CESC - Results below expectations; downgrading to ADD - BRICS

CESC's Q2FY13 results were below expectations, with PAT up 19.3% yoy to Rs1.36bn, vs. estimate of Rs1.68bn, due to delay in passing of tariff order. Revenue grew 8.3% yoy toRs13.2bn, driven by higher tariff realization and moderate demand in Kolkata, while EBITDA increased 20.2% yoy to Rs2.9bn. Spencer's cash losses amounted to Rs60mn/month and should achieve its target of Rs50mn/month by March 2013. However, we believe the Firstsource acquisition is likely to be negative for the company in the short term. Downgrade to Add.

Moderate demand growth in Kolkata: CESC reported generation growth of 3.0% and PLF of90%, as against 88% in Q2FY12. Demand in the Kolkata license area saw a moderate growth of 1.7% yoy. PLFs improved across all the base load stations. Tariffs were up 8.3% yoy, partly due to rising coal costs and fixed charge approval from WBERC in March 2012. Consequently, overall revenue was up 8.3% yoy to Rs13.2bn.

EBITDA margin improves: Despite rise in coal costs, CESC managed to report marginal savings in fuel costs by increasing generation from base load stations and curtailing generation in its peak load stations that consumes expensive A grade coal. However, power purchase cost was up 33% yoy, due to steep rise in imported power rates. Despite this, EBITDA rose 20% yoy, aided partly by a lower Q2FY12 base, as the increase in fixed costs was allowed as pass through only in Q4FY12. Other income declined 6% yoy, as the company deployed cash for the Haldia and Chandrapur projects. PAT stood at Rs1.36bn, vs. our estimate of Rs1.68 bn, due to delay in issue of tariff order for FY13.

Outlook: Adjustments to tariff relating to escalation in fixed costs, is likely to be allowed in Q3/Q4FY13, after WBERC issues a new tariff order. Chandrapur project should be commissioned in April 2013 and the FSA with CIL is likely to be signed by Dec 2012. Haldia project is progressing as per schedule and monthly losses of Spencer's Retail are down to Rs60mn, in line to meet target of Rs50mn by FY13 end.

Valuation: Power business will continue to generate stable cashflows, though the Firstsource acquisition will increase its debt burden. CESC will also be foraying into a new business in which it lacks prior experience. We cut our target price by 26% to Rs311 and downgrade the stock to Add.

CESC's acquisition of First Source marks second venture into non-power business

In Q2FY13, CESC decided to acquire a controlling stake in FSL, a BPO firm, through its wholly-owned subsidiary, SpenLiq, for about Rs6.5 bn. The company will acquire a 34.5% stake through fresh equity for Rs2.78 bn, while the acquisition of an additional 15% stake from ICICI, Fidelity and Temasek (5% each) will be worth about Rs1.2 bn. This will be followed by an open offer to acquire an additional 26% stake, as per SEBI's takeover regulations. The open offer price will be Rs12.10 per share, according to SEBI's guidelines, thereby taking the overall deal value to Rs6.5bn and valuing FSL at Rs8bn.

First Source acquisition likely to be financed largely through debt CESC has cash and cash equivalents ofRs10bn in its balance sheet. Additionally, the company generates operating cash flow ofRs7bn. However, the yearly capex for the Kolkata license business alone stands at about Rs6.5bn. Further, CESC has two projects in the construction stage at Chandrapur and Haldia of 600MW each, in which the company's equity contribution is likely to be about Rs18bn. These projects are expected to be commissioned by March 2013 and June 2014 respectively. Consequently, the company will have to resort to further debt to fund the FSL acquisition.

CESC's record in non-power business not very encouraging

This is the second time that CESC is diversifying into a non-power business. The company's first attempt was its foray into retail with the acquisition of Spencer Retail in 2006, which proved unsuccessful, with Spencer continuing to incur a cash loss of about Rs700 mn. Management is convinced that the BPO business will provide impressive returns to CESC, though we remain sceptical, given the company's past record in the retail business and management's lack of experience in the BPO business.

Reduce TP and downgrade to ADD

We have reduced our target price by 26% to Rs311 after factoring in the cash outflow of Rs6.5bn for FSL. We are not assigning any value to FSL for the time being. Until the time we see the BPO business generate impressive returns, we prefer being conservative in our valuations. Despite the core power business likely to generate stable cash flows, we believe the sentiments surrounding the stock are likely to remain negative in the short term, given the company's performance in the retail business. Downgrade to Add.

Source : Equity Bulls

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