Indian Energy Exchange's Q3FY18 results (Outperformer) - Strong volume growth

Q3FY18 result highlights

• IEX reported a 62% yoy growth in trading volumes to 17.9BU in Q3FY18. Growth was led by 8x increase in REC trading volumes to 5.5BU whereas  day ahead market witnessed an increase of 6% yoy to 10.7BU EScerrt, a new product, saw a volume of 1BU in Q3FY18
• During 9mFY18, volume grew by 32% yoy to 43.3BU. Day haead market, mainstay of business, grew by 14% to 34.4BU, term ahead market grew by 81% to 1BU, REC market grew by 275% to 6.7BU and EScert, introduced in 3QFY18, reported a volume of 1BU
• As a result, Sales grew by 30% yoy to 647m, EBITDA grew by 41% yoy  to Rs525m and  PAT grew by 27% to Rs362m . Sales growth of 32% yoy is lower in comparison to trading volume growth on account of higher REC volume in Q3FY18 which has a lower margin of Rs0.02/Kwh (vs Rs0.04/Kwh in all other products)
• During the 9mFY18, growth in volumes in day ahead market have driven  by distribution companies whose volumes have grown  to 67% (vs 43% in FY17)  of entire volume while open access volumes growth has declined to 33% (57% in FY17) of entire volumes on account of higher exchange prices compared to last year.

Key positives: Strong volume growth; IEX is likely to be beneficiary of provision of 25% corporate income tax on companies with less than Rs2.5bn of revenues (as per Union Budget 2018-19)

Key negatives: Decline in open access volumes

Impact on financials: We maintain our earnings estimates for FY18E/FY19E/FY20E.

Valuations & view

IEX, is a dominant player in India’s duopolistic power exchange market  with 94% market share. The exchange is a direct beneficiary of undergoing reforms in the electricity and energy markets. We estimate 17% earnings CAGR over FY17-FY20E for IEX based on its extraordinary track record and competitive advantages. We value the stock at a DCF-based target price of Rs1862/share, implying 18% upside from the current market price (26x FY20E) earnings). Restriction of open access, increase in charges under open access and regulatory risk like capping of transaction fees are key risks to our rating and target price.