Stock Recommendation: BSE - Unlocking Potential in Derivatives Market
By HDFC Securities
Overview: BSE, once considered a secondary player in the equity derivatives segment, is making a remarkable comeback. With the launch of a weekly index options contract (SENSEX) in May 2023, BSE has seen substantial growth. Its market share in the equity derivatives segment surged to an impressive 3.4% in August, up from zero in April. Even more remarkable is the fact that BSE's expiry day market share stands at approximately 11%, all this without any liquidity enhancement scheme. The derivatives volume growth is organic and is being driven by a growing base of 219 members, including proprietary and retail traders. Additionally, active UCCs (Unique Client Codes) on the BSE derivatives platform have grown from nearly zero in just three months.
Growth Outlook: HDFC Securities foresees a bright future for BSE in the derivatives market. They anticipate BSE's derivative market share to reach approximately 10% by the fourth quarter of FY24E. Several factors will contribute to this growth, including the on boarding of large member brokers, the launch of new weekly index contracts, increased hedging activity, and a continued rise in active traders. This upswing in derivatives volume is expected to have a positive ripple effect, boosting cash volumes as well.
Financial Projections: The steps taken by BSE's new management are showing promising results and are expected to drive growth and margin expansion. HDFC Securities predicts a revenue and earnings per share (EPS) Compound Annual Growth Rate (CAGR) of approximately 19% and 25%, respectively, over the period FY23-26E. This growth will be primarily fuelled by a revival in transaction revenue. As a result, HDFC Securities has revised their EPS estimates upward by about 7% for FY24 and 11% for FY25. Furthermore, they have increased the core multiple to 28x (previously 25x).
Investment Recommendation: HDFC Securities upgrades its rating for BSE to "BUY." They assign a Sum-of-the-Parts (SoTP)-based target price of INR 1,230. This target price is based on 28x core September 2025 PAT (Profit After Tax), the value of the CDSL stake, and net cash excluding the Securities Guarantee Fund (SGF).
Derivatives Market Potential: The derivatives market is vast and continually expanding. While NSE (National Stock Exchange) dominates this sector, BSE is making inroads. Currently, NSE's derivative volume is approximately 30 times larger than that of BSE. However, there is a clear shift towards near-term expiry weekly contracts in both NSE and BSE, with index options accounting for about 99% of the derivatives volume. This shift presents an opportunity for BSE to tap into this significant market.
Pricing Strategy: BSE is adjusting its pricing strategy to compete effectively with NSE. The new management has decided to match pricing with NSE, recognizing that exchange transaction charges alone do not trigger volume shifts. BSE has increased its pricing in cash transactions, currency futures, and listing fees to align with NSE's rates. Despite these adjustments, there is still ample room for pricing revision, particularly in the options segment.
Valuation Scenarios: HDFC Securities presents three valuation scenarios:
- Base Case: Assuming a 10% derivatives market share and a core PAT CAGR of 37%.
- Bear Case: Envisaging around 4% derivatives market share, slower revenue growth, and a multiple of 20x.
- Bull Case: Assuming a 10% derivatives market share (similar to the base case) but with higher options pricing, resulting in a 23% revenue CAGR and a 30x multiple.
Investors are encouraged to consider these scenarios when evaluating their investment strategies.
In conclusion, BSE's resurgence in the derivatives market, along with its strategic pricing adjustments and growth prospects, presents an enticing opportunity for investors, as noted by HDFC Securities' "BUY" rating and target price of INR 1,230.