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At deep discount vs peers

The West Bengal Electricity Regulatory Commission (WBERC) has started issuing tariff orders, which bodes well for CESC Kolkata discom’s tariff approval. With the anticipated issue of the order, and approval of capex incurred in the past three years and of future capex as well, we expect ambiguity in CESC’s earnings and valuation to diminish and the stock to rerate. Despite its higher profits, RoE and FCF yield, CESC currently trades at 52% / 70% discount to its private sector peers Torrent Power / JSW Energy’s FY23E P/E. Of the three main concerns – the pending tariff order, franchise distribution profitability, and growth concerns – two are about to be addressed. Also, with its bids during the recent UT discom privatisation auctions, we see some growth intent in CESC. However, the company has to do much more, especially in the RE space, to close the peer valuation gap further. Maintain BUY with a revised target price of Rs1,131 (earlier: Rs903).

* WBERC has started issuing tariff orders; approval of CESC’s petition expected soon: In the past month, WBERC approved the tariff petitions for West Bengal State Electricity Transmission and IPCL, which indicates that the order for CESC too is forthcoming. The tariff order has been pending for three years and has resulted in no growth in CESC’s regulated equity, hence earnings. However, on a consolidated basis, the company has witnessed growth since both its DL businesses (NPCL) and distribution licensees for the Rajasthan DFs have approved tariff orders. With the expected issue of tariff order for Kolkata distribution business, approval of capex incurred in the past three years and also of future capex, we expect the ambiguity in CESC’s earnings and valuation to diminish. Although future earnings may not change meaningfully as we expect some cut in T&D incentives (to be offset by increase in regulated equity base), the massive overhang of returns on future capex gets addressed. Further, MoP’s directive on timely tariff determination and full cost reflectiveness of tariff will also push WBERC to expedite the tariff order.

* Quicker-than-estimated turnaround in DF businesses: Billing and collections normalised to pre-covid levels in H2FY21. But with the second wave restricting commercial activities in hubs like Kota, Q1FY22 was hit although with lesser impact than in Q1FY21. We now estimate the Rajasthan DFs to turn profitable in FY23E and Malegaon DF’s losses to reduce substantially as AT&C losses shrink further.

* Participating in discom privatisation bids: We believe CESC’s wide experience in the distribution space, both as a licensee and franchise, will help it in all upcoming privatisation bids. Its participation in the bids for the two UT discoms is a positive.

* Valuations: We maintain our BUY rating on CESC, but increase our target price to Rs/1,131sh (earlier: Rs903/sh), incorporating higher cash balance due to: 1) regulatory asset liquidation on tariff approval, 2) higher other income, and 3) better profitability of Kolkata distribution and DFs. On FY23E basis, compared with Torrent Power and JSW Energy’s P/E of 15.6x / 25.2x and P/B of 1.9x / 1.6x, CESC remains much behind at FY23E P/E of 7.5x and P/BV of 1x. This is despite the company’s FCF yield of 12% and dividend yield of 6.5%. Even at our revised target price, the FY23E P/E is 10x and P/B is 1.3x. 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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