CESC: Silent on critical issues

25 Jul 2023 , 10:42 AM

Recommendation: Buy; Target Price: Rs 90

CESC’s integrated FY23 AR has good disclosures on initiatives taken to improve efficiency, rein costs, digitalisation/automation at each of its businesses; it, however, does not address key issues such as strategy to revive muted earnings growth, worsening working capital and cash flows, etc. Arguably its cheap valuation multiples (0.8x BV, 7x P/E on FY24) well reflect these issues; marginal tariff hike / regulatory relief can re-rate the stock materially.

Silent on critical issues: 

CESC’s FY23 AR gives a good perspective on operations of its generation (2.3GW) and distribution (six circles) portfolio; the ESG disclosures have improved over the years. However, the AR is silent on key issues such as strategy to grow the business, plans to improve profits/cash flows of flagship Kolkata business (flat for the past 5 years), RE growth opportunity and delay in taking over Chandigarh discom where it has outbid other utilities to acquire 100% stake from Govt of India. Comments on these issues could have helped investors get a grip on future capital allocation.

Deteriorating financials: 

CESC’s FY19-23 consolidated PAT is up only 3% p.a. vs 7-24% p.a. growth seen by other utilities. The muted gowth is due to no growth in its Kolkata circle (no tariff hike); Dhariwal IPP (turnaround), Noida Power (73% stake) – one of the fastest growing discom etc. have done well while performance of 4 franchising circles is mixed. There has been a significant increase in working capital (14% share in balance sheet vs 5% in FY19), as regulatory assets rise (Rs 43bn as of FY23); the Ebidta/OCF conversion is 58% (lowest in the industry) and remains an overhang. Political donations which average 10-15% of PBT through FY21-23 seem high relative to others.

Cheap multiples reflect key issues: 

CESC’s FY24 earnings will remain flat YoY due to changes in tariff regulations at Kolkata (cut in G RoE + lower incentives in D), even as franchising operations deliver growth. As such, through FY24-26 PAT growth of 7% p.a. is mainly driven by non-Kolkata business. The inexpensive stock multiples (7 x FY24 P/E, 0.8x FY24 consol BV), to an extent, reflect these issues; the stock can re-rate materially, with a marginal regulatory relief. Analysts of IIFL Capital Services keenly watch the implementation of fuel surcharge mechanism at Kolkata.