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S/A miss on higher-than-expected expenses

DFs’ performance improves; Dhariwal remains profitable

* CESC’s S/A 1Q results highlight a modest profitability improvement. Volumes for S/A improved 23% YoY (on a low base), but S/A PAT was up just 3% YoY. Consol. PAT, on the other hand, rose 37% YoY on lower losses in its Distribution Franchise (DF) business.

* Dhariwal has turned profitable and DFs are showing signs of a turnaround. CESC’s integrated business in Kolkata is high RoE and generates strong cash flows. Even as we factor in the tightening of norms at Haldia and S/A, the stock trades attractively at 7.3/6.8x FY22/FY23 P/E. Maintain Buy, with TP of INR890/sh based on 8x FY23EPS.

S/A profitability below expectations

* S/A PAT rose just 3% YoY to INR1.4b (29% lower v/s our estimate: INR2.0b). The large miss was on account of 1) higher O&M and other expenses and 2) a marginally lower than expected rise in volumes amid the impact of the second COVID wave.

* As per the co., the previous year had seen certain cost measures being implemented, which were unsustainable. Other expenses at S/A were up to INR2.7b v/s INR1.5b in the previous year.

* Sales volumes rose 22.5% YoY to 2.6BU (on a low base; 1QFY21: -31% YoY). S/A other income for the quarter was lower at INR0.1b (v/s INR0.3b in the previous year).

* Consol. PAT was up 37% YoY to INR2.7b in 1Q, led by lower losses in its DF business.

DFs’ performance improves on lower T&D losses, better demand

* DFs in Rajasthan reported loss of INR110m v/s loss of INR330m in 1QFY21. This was on the back of improved demand and lower T&D losses for the business. The co.’s recently acquired Malegaon DF reported profit of INR20m in 1Q (v/s loss of INR310m in 1QFY21). T&D losses have come down to 35% v/s 50% at the time of takeover in Mar’20.

* Dhariwal reported profit of INR250m (v/s INR240m in 1QFY21). Numbers continue to show the benefit of the pass-through of higher coal cess in tariff and higher PPA quantum. Dhariwal had signed a 185MW PPA with Maharashtra in 3QFY20, and the same has been extended up to Oct’21.

* Crescent and Surya reported profit of INR70m v/s INR120m in 1QFY21.

* Profits at Haldia improved to INR900m in 1QFY22 v/s INR850m in 1QFY21.

* Profitability at Noida improved to INR290m v/s INR90m in the previous year, led by an increase in stake in the entity.

FCF generation strong; maintain Buy

* Subdued power demand has impacted profitability for CESC’s businesses. However, Dhariwal has turned profitable, and the performance of DFs is improving as the co. gains a better understanding of the circles and leverages from its experience in Kolkata.

* CESC’s existing Distribution business is high RoE and delivers steady growth. Generation assets generate healthy FCF. Even as earnings visibility at Dhariwal improves, and we factor in the tightening of norms at Haldia and S/A in FY23E, the stock trades attractively at 7.3/6.8x FY22/FY23 P/E.

* CESC has recently emerged as the highest bidder for the takeover of the Chandigarh circle. Pending details on the plan (initial regulated equity base, capitalization outlook, AT&C norms and incentives) and the actual takeover itself, we do not bake this into our estimates.

* Untied generation capacity and scale-up in DFs have the potential to boost earnings. We value the stock at 8x FY23 P/E. Maintain Buy, with TP of INR890/sh.

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