More gains ahead for CESC

Demerger of the company's four businesses will lead to further re-rating

The CESC’s scrip has been a market outperformer in 2017, more specifically from mid-May. 

According to the Street, the company’s announcement to demerge its business into four entities — power distribution, generation, retail and other ventures (to be completed by October 1) — would unlock value.

So far, CESC’s diversification was a key overhang. It also led to stronger businesses such as power distribution getting lower valuation multiples, analysts said. The demerger will streamline operations and enhance focus on each business, besides allowing them to command the value they deserve.

For instance, the power distribution business (which contributes over half of FY17 revenue) would be able to use all the cash generated to expand into cities like Kota, Bikaner and Bharatpur in Rajasthan, where it has won distribution franchisee licence. The distribution business has a high return on equity of 15.5 per cent, and is growing at a steady rate of six per cent, analysts at IIFL said, who remain bullish, as this business is steady, attractive and requires less capital infusion and minimal government intervention. It should command higher valuation multiples, as concern over funding other businesses (of CESC) would recede after demerger.

The power generation business comprises 600 megawatt (Mw) thermal capacities each at Chandrapur (Maharashtra) and Haldia (West Bengal), besides a few small thermal/solar/wind assets. The Haldia unit, which commissioned in 2015, reported a 27 per cent growth in profit in FY17, while the Chandrapur unit is witnessing improved prospects with the start of 170 Mw supply to Noida Power under a power purchase agreement from March 2017. Another 100 Mw (of the Chandrapur unit) has a long-term pact with Tamil Nadu. CESC is also trying to convert a short-term agreement of 270 Mw with Maharashtra into a long-term one. Analysts expect the regulated-return power generation business to continue generating 16-17 per cent return on equity over the next two years.

The company could also spot a silver lining in its retail business — Spencer’s. While the goods and service tax-related disruptions affected the June quarter performance, its same-stores per square foot sales and operating profit improved. Spencer’s plans to open 11 stores in FY18. Analysts believe its foray into high-margin apparel business (brand ‘2Bme’) should support profit growth. Firstsource Solutions (the company’s BPO business), under CESC Ventures, is already looked at with optimism.

Overall, while some analysts believe the positives are largely priced in, others remain bullish. Analysts at Motilal Oswal Securities expect Spencer’s to command higher valuations with a turnaround in FY18, besides re-rating of the distribution business. They have a target price of Rs 1,360. On Monday, analysts at IIFL, too, arrived at a sum-of-the-parts based target price of Rs 1,172. 

This suggests, for the CESC stock, which scaled to its new high of Rs 1,037.50 on Wednesday, there could be more gains.