Inexpensive sector valuations notwithstanding, CESC shares are trading at a discount to those of peers Tata Power, NTPC and JSW Energy. (Vipul Sharma/Mint)
Inexpensive sector valuations notwithstanding, CESC shares are trading at a discount to those of peers Tata Power, NTPC and JSW Energy. (Vipul Sharma/Mint)

CESC’s power distribution foray lowers capital outlay, returns still elusive

  • CESC Ltd is making progress on its strategy to stay away from the capital-intensive power generation business
  • But scope of earnings accretion from power distribution business is low, given that CESC does not own assets in distribution

Mumbai: CESC Ltd is making progress on its strategy to stay away from the capital-intensive power generation business. It won distribution franchises for three cities in Rajasthan (Kota, Bikaner, Bharatpur in FY17 and FY18) and is about to secure another one in Maharashtra (Malegaon).

Returns from the distribution franchise are linked to loss reduction in transmission and distribution (T&D). Channel checks by IIFL Institutional Equities show a notable reduction in T&D losses in the distribution franchises that the company won in Rajasthan. The broking firm estimates the three distribution franchises in Rajasthan to break even at the Ebitda level in the current fiscal year (FY20) and generate profit in FY21. Ebitda is earnings before interest, tax, depreciation and amortization.

Compared to the traditional power generation business, the scope of earnings accretion from the distribution franchise is low, given that CESC does not own assets in distribution. It only gets incentives for efficiency improvement, say, in reducing T&D losses.

However, as IIFL points out, the business does give good returns on capital, because of low investments. “While the share of profit is a low 3.3%, the FY21 return on equity and on invested capital are attractive at 17% and 32%, respectively," said analysts at IIFL in a note referring to CESC’s distribution franchises in Rajasthan.

The experience should set the company well on the way to securing more distribution franchises and reassure investors, who otherwise are perturbed by the continuing losses at the 600 megawatts thermal power plant at Chandrapur in Maharashtra. The plant does not have sufficient power offtake agreements, leading to underutilization of the asset. In FY18, it had suffered losses of 199 crore.

Till recently, CESC has been providing growth capital to group firm, Spencer’s Retail Ltd. With the retail business now a separate entity and no major capital investments in the pipeline, it has to be seen how the company plans to deploy earnings from its core business.

In FY19, CESC stepped up payouts, declaring an interim dividend of 17.50 a share, up from 12 in FY18.

“With limited capex and the plans to expand into an asset-light distribution model, we believe the pay-out ratio will improve YoY," SBICAP Securities Ltd said in a note.

A clear articulation of its cash-deployment strategy will provide the much required support to the CESC stock, whose valuation is underperforming some of its peers at 0.9 times of FY20 estimated book value. It seems that investors may have to wait for an electrifying performance.

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