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When a good business is in the news for all the wrong reasons, which do not have a bearing on its long-term fundamentals, it is the best time for investors to buy into the stock.
One of India's contrarian thinkers and well-known investors, Rakesh Jhunjhunwala, has used this opportunity to buy a stake (about two per cent) in Multi Commodity Exchange of India (MCX), the country's largest listed commodity exchange.
On Tuesday, the MCX stock was up 8.8 per cent to close at Rs 769 after Jhunjhunwala bought additional shares through his investment firm, Rare Enterprises. While there is a buzz that some big companies are looking to acquire a large stake in the MCX from its distressed promoters, given the long-term prospects of the company, investors might consider it on corrections.
The MCX has been reeling under a string of negative developments, starting with the tax on commodity trading and the National Spot Exchange Limited (NSEL) scam (both occurred last year). The impact was difficult to assess where even institutional investors were seen seeking more clarity about the assets, liabilities and the litigations that were associated with the NSEL scam.
In this light, what explains the recent buying of MCX's shares by some of the prominent investors, including Jhunjhunwala?
While there have been apprehensions after the NSEL scam surfaced, it seems the investors are now confident, looking at the changes happening in the MCX. The company's share price had dropped from about Rs 1,600 to a low of Rs 238 per share in August last year. However, as clarity started to emerge and investors saw an opportunity because of the distressed valuations, the stock started gaining traction and since then has trebled to currently Rs 769. While speculators and traders are also active considering the surge in activities in the counter, what explains this interest fundamentally is worth considering.
In FY14, thanks to the implementation of the CTT (commodity transaction tax), the company reported 42.7 per cent decline in volumes. The company's return on equity (RoE), a key parameter that investors consider to judge the health of a company, fell to 13.3 per cent as against 31 per cent in FY12, while EPS (earnings per share) dipped to Rs 24 as against Rs 56.2 in FY12. As a result, the Street had lowered the earnings expectations by almost 50 per cent leading to low valuations.
But, more importantly, the business model has not changed, and most of the inherent business advantages of the MCX such as high market share in its business, wide reach, technological edge, low asset base, strong operating leverage, first mover advantage, large customer base and huge cash in the balance sheet remain intact. Also, the promoter group related issues are also getting resolved with the expected gradual exit of Financial Technologies (India) and appointment of the new board and management.
Additionally, if all these changes are looked from the perspective of structural growth that the Indian commodity exchanges offer, there is enough room for investors to make good returns in the long run even from current levels. At some point in time, the structural growth in volumes will start to kick in and if the FCRA (Forward Contract Regulation Act) Bill is passed, which will enable the banks and insurance to participate in the commodities futures market, there will be an added advantage. That's because, the same will boost commodity volumes significantly without much need for capex and expenses, leading to higher earnings for the MCX. The FCRA Bill was introduced in the Lok Sabha in December 2010 and subsequently cleared by the parliamentary standing committee with amendments and submitted in December 2011.
While year-on-year trend in revenues and profits is still weak, there has been sequential gain in these parameters indicating that the performance has bottomed out. Going ahead, analysts are expecting the company's prospects to look up. They are estimating MCX's EPS to move up from Rs 24 to Rs 27 in FY15 and further to Rs 32 in FY16. However, the recent surge in share price means that valuation is no longer cheap as the stock is now trading at 28 times its FY15 and 24 times its FY16 estimated earnings.
