Upgrade CESC to Buy - Motilal Oswal

CESC: High-powered growth plans; Steady cash flows; Growth option not equity dilutive; Upgrade to Buy

- Regulated business provides steady cash flows: CESC's (CESC IN; Mkt Cap US$1.1b, CMP Rs400, Buy) regulated business, comprising largely of the generation (1,225MW) and distribution assets in Kolkata, generates steady profits of Rs3.5b+ per year. The regulated equity base (RAB) now stands at Rs22b, up from Rs17b as at end-FY09, driven by commissioning of the Budge Budge 250MW generation capacity in February 2010. Given that FY11 will be the first full year of operations, we expect net profit from regulated business to increase to Rs4.2b in FY11 and Rs4.4b in FY12.

- High-powered growth plans: CESC intends to transform from a regional player to a national player in the Indian power utilities segment. To begin with, it intends to commission 600MW power generation capacity each at Chandrapur (Maharashtra) and Haldia (West Bengal); both projects have achieved financial closure. Project pipeline is interesting and includes: (1) 1.3GW in Orissa, where substantial land has been acquired and the project has secured 70 marks out of 100 for the Twelfth Plan coal linkages, (2) 1GW in Jharkhand, with captive coal mine; land acquisition has just commenced, (3) 1GW in Bihar, where land acquisition has just commenced, and (4) 1.3GW expansion in Haldia with TOR approved recently. The Maharashtra project has been acquired through the inorganic route, and the company is looking for further M&A opportunities. CESC is also pursuing distribution opportunities in states like Bihar.

- Funding comfortable; growth option not equity dilutive: CESC is comfortably placed to fund the equity requirements towards capex in regulatory business, projects under construction, and to fund cash losses in Spencer. Over FY11-12, these will entail equity funding of Rs11.8b; CESC has cash and liquid investments of Rs13.5b as at March 2010. Also, CESC has annual steady cash flows of Rs5b+ from its regulated business. DER is comfortable at 0.5x, providing opportunities to leverage for growth. We believe that the company is comfortably positioned in and growth option is not equity dilutive.

- Valuations attractive; upgrade to Buy: We expect CESC to report standalone net profit of Rs4.6b in FY11 (up 7.2%) and Rs4.9b in FY12 (up 5%). Spencer's reported pre-tax loss of Rs2.9b in FY10; we estimate pre-tax loss at Rs2.3b-2.5b for FY11. Our SOTP-based price target for the stock is Rs568. We value its Kolkata regulated business at Rs346/share (10x FY12E EPS), Real Estate at Rs17/share (NPV), Spencer Retail at Rs39/share (EV of 1x FY10 sales), Haldia Energy at Rs57/share and Cash at Rs110/share (BV). Spencer's has been a drag over the past two years, with investments of Rs20b (including shares issued to promoters on acquisition) valued at Rs4.9b currently. Possible upsides: (1) progress on 1.2GW projects under construction and development pipeline of 4.6GW, (2) reduction in cash losses / operational turnaround / PE investor for Spencer's.

Source : Equity Bulls

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