Easing pain points trigger CESC re-rating

CESC share prices have almost doubled in the last one year as the firm delivered a steady performance in its core power distribution business


Graphic: Ajay Negi/Mint
Graphic: Ajay Negi/Mint

The CESC Ltd stock hit a new 52-week high on Tuesday. And although it closed lower on Wednesday, it has almost doubled (up 96%) in the last one year as the firm delivered a steady performance in its core power distribution business and indicated easing of pressures at its troubled businesses.

True, the rally in the share price has expanded the one-year forward price-earnings multiple from single digits a year ago to 12 times now, making several analysts wary. But as its retail business turns profitable and the Chandrapur power plant nears break-even, some analysts see scope for more returns.

The Spencer’s retail business, which is making an operating loss of Rs100 crore a year, has stopped making losses at the operating level in the last quarter, according to the management. Further, it also indicated that it is open to listing the retail business, fuelling valuation gains.

Even if one sets the listing gains aside, analysts see value accretion to CESC’s earnings from Spencer’s. “We have revised our estimates, building in first full-year of EBITDA break-even now in FY18E,” Motilal Oswal Securities Ltd said in a note. The broking firm expects the improving retail business to raise CESC’s consolidated return on equity. Ebitda is short for earnings before interest, taxes, depreciation and amortization.

The second positive is the 600 megawatts (MW) thermal power plant at Chandrapur, Maharashtra. The plant is losing money (it lost Rs590 crore last fiscal year) due to sub-par utilization. Like Spencer’s, the plant is also likely to turn around next fiscal year. The management expects to tie up about three-fifths of the plant’s capacity next fiscal year, potentially wiping out losses.

“The cash drain at the Chandrapur plant would be arrested in FY18E, as it signs a PPA for the balance capacity,” HDFC Securities Ltd said in a note. PPA is short for power purchase agreement. A little less than half of the plant’s capacity has been tied up currently. It is awaiting regulatory approval for a new 200MW contract.

If the management succeeds in tying up the Chandrapur plant, then 2017-18 earnings of CESC will see notable upside as the firm will no longer have to fund losses at these two units, which have been significant till now.

The optimism is visible in the stock valuations. For it to continue to do well, CESC has to demonstrate that the retail business is on a sustainable profitability path. Also it is crucial that the Chandrapur plant’s 200MW contract does not see inordinate delays. A prolonged delay will extend losses at the plant, undermine the Street’s earnings recovery expectations and set the stage for correction.

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