Market coupling to dilute IEX’s liquidity moat: IIFL Capital Services

12 Jun 2023 , 11:07 AM

Recommendation: Add; Target Price: 120

 

Following the news of a likely introduction of market coupling (MC), IEX has corrected by 17% in the last 2 days. If implemented, this would significantly dilute the Exchange’s revenue model (and IEX’s liquidity moat) as well as pose a significant risk to IEX’s market share and earnings (analysts of IIFL Capital Services estimate 40% EPS cut if market share halves). While there is no clarity on the implementation of MC, the regulatory risk for IEX has significantly increased. They cut their target multiple by 30% and value IEX at 25x 2YF EPS (TP of Rs120). The stock is likely to consolidate here, unless clarity emerges on MC.

MOP pushes for market coupling: 

As per media reports, Ministry of Power (MOP) has directed CERC to implement MC after due consultation. Market coupling is essentially coupling of clearing price across different power Exchanges in India. Based on past discussions, this could be achieved through a price discovery at the MC operator (NLDC or equivalent entity). Thus, this would take-away one of the key function of the Exchanges and consequently dilutes liquidity moat of the market leader i.e. IEX (~100% market share in DAM and RTM). Previously, market coupling was seen as a means to implement market-based economic despatch or MBED (100% of the Power to be cleared on the Exchange– implying 15x jump in Exchange volumes). However, as analysts of IIFL Capital Services understand – the MOP directive has no mention of MBED for now (opposition by states). In the absence of MBED, MC may add little value (and dilute utility of an Exchange), except for democratising the Exchange volumes.

IEX sees challenges in implementation: 

IEX believes that the directive should not be construed as a directive to implement MC, but rather it is asking regulator to study all aspects and to check if there is any merit to implement the same. In the past too, MOP had made suggestions to CERC to evaluate different aspects of Power market structures, but not forced to implement. As such, the consultation process itself may take 6-12 months. 

A de-rating event; stock to remain under pressure: 

MC would risk IEX’s dominant market share in the collective transactions. Assuming 50% market share in the DAM and RTM segments, FY25 EPS would see 40% cut. Although analysts of IIFL Capital Services maintain their estimates given no clarity on MC implementation, given the increased regulatory risk and high sensitivity to earnings – they cut their 2YF target PE multiple by 30% to 25x, and lower their TP to Rs120.