The share price of CESC is up 16 per cent since last week after the West Bengal Electricity Regulatory Commission (WBERC) gave the much-awaited approval of tariff hike to the company. CESC’s performance in the nine months ended December 2011 (9M FY12) was affected due to higher costs and inability to charge higher tariffs. Says Hitul Gutka, analyst, PINC Research, “The move has been late but it is both sentimentally and fundamentally positive for the stock.”
Though the tariff order removes near-term overhang on the stock, a bigger positive and key trigger for a re-rating would be the government’s final approval of foreign direct investment (FDI) in multi-brand retail, believe analysts. Such a move would help unlock value of its 95 per cent loss-making retail subsidiary, Spencer’s Retail, by way of induction of a foreign partner. Says Shankar K, analyst, Edelweiss Securities, “Clarity on FDI in multi-brand retail will provide the much-awaited impetus for the stock.” Nevertheless, the overall outlook for the stock is still positive.
Tariff hike: late but vital
In July 2011, CESC had demanded a hike of Rs 1.11 per unit (or 21 per cent) for FY12 due to increase in non-fuel costs (or fixed costs). Despite raising tariffs by 46 paisa per unit at the start of FY12 (thereby increasing tariffs to Rs 5.19 per unit), CESC’s financial performance in the past three quarters was marred by growing under-recoveries of its fixed costs. The company had to make a provision for Rs 35 crore in the recent quarter, and thus its profit for the nine months ended December 2011 fell 20 per cent year-on-year to Rs 299 crore.
| BRIGHTER OUTLOOK | |||
| In Rs crore | 9MFY12 | FY12E | FY13E |
| Total operating income | 1,032.0 | 4,651.0 | 5,355.0 |
| % change y-o-y | 10.0 | 16.0 | 15.0 |
| Operating profit | 213.0 | 1,099.0 | 1,448.0 |
| % change y-o-y | -16.0 | 2.0 | 32.0 |
| Net profit | 74.0 | 456.0 | 537.0 |
| % change y-o-y | -33.0 | -6.5 | 18.0 |
| E: Estimates Source: Company, Analyst reports | |||
WBERC has finally allowed a hike of 69 paisa (or 13.3 per cent) with retrospective effect from April 1, 2011. This will increase the average realisation for CESC to Rs 5.88 per unit and reverse the provisioning effect, thereby boosting profitability. Besides, arrears for the past 11 months, along with interest, will be recovered over the next 48 months. The company has already started charging customers as per the new order from the current billing cycle, which should reflect from the March 2012 quarter onwards.
Analysts have accordingly revised their earnings estimates upwards and the event has improved the near-term prospects for the stock. Says Shankar K, “Given that the state (of West Bengal), under political duress, has been strongly resisting any increase in power tariffs, the hike is a definite positive as it eliminates the near-term overhang of regulatory risk of delay in tariff approvals and addresses its impact on cash flows.”
While analysts are estimating CESC’s revenues and profits to grow by 15-18 per cent in FY13, commissioning of projects (Haldia and Chandrapur of 600mw each; currently under construction) in FY14-FY15, which will double CESC’s existing installed capacity, will provide visibility beyond FY13 and further boost financial performance of the power business.
FDI in multi-brand retail: A key trigger
Now that the issues facing the power business have been largely resolved, analysts’ focus has shifted to the retail business. Spencer’s Retail is doing well with improvement in average sales per square feet (up 13 per cent to Rs 1,087 in the nine months ended December 2011) and store level Ebitda (Rs 35 per square feet in 9M FY12, compared with Rs 31 in the first half of FY12). This has been achieved through focus on cost rationalisation, (which has also seen a reduction in the number of stores) and profitable growth.
While the company is yet to breakeven at the net level, the management expects it to turn profitable by FY13 or FY14. Gutka, though, is sceptical and believes the breakeven could be delayed due to the slowdown of the Indian economy.
For now, CESC is able to generate sufficient cash to fund Spencer’s losses and other capex. Induction of a foreign partner, however, would not only help financially but also in terms of expansion (from one million square feet currently), operational skills and rich retail experience from developed countries. More importantly, it would leave CESC with more cash for investment in further expansion of its power portfolio or acquisition of mines (currently 60 per cent coal is sourced from the group’s captive mine).
Outlook
Despite the sharp rise in a short period of time, there is further upside potential of about 24 per cent for the stock (now at Rs 302) given the average fair value estimates of Rs 375. Shankar K has upgraded the price to book value multiple of the power business from 1.1 times to 1.2 times (with regulatory risk easing off), which increases his fair value estimates by seven per cent to Rs 399. Gutka too, believes the stock continues to offer value even after assuming increased cash infusion from generation business into the loss-making retail venture.
