Indian Energy Exchange (IEX)

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396

That’s an interesting proposition. IEX does handle that kind of volume. But I guess the projection sits on one issue -

After your message, I did look at YoY change in quarterly power exchange volumes vs other components. So in your case, you covered the first layer, ST vs LT (PPAs). But there’s another layer of within ST. It’s not very direct to compute this. More on this in a bit.

Let’s start off with the values being computed. The INCRE_ values show the incremental values vs the same period in the last year. It’s been done for – Power Exchanges (PX), Short Term market (ST), Long Term market (LT) and Total (ToT). Tot = LT + ST.

There are 4 % values computed:

INCRE_ST/INCRE_TOT – To see what part of the incremental value goes to the short term market.

INCRE_PX/INCRE_ST – What percentage of the short term market increase goes to power exchanges.

(INCRE_PX-INCRE_ST)/INCRE_TOT – A clear case of growth in PX from outside the short term market. (Here the condition is that ST growth has to be positive. Why? Because if ST is negative and PX is positive, it is difficult to tell what part of the increase in PX from cannibalizing and what part is from the overall growth. PX is after all a component of ST. If both are positive, it is a clear case of incremental growth – the type we are discussing. If both are positive and PX is greater, it’s growth + cannibalizing).

INCRE_PX/INCRE_TOT – the metric we are discussing. (this is a slightly tricky way of looking at it, as you’ll see in the figures below).

CY INCRE_PX INCRE_ST INCRE_LT INCRE_TOT INCRE_ST/INCRE_TOT INCRE_PX/INCRE_ST (INCRE_PX-INCRE_ST)/INCRE_TOT INCRE_PX/INCRE_TOT
2019Q1 -638 18 328 346 5% 0% 0% 0%
2019Q2 -1089 -599 22050 21451 0% 0% 0% 0%
2019Q3 1600 -743 3054 2311 0% 0% 0% 69%
2019Q4 -1029 -5510 -17094 -22604 0% 0% 0% 0%
2020Q1 3453 -1186 2882 1697 0% 0% 0% 204%
2020Q2 1856 -4372 -57093 -61465 0% 0% 0% 0%
2020Q3 1596 -7211 10412 3202 0% 0% 0% 50%
2020Q4 9705 7159 8317 15476 46% 136% 16% 63%

Call outs:
You’ll have to be careful of the negatives and 0s in all the % columns columns. 0s either mean one or both values are negative.

I took quarterly because monthly is a mess.

Source is CERC MM Report (I track the volumes on my blog, so I have it handy).

I could be wrong. Please do let me know if you notice something that’s off.

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397

You have some good granular data but can we really use that to extrapolate for next 10 years.

With village electrification, railway electrification, battery powered vehicles, power sector reforms, industrialization, increasing comfort need of middle class, I prefer to use simple math

2021 2031
Electricity Consumption 100 259 (10% Growth Rate in Electricity Consumption)
Exchange Share in Total Electricity 5% 10%
Traded Power on Exchange 5 26 (10% of 259)
i.e.18% Compounded Growth

If we get 18% underlying growth, Company profit can grow much higher. At the core IEX is a software product / platform which can scale up to handle 5X more volume without same increase in cost.

Disclosure: Invested

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Will coupling affect iex’s business. When is it likely to be introduced

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Hi @Hrishi

Why have you assumed 259 electricity consumption for 2031. That assumes a 10% annual growth in electricity generation, much higher than India’s historical average of 5-5.5%.

If we run the same analysis with a 5% growth, we would only be looking at a 12% volume growth; quite poor for a company valued so richly.

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We need to consider the EBITDA growth as well. Growth is volume should lead to margin expansion as well. Hence, growth in EBITDA > growth in volume.

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I have used 10% but one can do math with 6% or 8% as well. I have also used exchange share to double in 10 Years, it can be more or less. One can put different numbers and find a range.
I am not qualified to do crystal ball gazing on these factors, I make some assumptions to understand the direction. Direction for me is 13%-18%-22% traded volume growth on exchange.

2021 2031
Electricity Growth Rate 6.00% 8.00% 10.00%
Electricity Consumption 100 179 216 259
Exchange Share in Total Electricity 5% 10.00% 12.50% 15.00%
Traded Power on Exchange 5 18 27 39
Growth in Power Traded on Exchange 13.61% 18.36% 22.77%

Not many business can grow revenue at 18%+ for a decade without major CAPEX and much higher profit growth than that. Hence I like it own it.
Valuation is an individual call.

6% increase in electricity consumption Y-O-Y can result into higher peak demand, resulting into higher short term volume traded. Companies may get into hedging there positions (when it’s available) to lock the prices resulting into even higher traded volume than Y-o-Y electricity consumption and share of exchange in total units consumed.

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While the skeptics here keep debating about how IEX will not grow as much as it has before, it keeps posting double digit volume growth numbers every year.

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A simple reason for growth, if electricity is available at 50% discount on the exchange why would someone buy it at a higher price via PPAs? Be it government or industry. Market moves to the cheapest source.

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The figures were only meant to illustrate the 2021, 2022 example you had given and that the relationship isn’t that simple. You’ll definitely need more data to project the next 10 years. Plus you’d lot more info on sources of use as well. This above figures definitely can’t be used.

Usually long term power growth is linked to or around growth rates of the economy. In the west, there has been a decoupling of late. But for a country like ours, I think it should hold. Personally, I am comfortable with 1.5x (GDP) assuming growth + cannibalizing. This is what the exchange has recorded/moved towards as well for DAM until this year. This year, lower prices have been a major driver.

But I guess what’s more important than the math is the actual drivers.

I haven’t seen any comments on PPAs. Unless we know more about what would drive volumes here (PPAs is the only major things that I see, there could be others as well.), it’s difficult to form opinions on final rates.

Haha @Tar , that’s a bit unfair :stuck_out_tongue_winking_eye: . Everyone recognizes the double digit growth and that this is a wonderful business. Most of us have positions. But the management is very good at projecting figures that are favourable in these monthly reports (my figures in the monthly report above are from their site. I don’t see 92% at the individual product level :stuck_out_tongue: . 65% increase in DAM (last March, we lost a week due to lockdown) + TAM volumes were down (pulling the base down further) + RTM impact this year have driven this.). We ended the year 31% higher.

In FY20 (2019 - Apr, May, Jun, then again in Sept, Oct, Nov), with no Corona, they suffered with volume growth being negative on DAM (largely driven by prices). They ended the year barely touching previous year’s volume. As you correctly point out, lower prices are what is driving growth this year. But these participants also leave as quickly (especially on the open access side).

The original discussion above on volumes started to understand where volume growth (permanent and sustained volume) would come from. Feel free to share your views :slight_smile:

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I am not an expert on this subject, nor I am interested in micro level calculations for predicting future earnings of IEX.

But I feel that DAM and RTM are their very successful products and will continue to grow, going forward RTM may have a big share in revenue mix.

I think there are still some probabilities for further expansions –

  1. After government allowing DISCOMs to exit PPAs, we have to see what are DISCOMs doing, if they exit PPA then where will they go for their power requirements, and where will power generating companies go for selling their power?
  2. IEX is also planning to launch long duration contracts, we have to see how will iit mpact growth.
  3. There is talks for cross-border trading of power on exchange, though I don’t think it will impact much.
  4. Also, there is IGX, after strategic partnerships with some gas companies along with NSE, we have to see its development. Gas market in India is still growing at good pace and if IGX become an alpha here then that can be a huge trigger for further growth.

IEX have very good profitability ratios, business is asset light, have a monopoly in its business space, and if it continues to maintain and grow its position for few more years then it may also develop a moat, which will support its valuations.

Disclosure – My views may be completely biased, as this is in my portfolio.

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I was just kidding :slight_smile: no offense to anyone here.

My views and investing style is bit macro and I don’t like to dwell deep on micro trends in any business that I invest in. My rationale for investing in companies are if

a. They have a good Moat (in IEX case its exchange technology, monopoly, ability to provide cheaper prices than age old PPAs via actual price discovery on exchange)
b. They can grow their target market (in IEX case its its ability to create new forms of trading contracts and eventually establish itself into cross border electricity trading)
c. They have sufficient tailwinds (in IEX case its govt’s push towards fixing the discom debt problem, state governments moving away from PPAs (eg. Andhra Pradesh), renewables trading)
d. Competent Management
e. Ability to generate cash flows with great margins
f. Ability to reinvest these cash flows at a good ROCE% or give back the profits to shareholders via dividends / share buybacks

If all the above aligns, the business itself will keep growing. How to grow the business and volumes on the exchange is IEX’s management problem and their job for which they are paid.

Business Improves → Cash Flows Improve → Share Price will automatically improve

As a shareholder my view is of an owner, if something drastically changes in the nature of the business and industry then I will take an exit.

Otherwise why should I care if volumes are actually increasing or not in the short term, I know for a fact they will increase in the long term, there are sufficient reasonable reasons and tailwinds around it.

But that’s just me and I understand everyone has their own style of investing and I do appreciate amazing insights on this thread. They have helped me personally understand a lot about this business. :slightly_smiling_face:

PS: I love your blog on IEX and several others you have written, some really good value there. Personally spent a few hours reading them.

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None taken :smiley: . Don’t worry about it. Most people who follow this thread are familiar with you via your posts even though we haven’t interacted much.

Thanks for sharing your approach and thesis.

Haha I ask myself the same question every month :stuck_out_tongue: .

Thank you so much. I’m glad you liked it :slight_smile:

(Since there’s nothing IEX specific in my post, please do remove the post if it’s not appropriate).

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Here is my understanding on business / key triggers.

  1. Distribution companies / end users need reliability in power supply. Can they be confident of scrapping PPAs and getting their demand fulfilled from exchanges? Currently 90% long term demand is addressed through PPAs. What would be deciding factor to jump from PPAs to arrangements through IEX? One could be long term products getting introduced in exchanges and acceptance of those from distribution companies. As things stands this would be multi year process and currently IEX do not have substitute for PPAs.

  2. IEX is best for catering Short term demand/supply mismatch -

    • Fluctuations in RE (Solar power) generation. This will be growth area as there will be more and more solar capacities added in short term (Target - 175 GW RE including 100 GW Solar by 2022)
    • Cross - border power trading
    • More open access suppliers/ consumers
    • More innovation around customized contracts / products
  1. Some initiatives from govt could be indirectly beneficial to IEX. Distribution reforms with more private players, smart meter implementation, reducing T&D losses (Target 15% by 2025 from current 22%)

References:
California invested heavily in solar power. Now there’s so much that other states are sometimes paid to take it - Los Angeles Times (latimes.com)
Q1’FY21 IEX Presentation
ijaerv13n21_27.pdf (ripublication.com)
Chapter 1 (cea.nic.in) - Information on solar /wind generation curve (Chapter 6) , India’s projected power demand

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My two cents

From the supply side - At the moment IEX is monopoly until the competitor in making comes online. Never the less if IEX continue to innovate then it will be ahead.

Are they innovating ? Yes, they are. They are talking about adopting blockchain

If we refer the latest investor presentation they have tied up with technology leaders in this space

Product: GMEX, UTrade,
Nagarro,
• System Design: Cap Gemini,
TCIL, Akamai

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For the Sellers : Tools to forecast the demand / supply and pinpoint the areas where there is high demand and any supply disruptions ( floods , failure of the equipment that is causing the surge in the demand in a particular geography etc… )

For the buyers :

Integrate the internal enterprise systems (like SAP / Salesforce ) with the IEX (the above slide gives all the building blocks that are needed to achieve this ) platform and forecast the demand and supply etc …

There are many more optionalaties to introduce like matured markets.

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If we compare IEX with Zerodha - Zerodha founders have been saying regularly that Zerodha is a Tech company and brokerage firm, if this a tech company then the valuations would be much higher.

  1. With IEX do we see similar aptitude and drive from the management ? Does the management have any technical expertise ?
  • Also in terms on market opportunity if there a scenario where this software or product can be sold outside of this market after integration with blockchain ?
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I think they have done that in the past their parent company [FTIL] , so if the systems are matured they can do the same with IEX and IGX, rollout the platform to other Asian markets. (Financial Technologies Group - Wikipedia).

FTIL launched many domestic and international ventures. It owned many subsidiaries that included National Bulk Handling Corporation (NHBC),[13] Multi Commodity Exchange (MCX), Dubai Gold & Commodities Exchange (DGCX),[14] Indian Energy Exchange (IEX),[15] MCX Stock Exchange (MCX-SX),[16] DOME,[17] Risk Solutions,[18] Singapore Mercantile Exchange (SMX)[19] and Bourse Africa.[20] ODIN, the flagship product of the company, was used for trading in securities and commodities.[21] In October, 2010, Financial Technologies (India) launched Global Board Of Trade (GBOT), an international multi–asset exchange in Mauritius.[22] In February 2011, Financial Technologies launched Bahrain Financial Exchange (BFX), the first multi–asset exchange in the Middle East and North Africa.[23]

Currently, FTIL has divested of all its domestic and international ventures

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Cross border trade with Nepal gets a go-ahead

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Cross Border Electricity started at IEX. This is another tailwind for volume growth at IEX.
Just to put this in context, about 25% of the world population lives in South Asia. More population generally means higher energy demand. Very likely that countries like Bangladesh who do not have a well built power infrastructure will start importing electricity from India and IEX will be the lead candidate to facilitate that.

Edit: Bangladesh already imports electricity from India just not through IEX. Along with Bhutan, Bangladesh is the next easy target country to be onboarded to IEX cross country trading platform.

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My thoughts on the business in detail-

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IEX POWER MARKET UPDATE, APRIL’21

  • Power Market trades 7707 MU in April’21 achieving 90.2% YoY growth.
  • Real-Time Electricity Market trades highest ever volume of 1473 MU
  • Green Market picks up momentum with 186 MU volume in April’21 seeing 262% MoM growth.
  • IEX Pioneers Cross Border Electricity Trade with Nepal as the first country to participate in the day-ahead market on the Exchange.
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