purchase of Fixed Assets Others CF from Investing Activities Inc/(Dec) in Loan Funds Others CF from financing activities Net cash/cashflow Cl. Cash and cash Eq So Balance sheet Crore (Year-end March) Source of Funds Equity Capital Reserves & Surplus Shareholder's Fund Minority Interest..... Long Term Borrowing..... Long Term Provisions Other non current liabilities Deferred Tax Liabilities Current Liabilities Short Term Borrowing Trade Payables Other current liabilities Short term provisions Source of Funds Application of Funds Net Block (Incl Intangibles) Capital WIP Total Fixed Assets Goodwill Non-current investments Long Term loans & advances Other non-current assets Deferred Tax Assets Current Assets Inventories..... Trade Recievables Cash & Bank Balances Current Investments Short Term Loans & Advances Other Current Assets Application of Funds Key ratios (Year-end March) Per share data ( ) Book Value Cash per share EPS Cash EPS Profitability & Operating Ratios EBITDA Margin (%) PAT Margin (%) Inventory Turnover (Days)..... Debtor (Days) Creditor (Days) Return Ratios (%) RoE RoCE Valuation Ratios 165 PE Price to Book Value EV/EBITDA EV/Sales Leverage & Solvency Ratios Debt to equity (x)..... Interest Coverage (x) 3, , ,67.4 Debt to EBITDA (x)..... Current Ratio So Page 11

12 RATING RATIONALE ICICIdirect.com endeavours to provide objective opinions and recommendations. ICICIdirect.com assigns ratings to its stocks according to their notional target price vs. current market price and then categorises them as Strong Buy, Buy, Hold and Sell. The performance horizon is two years unless specified and the notional target price is defined as the analysts' valuation for a stock. Subscribe: Apply for the IPO Avoid: Do not apply for the IPO Pankaj Pandey Head Research pankaj.pandey@icicisecurities.com ICICIdirect.com Research Desk, ICICI Securities Limited, 1st Floor, Akruti Trade Centre, Road No 7, MIDC, Andheri (East) Mumbai 4 93 research@icicidirect.com Page 12

13 Disclaimer ANALYST CERTIFICATION We /I, Chirag Shah PGDBM, Research Analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. Terms & conditions and other disclosures: ICICI Securities Limited (ICICI Securities) is a full-service, integrated investment banking and is, inter alia, engaged in the business of stock brokering and distribution of financial products. ICICI Securities Limited is a Sebi registered Research Analyst with Sebi Registration Number INH99. 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