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Distribution business to be the key growth driver Rs84

We participated in RP-SG Group’s virtual investor conference on 22nd Nov’21 in which CESC explained in detail its ongoing technological digitalisation initiatives, and laid out its growth strategy. Despite key systems in place, CESC aims to become more digital and flexible on the distribution front, improving its system and consumer understanding so that capex is done on just-in-time basis resulting in higher returns. Its medium term growth strategy is focused on inorganic expansion of its distribution businesses by acquiring new areas; it is betting big on distribution de-licensing and privatisation. Kolkata license area continues to be the key focus business, and while tariff order is awaited, CESC continues to optimise costs and maintain profits. It aims to expand adoption of new technologies including EV charging, BESS, microgrids, among others, and is performing well on the ESG front. Maintain BUY.

* Technological initiatives, digitalisation with customer-delight approach, focus on optimising costs and improving RoE in distribution business: CESC is adopting state-of-the-art technology at its distribution areas which includes: 1) Big data analytics, AI / ML, IoT for predictive analytics and real-time monitoring, 2) automating redundant practices /services to reduce costs through bots and workforce automation, 3) deploying smart metering solutions to reduce losses, provide improved services to customers and for outage management, 4) moving from smart to intelligent grid solutions, 5) digitising customer services and providing value-added services for premium customers, 6) leveraging blockchain technology for demand side management. CESC aims to become more digital and flexible, improving its system and consumer understanding so that capex is done on just-intime basis resulting in higher returns.

* Growth mainly targeted in distribution space; betting big on distribution delicensing and privatisation: CESC’s growth strategy in the medium term is to inorganically expand its distribution footprint by acquiring more distribution circles. The company is eagerly awaiting key distribution reforms proposed in the draft Electricity Amendment Bill and privatisation of discoms by more states. Its experience is huge both in improvement and turnaround of distribution areas (operational and financial), and in both licensed and franchised models. It is also awaiting de-licensing opportunities.

It has recently won the bid to acquire Chandigarh discom (transfer is awaiting court order; expected soon). With high per capita income, high annual per capita power consumption (7,000 units, vs 3,000 units at Kolkata), good consumer mix and anticipated growth in MSME activities, CESC has high expectations from Chandigarh. Post transfer, CESC will aim to improve network reliability, optimise employee costs, replicate digitisation and automation processes it is currently deploying in Kolkata, and also look for behind-the-meter and non-tariff revenue opportunities.

* No issues on generation front in the next decade: CESC has a portfolio of 2,125MW of operational thermal assets with varying residual lives. However, inline with the declaration during COP-26, where India insisted on phasing-down of coal generation vs phasing-out approach insisted upon earlier, the management expects its thermal assets will not face any operational concerns over the next decade, despite sustainability-related challenges. CESC’s thermal plants, being among the most efficient in the country with highest annual PLFs, in addition to the requirement of embedded generation to cater to islanding for metro cities and grid stability, further justify the requirement of thermal plants, especially to cater to the base load

Only in case of Southern GS there may be an issue related to emission control equipment not being installed due to space constraints. SGS is currently deployed as a peaking station and for grid stability purposes.

In case of Chandrapur, the capacity is 50% tied up for long term. CESC is focusing on improving availability, increasing efficiency and reducing costs (mainly through debt repayment) and will benefit from the opportunities arising in short term and exchange markets, until LT PPA for the untied capacity is signed.

CESC is not keen on adding renewable generation capacity at the moment as it believes that changing tariffs lead to variation in IRRs.

* Looking to expand in EV charging and battery storage related infrastructure: CESC has 3 operational public EV charging stations and is looking to increase its penetration and create a larger scale public and home charging infrastructure. Even the immediate opportunity is huge as 1,000 ebuses are expected to be deployed in Kolkata shortly (80 operational currently). CESC will also procure EVs for in-house usage. In the BESS space, too, the company envisages huge opportunities for voltage and frequency regulations, grid stability and optimising peak power costs, particularly with increasing RE generation in the mix. While it already operates a 315kWh BESS at one of its substations in Kolkata, plans are to set up larger scale storage solutions for HV distribution among others. CESC is working on developing a microgrid (along with floating solar & battery) at a Kolkata substation.

* Focusing on cost optimisation in Kolkata distribution area: Kolkata distribution tariff order continues to be pending; however, company is focusing on reducing operating costs, mainly manpower and finance costs to reduce the fixed cost burden. Instead of under-grounding, CESC is currently deploying aerial bundled cables and co-axial cables, which are resistant to climate variations, and will also make poles stronger to better withstand cyclones. For RPO obligation, CESC is buying power from the exchanges (through GTAM, GDAM products). It does not expect RPO obligation to become a huge concern since for Kolkata, embedded generation is required for islanding and grid stability purposes for uninterrupted power supply.

* Performing well on the ESG front: CESC’s ESG rating upgrade from B to BB by MSCI is the testament to various steps which the company has taken on the ESG front. It considers sustainability as one of the core areas and is working to increase its footprint in tRE, EV, electric cooking and BESS spaces. On the generation front, despite 100% thermal portfolio, CESC’s plants are among the most efficient in the country and there has been a steady decrease in emission intensity in all its generation stations from FY18 to FY20. It also continues to remain committed on biodiversity, employee and community welfare fronts.

Valuation and risks

We maintain BUY on the stock with SoTP-based target price of Rs120. The stock is currently trading at FY24E P/E of 6.7x, P/BV of 0.9x, and a dividend yield of 7.2%.

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