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Expanding its distribution footprint

* CESC has emerged as the highest bidder for a 100% stake in Chandigarh Distribution Company (DISCOM). The takeover would be subject to the completion of certain formalities, as per the company. The receipt of the Letter of Intent (LOI) for the same is still pending.

* The move is in line with the co.’s strategy to grow its presence within the Distribution space. With a healthy balance sheet (net debt/equity: 1.2x) and strong expertise, the company is well-placed to capitalize on privatization opportunities.

* Media articles reveal CESC bid INR8.71b for the acquisition. Based on the current regulated equity base and regulated RoEs of 15.5–16%, the bid appears to be on the higher side. Although, CESC has significant expertise in power distribution, along with the ability to generate returns higher than the regulated RoEs. We await clarity on the details of the Chandigarh circle takeover.

Steady circle, with scope to lower T&D losses

* A look into the tariff filings indicates a steady circle – nearly a 50% mix of residential consumers. Power demand / The number of consumers at the Chandigarh circle has seen a modest ~2% CAGR over FY15–20.

* Aggregate T&D losses have been in the range of ~16% over the past five years (intra-state: 12%; inter-state: 4%).

* Regulated RoEs stand at 15.5–16% (Wires business: 15.5%; Supply: 16%), with avg. gross fixed assets posting a 3% CAGR over the last five years.

* Capitalization has been at an avg. of ~INR100m in recent years. There is scope for T&D losses to decrease, with intra-state losses of 12%, and the same may necessitate higher capex/capitalization.

Await details on the takeover

* Media articles (see here) have indicated that the co. has won the stake for INR8.71b. Given a) the current regulated equity of INR1.3b for the circle, b) a growth rate of just 2%, and c) regulated RoEs of 15.5–16%, the bid appears to be high – implying a value of ~6.5x regulated equity.

* However, we await details on the takeover plan (initial regulated equity base, capitalization outlook, AT&C norms, and incentives). We note CESC has significant expertise in the Distribution space, with operations in Kolkata, Rajasthan, and Noida, along with the ability to generate returns higher than the regulated RoEs. Our interaction with the co. further indicates a longer term strategy being employed with its entry into Chandigarh – which would prepare it well for future opportunities in nearby (Haryana and Punjab) circles.

* Accordingly, we do not bake in Chandigarh into our estimates – as the actual takeover is yet to take place. While we keep a keen eye on details and valueaccretion from the circle, the turnaround story for its existing businesses of Dhariwal as well as distribution franchises (DFs) remains intact. CESC’s existing Distribution business is high-RoE and delivers steady growth, with generation assets yielding healthy FCF. The stock trades attractively at ~7x FY22/23E P/E as we factor in the tightening of norms at Haldia and S/A in FY23. We value the stock at 8.5x FY22 P/E and maintain our Buy rating, with TP of INR905/sh.

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