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Next rerating candidate?

With the overhang of West Bengal elections now over, we expect the West Bengal Electricity Regulatory Commission (WBERC) to expedite the issuance of tariff order for CESC’s Kolkata discom, which has been pending for the past three years (MoP’s recent directive on timely tariff determination and full cost reflectiveness of tariff will help).

Although, on consolidated basis, CESC’s earnings have improved on better performance by subsidiaries, profits from the Kolkata business have remained stagnant as regulated equity growth has not been approved. With the expected issue of tariff order, approval of capex incurred in the past three years and future capex, we expect the ambiguity in earnings and valuation to diminish and CESC may be the next utility stock to rerate. Maintain BUY with the target price unchanged at Rs883/share.

* Issuance of Kolkata distribution tariff order to provide much needed boost:

As the elections in West Bengal culminate, we expect the state regulatory commission to move forward to issue the tariff order for the Kolkata distribution area (as well as other circles). The tariff order has been pending for the past three years and has resulted in no growth in CESC’s regulated equity and subsequently earnings. However, on a consolidated basis, the company has witnessed growth as subsidiaries have fared much better. With the expected issue of tariff order for subsequent years, approval of capex incurred in the past three years and future capex, we expect the ambiguity in earnings and valuation to diminish. Although future earnings may not change meaningfully as we expect some cut in T&D incentives, which will be offset by increase in regulated equity base, the overhang of returns on future capex gets addressed.

* MoP’s directive on timely tariff determination and full cost reflectiveness of tariff may also push WBERC to expedite the tariff order:

The MoP has issued directives to state electricity commissions to ensure timely determination of tariff orders and full cost reflectiveness of tariffs for ensuring sustainability of the sector and also in consumers’ interest. The directive reminded CERC and SERCs to abide by the provisions of the Electricity Act and ensure recovery of full cost of power supply plus a reasonable return and ensure that there is no creation of regulatory assets under business as usual situation. It has directed that annual performance review, annual revenue requirements, tariff determination, and true-up of past expenses have to be conducted on a yearly and timely basis. All tariff orders have to be issued before 1st April of the year. Status of compliance of these provisions has to be sent to the MoP by 31st May every year. Based on these directives and compliance requirements, we expect the WBERC to expedite the issue of the pending tariff orders for CESC.

* Valuations lag peers – next rerating candidate?

We maintain our BUY rating and target price of Rs883/sh on CESC. We estimate an improvement in profit from Kolkata distribution business and better-than-estimated recovery in DF businesses. The stock, which is currently trading at FY23E P/E of 5.7x, P/BV of 0.7x and dividend yield of 8.2%, by far lags its peers, viz. private utilities including Torrent Power and JSW Energy. We estimate this gap to partially shrink on passage of the tariff order and improvement in profit of the standalone entity as well as subsidiaries. However, valuations may reach levels similar to peers only when CESC shows growth intent and action in next-gen business segments, including renewables.

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