Buy MCX for target price of Rs 2400 (26% upside). Tech transition is underway; options surge: HDFC Sec

Tech transition underway; options surge

The Multi Commodity Exchange of India Ltd (MCX) has witnessed impressive growth in options volume but uncertainty around the technology shift has been the key overhang. The commodity exchange, in a press release, has indicated that the technology shift is underway and might happen three months ahead of the deadline. In the last seven days, MCX has conducted mock trading sessions for 14 hours without any glitches. We believe that post the technology transition, the investor focus will shift to product launches, volume growth and improving profitability. Options notional ADTV has increased ~3x YoY and is currently >INR 1,000bn (~5x of futures). Options growth is driven by a surge in active UCCs (+126% YoY) and higher activity in crude/natural gas contracts. The launch of new products like index and mini/weekly options will further boost volumes. The options premium-to-notional ratio will decline gradually but the premium volume will register ~47% CAGR over FY23-26E. We increase our EPS estimate by ~8-9% for FY25/26E and increase multiple to 28x (vs 25x earlier) to factor in options surge and lower uncertainty around the technology shift. We maintain BUY with a target price of INR 2,400, based on 28x Sep-25E core EPS + net cash ex-SGF.

► Options volume driving growth: Options ADTV stood at INR 860bn in Q2FY24 (+38/174% QoQ/YoY) but the premium growth stood at +31/99% QoQ/YoY. The exchange earns on premium and the premium to notional ratio is gradually coming down; we have assumed 1.8/1.7/1.6% for FY24/25/26E vs. 2.4% in FY23. As per sensitivity, a ~10%/10bps increase in options volume/premium-to-notional ratio boosts EPS by ~13/5%. We expect commodity options volume/premium volume to grow at a CAGR of 69/47% over FY23-26E and options will account for ~60% of total revenue in FY26E (vs 34% in FY23). Algorithmic/mobile trading constitutes 55/31% of options volume while proprietary/client is 53/45%, and FPI/DII volume is negligible.

► Improvement in profitability: MCX profitability was impacted by the higher payout of INR 1.4/3.3bn to the technology vendor in FY23/24E, leading to a drop in EBITDA margin (26/17% in FY23/24E vs. ~45% average). The shift to the new platform will pivot the cost structure to a higher fixed-cost model. The total cost will decline by 51% in FY25E due to a significant reduction in software support charges. We expect SSC to be at INR 0.6/0.65bn in FY25/26E and other costs to grow at ~13% CAGR over FY23-26E. The embedded non-linearity in the business model will lead to significant margin expansion in FY25/26E (EBITDA margin of 65% in FY25E).

► Valuation and return ratios: MCX price performance has a high correlation with volume growth. In the last ten years, the price-to-volume correlation stood at ~55%, which came down to ~12% in the last three years due to technology challenges. The stock has traded at an average one-year fwd P/E 30x and currently trades at a P/E of 23/19x FY25/26E EPS. Net cash stands at INR 10bn (~11% of market cap) with significant improvement in return ratios.