Resolution of Spencer's biz to be positive for CESC

As the retail arm is loss-making, any move to monetise or hive it off will enhance CESC's consolidated profits and cash flows

CESC has been in the news recently for acquiring BPO firm Firstsource Solutions and its plans, including a possible listing of its wholly owned subsidiary, Spencer’s Retail. While the former saw the CESC stock fall over 15 per cent indicating the Street’s concern over diversification into a new segment, the development regarding Spencer’s is positive as analysts believe this will help unlock value. That’s because, the market looks at Spencer’s as a drag on CESC's overall valuations. In fact, many analysts assign a negative value to the retail business. This is also the reason for the wide difference in valuations of CESC. At the current price of Rs 282, it trades at 0.5 times its FY13 estimated book value compared to its peers trading at 1.5-1.7 times.

“We have valued the retail business of Spencer’s Retail at negative Rs 37.8 per share. However, we have a buy rating on CESC with a target price of Rs 306 per share,” says Rabindra Nath Nayak, analyst, SBICAP Securities. While the Street is awaiting further clarity on the Firstsource deal and its future, progress over Spencer’s will help unlock value and possibly lead to a re-rating of the stock given that the core business prospects remain healthy. Hence, long-term investors with appetite for risk could consider the stock on dips.

CESC is a well established player in its core business of power, with a generation capacity of about 1,225 mw. On an average the standalone business (captures the power business) has been generating Rs 800-1,000 crore annually in cash from the operating activities for many years. However, a large part of this cash is deployed in businesses like retail. Today, Spencer’s has total equity of Rs 325.6 crore (including negative reserves of Rs 661.68 crore). However, despite Spencer’s operating 200 stores across 45 cities in India, it is yet to contribute to CESC’s profits. In fact, thanks to the losses (including Rs 152 crore in FY11), the retail arm's accumulated net loss has risen to over Rs 1,000 crore. This in turn is proving to be a drag on the consolidated performance of CESC and its stock. Recurring losses mean that CESC has to regularly infuse equity into Spencer’s.

STEADY GROWTH IN CORE BUSINESS
In Rs crore	FY12	FY13E	FY14E
Sales	4,605	5,798	6,211
Ebitda margin (%)	23.5	21.4	19.7
Net profit	554	597	625
EPS (Rs)	44.1	47.5	49.8
Return on equity (%)	9.2	8.9	8.6
PE (x)	6.5	6.1	5.8
Standalone financials Source: SBICAP Securities

The impact of Spencer’s performance is already visible on CESC’s financials. For instance, CESC on a standalone basis made a net profit of Rs 554 crore in FY12, but on a consolidated basis its profit stood at just Rs 236 crore. Considering the financials and cash flows of the retail business, the market views any move to hive off the retail business to be positive. Moreover, hopes are increasing as foreign direct investment in retail is already in place and the management has guided for several options, including a demerger from the parent company (as per existing shareholding pattern), initial public offering and induction of a strategic investor in Spencer’s.

This is crucial as after the plans to acquire Firstsource, the company’s balance sheet will be stretched. Analysts say CESC has consolidated cash of Rs 1,343 crore, which will be required for its upcoming power plants at Chandrapur and Haldia, in addition to funding loss-making Spencer’s.

So, managing the balance sheet risk will be critical and if CESC is able to monetise Spencer’s business it will lead to re-rating of the stock, as that will ease concerns over liquidity, boost its consolidated profits and instil higher confidence in the company’s core business.