IDEA 2 ACT: Calcutta Electric Supply Corporation (CESC)

Buy - CESC

CMP (NSE) 15:56, 27 Sep

82.45 -1.65-1.96%

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Power

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Reco. Price

957

Period

1-Year

Target Price

1,172

upside

22.5%

Stop Loss

0

Last updated on

28 Aug, 2017

De-merger to streamline business segments

CESC is demerging its business segments into four separate entities: Power generation, Power distribution, Retail and CESC ventures (business process outsourcing - Firstsource Solutions, Quest mall and other businesses). Post the de-merger, CESC along with the other three entities, will be listed on the stock exchanges, with a similar shareholding pattern of CESC. The entire process is expected to be completed by October 1, 2017.

First-listed Power Distribution Company, generation business to provide consistent returns

Power contributes ~60% (FY17) to the consolidated sales of CESC. Its core business Power distribution will be the first distribution entity to be listed in India. CESC’s distribution business has high RoE @15.5% and is growing at a steady rate of ~6%. We are bullish on regulated power distribution business as it is steady and attractive, requiring less capital infusion and minimal government intervention. CESC also plans to pursue asset light distribution franchise model. In FY17, it has already won franchise in few cities in Rajasthan and plans to grow in other states as well. With respect to power generation, the total capacity with PPAs is ~ 2.0 GW. The performance of Haldia plant continues to be strong with PAT of Rs 296 cr (up 27% YoY) in FY17. Also, Chandrapur plant’s performance is likely to improve as the company is trying to convert short term PPA of 270MW unit with the Maharashtra government to a long term one. We expect regulated power generation business to continue to generate 16-17% RoE over the next two years.

Rebound in Retail business through expansion, bright prospects for CESC ventures

Spencer Retail reported same store sales growth of ~ 9% YoY and store EBITDA of Rs 101/sqft per month (up 19% YoY) in FY17. The company plans to open 11 new stores in FY18 and add 0.2 mn sq.ft. p.a over the next two years. Its recent entry into high margin apparel business under the brand “2Bme” will support profit growth going forward. We believe that de-leveraging, expansion and operating leverage are likely to drive 12% sales CAGR (over FY17-19E) and break even (at PAT) in FY18E in Retail.

CESC’s fourth entity- CESC Ventures’ growth will be driven by Quest Mall (PAT CAGR of 20% over FY17-19E) and Firstsource Solutions (sales growth @8.5% CAGR over FY17-19E through new deal wins).

Outlook & Valuation

We believe the demerger is a step in the right direction as each business has varied risk and return profile and different working capital requirements. We believe that the demerger will lead to re-rating of multiples in each of its businesses and expect investors to benefit from value unlocking. We have valued the company on SOTP basis and arrived at a Target Price of Rs 1,172. We recommend Buy on the stock.

Financial Summary

Consolidated Rs cr

FY16

FY17

FY18E

FY19E

Revenue

12,124

13,904

14,993

15,263

YoY Growth %

9.6

14.7

7.8

1.8

EBITDA Margin %

27.1

22.4

22.9

24.3

PAT

729

810

1,048

1,205

YoY Growth %

268.2

11.1

29.4

15.0

EPS (Rs)

54.8

60.9

78.8

90.6

P/E (x)

17.5

15.7

12.1

10.6

ROE %

12.1

11.3

13.0

13.3

Source: Company, IIFL Research

SOTP Valuation

Segments

Business

Valuation Method

Valuation Multiple

**Value Per Share

Power Standalone*

Gen & Distribution

P/E

9.0

602

Haldia

Gen & Transmission

EV/EBITDA

5.0

149

Chandrapur

Generation

P/BV

0.8

77

Power

828

Spencer

Retail

EV/Sales

0.8

174

Firstsource Solutions

IT/Business Processing

P/E

10.0

101

CESC Ventures-Property (Quest)

Mall

P/E

6.0

70

Target Price

1,172

*Includes Kolkata Distribution and few generation assets

**Valuation based on current O/S shares – 13.3 cr

Source: Company, IIFL Research

Company Background

CESC is the flagship company of the RPG Group and is the sole power distributor in Kolkata. CESC has four main business segments: power generation and distribution, Spencer retail business, IT business and real estate. CESC’s power business generates and distributes 1.8GW power annually to 3.0 mn consumers in Kolkata and Howrah; it has a generation capacity of 1125 MW (all coal based). The company’s licensee area is 567 sq. km. Additionally; CESC has a 2x300 MW thermal power plant at Haldia in West Bengal operated by its subsidiary Haldia Energy Limited (HEL). The company also has a 2x300 MW thermal power plant at Chandrapur in Maharashtra, run by its step down subsidiary - Dhariwal Infrastructure Limited (DIL).

In the Retail segment, CESC operates 125 stores having a total area of 1.2m sq ft across India through its 100% subsidiary Spencer Retail. Further, it also operates Quest-a high-end luxury mall in Kolkata with retail area of 0.4m sq. ft. CESC has a controlling stake of ~55% in Firstsource Solutions Ltd. (FSL), a leading global BPO company.

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