CESC: Best fully integrated power DISCOM

CESC

Initiating Coverage | Sector: Utilities

CESC

Buy

BSE Sensex

27,591

S&P CNX

8,544

CMP: INR599

TP: INR940 (+57%)

Best fully integrated power DISCOM

Stock Info

Bloomberg

Equity Shares (m)

52-Week Range (INR)

1, 6, 12 Rel. Per (%)

M.Cap. (INR b)

M.Cap. (USD b)

Avg Val, INRm

Free float (%)

EPS CAGR of 30%; Initiating with Buy and TP of INR940

CESC IN

133.2

683 / 405

-3/5/6

79.8

1.2

238.6

50.08

RoEs and profits to double led by asset sweating

CESC is primarily an integrated electricity generation, transmission and

distribution company. Its recent diversification into independent power

generation (Dhariwal), organized retail (Spencer) and business process

management (Firstsource) entailed significant investments, which compressed

consolidated RoE to single-digit over FY11-16. However, the earnings outlook

has improved with commissioning of generation assets, signing of PPAs,

reducing losses at Spencer and growth at Firstsource (FS). We expect RoE and

PAT to more than double to ~14% and INR8.6b, respectively, over FY16-18E.

Financial Snapshot (INR b)

Y/E Mar

2016 2017E 2018E

Sales

EBITDA

EPS (INR)

EPS Gr. (%)

BV/Sh. (INR )

RoE (%)

RoCE (%)

P/E (x)

P/BV (x)

119.0

28.5

3.7

27.8

86.6

470.5

6.0

9.1

17.0

1.0

135.6 147.7

31.6 34.6

5.4

8.6

40.9 64.7

47.1 58.4

431.9 484.6

9.1 14.1

9.8 11.0

14.6

9.2

1.4

1.2

High RoE in distribution business

CESC’s integrated electricity distribution business in West Bengal is its key

strength and major value driver. While normative returns are 15-16%, the

distribution business is able to generate high RoEs of +25% via operating

(attractive AT&C incentives) and capital (customer advances) efficiencies.

Distribution and Firstsource as growth drivers

New customer additions and upgradation of infrastructure are the key growth

drivers of its regulated distribution business. Over FY16-20, we expect regulated

equity CAGR of ~7% and Firstsource PAT CAGR of ~14%.

Shareholding pattern (%)

As On

Jun-16 Mar-16 Jun-15

Promoter

49.9

DII

18.2

19.1

14.1

FII

23.5

22.6

26.6

Others

8.4

9.4

FII Includes depository receipts

Reducing losses at Dhariwal and Spencer to boost RoE

Dhariwal’s losses have started reducing with operationalization of the 100MW

Tamil Nadu PPA at end-FY16. Another 187MW PPA with Noida is expected to

become operational by 3QFY17. Besides this, 300MW may remain unsold for

next few years until the demand-supply gap is bridged. Losses at Spencer too

CESC

have started declining due to the focus on consolidation (rather than growth)

Best fully integrated power DISCOM

and operational efficiencies. GST should also be beneficial, in our view.

Opportunity: Privatization of power distribution

The Indian power distribution system with INR3.9t of revenues is incurring

heavy operating losses under state governments’ control. With banks no longer

funding losses, DISCOMs will have to take various measures (including partial

privatization) to turn around under the ‘UDAY’ scheme. This is big opportunity

for CESC, which is one of handful players with a proven track record. Notably, it

has recently won the privatization rounds in Kota and Bharatpur.

91 22 3027 8033

Dhruv.Muchhal@motilaloswal.com

Please click here for Video Link

10 November 2016

CESC

Stock Performance (1-year)

Initiating with Buy; SOTP-based valuation at INR940

CESC is one of the few private sector power companies with strong earnings growth

visibility, healthy FCF generation and strong balance sheet. Profit and RoE are

expected to more than double in two years. While distribution and FS are the key

business growth drivers, we believe reducing losses at Dhariwal and Spencer will

boost RoE.

At current market price, the stock is trading at attractive 11% FCF yield, ~1.2x P/BV

and 9.2x P/E on FY18E. Valuations are compelling in light of 30% EPS CAGR and

recovery in RoE from 6% to 14% over FY16-20E.

We value the standalone regulated business at INR603/share based on 10.6x P/E,

considering RoE, cost of equity and growth. Since cash flows are structured for the

power generation businesses of Haldia and Dhariwal, we value them on INR164 and

INR5/share based on DCF.

Spencer is a loss-making business currently, and we have thus valued it at 0.4x

EV/sales or INR27/share. FS is valued at 9x P/E or INR141/share. Other businesses

(comprising shopping mall, real estate, sports and renewables) are valued at

EV/EBITDA of 6x. Thus,

we value the stock at INR940 on SOTP, with a Buy rating.

CESC target price derivation

Business

Method

CoE

(%)

a. Power business

Standalone Gen. & distribution

Haldia

Gen. & transmission

Dhariwal

Generation

b. Spencer

Retailing

c. Firstsource

Business process o/s

Mall/renewable &

d. Others

others

Less: Cricket loss

PE FY18E

DCF based

EV/sales FY18E

PE FY18E

EV/EBITDA

FY18E

Rounded

11.6

Sus.

RoE Valuation Base Stake

Gr. FY17- Multiple Value

(%) 20E (%)

(x)

5.0

16.8

10.6

7,549 100.0

100.0

23,063 100.0

3,755 55.5

908 100.0

EV Debt &

Eq. cont.

INR m INR m

212,393 109,451

125,255 44,864

50,050 28,207

37,089 36,380

9,225 5,674

36,114 2,318

5,448

3,346

Value

0.40

9.0

6.00

INR m INR/sh.

102,942

773

80,391

603

21,843

164

709

3,551

18,771

141

2,102

-1,000

-8

940

10 November 2016

CESC

Executive summary

CESC began operations as an integrated electricity utility (standalone and Haldia),

and later diversified into independent generation (Dhariwal), organized retailing

(Spencer), business process management solutions (Firstsource) and other

businesses (malls, renewables, etc.). It holds ~55% stake in Firstsource.

~80% of CESC’s capital is

invested in power

generation and distribution

business

Exhibit 1: CESC’s invested capital by businesses and as share of total (FY16)

BPM (Firstsource),

INR32b, 14%

Retail (Spencer),

INR5b, 2%

Others, INR4b, 2%

Generation

(Dhariwal),

INR38b, 17%

Integ. utility

(Stdalone+Haldia),

INR146b, 65%

Source: MOSL, Company

PAT was dragged by loss of

INR5.9b at Dhariwal and

INR1.4b at Spencer

Exhibit 2: CESC group FY16 PAT – INR m

631

1,695

623

Core

equity

return

(5,894)

1,121

(1,423)

Dhariwal

Spencer

1,472

Firstsource

Others

3,704

Group

5,479

S/A core

Haldia

Source: MOSL, Company

We expect CESC’s consolidated PAT to more than double from INR3.7b in FY16 to

INR8.5b in FY18E (and to INR10.5b by FY20E), led by commencement of long-term

power supplies at Dhariwal for part of capacity and growth at Firstsource. The

estimated decline in losses at Spencer should also contribute, but to a certain

extent. The integrated utility business is a steady 6-8% growth business.

We build annual INR0.7b impact from FY17 onwards for the captive coal block,

which offsets part of the growth. We believe the remaining untied capacity at

Dhariwal (~300MW) is unlikely to secure long-term contracts at least until FY20E

due to its exposure to the surplus Maharashtra region (we build in only 50% PLF for

the plant until FY20E). Breakeven at Spencer is estimated only by FY20E.

10 November 2016

CESC

Exhibit 3: CESC’s attributable PAT to double – INR b

9.5

10.6

Exhibit 4: Drivers of PAT for CESC – INR m

Integrated

utility

business

1,301 656

3,704

3,415

234

612

8,626

8.6

4.9

2.0

5.4

3.7

4.2

2.6

2.7

Asset

sweating

Source: MOSL, Company Data

Doubling of PAT should lead to a significant increase in RoE from subpar 3-9% levels

over FY11-16 to ~14% over FY17E-20E, given that it would come from sweating of

assets commissioned over last few years and an increase in contribution to PAT from

less capital-intensive businesses (Spencer and Firstsource) from ~1% in FY16 to

~16% in FY20E. The likely commencement of power supplies under long-term

contracts for part of capacity at Dhariwal would drive better asset utilization.

Exhibit 5: CESC’s RoE (%) to double

14.1 13.9 13.7

8.4

5.6

5.7

3.4

9.1

6.0

-10

-202

9.1

Exhibit 6: Share of profit from less capital-intensive business

PAT from specner and firstsource - INR m

% of group PAT

463

892

1,233

1,648

Source: MOSL, Company

CESC’s subpar RoE performance in past five years was on account of the heavy

investment phase, when its asset base more than doubled. Utilization of these new

generation assets was low due to the oversupplied power market. In FY13, it

diversified into Firstsource, an under-performing business then. Returns were also

impacted by continuing losses at Spencer due to slow improvement in its operating

performance.

10 November 2016

CESC

CESC’s asset base more

than doubled in last five

years

Exhibit 7: CESC’s net fixed assets (incl. goodwill) and CWIP as % of total

S/A

FSource

Haldia

Others

107

FY12

160

FY13

Dhariwal

CWIP % of total

213

198

FY14

FY15

Spencer

219

FY16

Source: MOSL, Company

FY11

We estimate CESC to generate annual FCF of ~INR3-11b (~4-14% of current market

capitalization). This is after factoring in estimated cash losses of ~INR1-2b p.a. at

Dhariwal (on account of unused capacity) and ~INR1-1.5b at Spencer. Strong cash

generation in the utility and Firstsource businesses provides support to these

underperforming operations and should help unlock value over the long term. It

allows Dhariwal to wait for lucrative deals until the electricity market improves and

facilitates funding to Spencer.

Exhibit 8: Break-up of FCF ex-Firstsource – INR b

Utility

1.0

Spencer

Dhariwal

Others

7.2

8.1

7.7

-1.0

-1.4

FY18E

8.5

-1.0

FY19E

9.5

3.1

-0.8

FY20E

-1.1

2.1

1.0

FY17E

3.2

4.9

FY18E

3.6

6.1

FY19E

Ex-firstsource FCF

4.9

6.1

Exhibit 9: FCF from Firstsource and ex-Firstsource – INR b

FCF ex-Firstsource

FCF Firstsource

11.5

9.8

4.4

5.2

-1.5

-2.3

FY17E

7.2

FY20E

Source: MOSL, Company

Predictability of cash flows at the utility business and growth at Firstsource also

provide deleveraging visibility. We estimate net debt-to-equity to decline from an

already healthy 1.8x in FY16 to 1.0x by FY20. We believe CESC is one of the few

private sector utility companies with balance sheet strength to pursue inorganic

growth opportunities.

10 November 2016

CESC

Exhibit 10: Net debt-to-equity (x)

1.63

1.40

0.80

0.45

1.79 1.76 1.82

1.52

1.25

1.00

JSWE

Tata Power

Adani

RPower

Rattan

Source: MOSL, Company

Net Debt / MW - INR m

Exhibit 11: CESC’s has one of the best balance sheets

CESC

JPVL

Source: MOSL, Company

Although CESC has grown via diversification into other businesses in the past, we

see the gradual privatization of the electricity distribution sector in India as a key

growth driver. The market is more than INR3.9t in size, but highly inefficient with

operating losses of more than INR0.5t. CESC is one of the few players in India with

experience in distribution. It recently won the bid for the privatization of Kota and

Bharatpur in Rajasthan, and has started operations there from September 2016.

Initiating with Buy and TP of INR940

CESC’s PAT/RoE is estimated to double in two-years while earnings growth would

continue on steady growth in its integrated utility business. CESC’s exposure to

electricity distribution, being one of the few, places it favorable to other private

sector companies operating in over-supplied generation sector. FCF generation is

estimated to be healthy at ~INR11b p.a. over FY17-20E – an FCF yield of ~11%.

For ~14% RoE and steady growth the stock currently trades at ~1.2x FY18E. The

current valuations do not factor the long-term value potential of the untied capacity

at Dhariwal and potential at Spencer. At current stock price the market is probably

factoring that Dhariwal would remain under-utilized (continue to operate at 50%

PLFs) over its life.

At current stock price, the

market is probably factoring

in that Dhariwal would

perpetually remain at 50%

PLF

Exhibit 12: What is CESC’s current stock price probably implying

164

573

(164)

574

660

Source: MOSL, Company

While currently loss making, Dhariwal and Spencer have long-term value potential.

Generation market will start to balance by FY20-21 while organized retail is

10 November 2016

CESC

maturing in India. CESC with its balance sheet strength has the ability to play the

cycle. This, in our view deserves premium.

We value CESC on SOTP – mix of DCF and relative – as it best captures the long-term

value potential of the various businesses. Moreover, earnings mix is expected to

diversify from ~1% of consolidated PAT in FY16 coming from less capital intensive

business (Spencer and Firstsource) in FY16 rising to ~16% by FY20.

Power business represents

~75% of our target value

Exhibit 13: CESC’s target price build-up – INR/share

141

164

603

773

940

Standalone

Haldia

Dhariwal

Power

Spencer

Firstsource

Others

(rounded)

CESC TP

Source: MOSL, Company

While not captured in our valuation, we believe CESC also offers one of the best

plays on the privatization of electricity distribution sector in India. It has more than

100 years of experience in the sector and is amongst the few players in the sector.

Notably, it recent won the privatization round at Kota and Bharatpur.

Our SOTP based target price is INR940/sh. Power business represents ~80% of our

target value. The implied P/BV is 1.9x FY18E. We initiate coverage on CESC with Buy

rating with an upside of ~60%.

Key risk:

(a) Slower-than-expected electricity demand growth in its distribution

license area leading to moderation in distribution capex investment, (b) Delay in

commissioning of the Noida PPA at Dhariwal and (c) Impact of ‘Brexit’ on Firstsource

– derives ~40% of revenues from UK.

10 November 2016

CESC

Profit to double in two years led by asset sweating

We estimate CESC’s attributable PAT to double in two years, from INR3.7b in FY16

to INR8.6b in FY18, driven by the full benefit of ~300MW long-term supply contracts

at Dhariwal and growth at Firstsource. Spencer’s performance is also estimated to

improve but remain in red. The ~INR0.7b impact from the penalty related to the

captive coal block would offset part of the growth at its integrated utility business in

FY17. Excluding this impact, we estimate utility business PAT to grow at a steady ~6-

8%.

Sweating of assets (supply

under PPAs starting) and

growth at Firstsource to aid

profitability

Exhibit 14: PAT doubling in two years – INR m

Integrated utility

business

1,301

3,704

656

Asset sweating

3,415

234

612

8,626

Source: MOSL, Company

Losses at Dhariwal to halve led by commencement of Noida supplies and

full benefit of Tamil Nadu contract

From EBITDA loss of INR0.7b in FY16, we estimate Dhariwal to turn EBITDA positive

with INR3.1b in FY18. Although the power plant was commissioned in FY15,

operations were constrained due to the lack of transmission network, fuel linkage

and PPAs. We expect supply of 50% of capacity under long-term contracts to

commence before end-FY17, with full benefits visible from FY18E. The remaining

50% capacity is connected to the surplus state of Maharashtra, where supplies

would be difficult, in our view. We estimate the plant to run at not more than 50%

PLF over FY17E-20E. However, with the start of PPAs, net loss would reduce from

INR5.9b in FY16 to INR2.5b in FY18E.

Dhariwal losses are

estimated to more than

halve on start of Noida PPA

and full benefit of Tamil

Nadu PPA

Exhibit 15: Dhariwal net loss – INR b

PAT - INR b

-2.5

-4.6

-5.9

FY15

FY16

FY17E

FY18E

-4.7

-2.6

-2.7

Improving on start of Tamil Nadu

and Noida PPA

FY19E

FY20E

Source: MOSL, Company

10 November 2016

CESC

Integrated electricity utility business at Kolkata to deliver steady 6-8%

earnings growth

Electricity demand growth drives earnings in the integrated electricity utility

business of Kolkata (including Haldia) in the form of capex and incentives/savings,

which are a factor of units sold. We estimate ~3-4% growth in peak demand (v/s.

4.3% CAGR over FY10-16 and guidance of ~4.5%). Regulated equity base is

estimated to grow at ~7% CAGR over FY16-20 v/s ~8% over FY10-16 on

demand/customer growth led distribution capex. We estimate ~INR0.8b p.a. (pre-

tax) impact from the unreasonable bid for the captive coal block. We view the

Kolkata business as a stable 6-8% annual growth business. Excluding the impact of

the captive coal block, we estimate PAT to grow from INR8.4b in FY16 to INR9.6b by

FY18, implying annual growth of ~7%.

Integrated utility business

(ex-captive coal block

impact) to grow steadily by

6-8% p.a.

Exhibit 16: Integrated utility PAT (standalone + Haldia) ex-captive block impact – INR b

RoE

Haldia

5.5

1.1

4.7

-0.2

6.4

1.6

5.1

-0.3

Incentives/others (ex-Haldia)

8.4

0.6

2.3

5.5

9.1

0.9

2.3

5.9

9.6

0.9

2.5

6.3

10.2

0.9

2.6

6.7

10.8

1.0

2.8

7.1

4.3

0.6

3.7

0.0

4.6

0.7

4.0

-0.2

5.1

1.0

4.3

-0.2

Source: MOSL, Company

Spencer to become operating breakeven by FY20

Looking at Spencer’s performance v/s other organized retail players whose data are

available and comparable, we find that Spencer has higher unit sales and broadly

similar gross margins. However, overheads are high, which leads to EBITDA losses.

Management is rightly focused on rationalizing non-profitable stores, increasing unit

sales and optimizing cost. We estimate 190bp improvement in EBITDA margin to

negative 1.3% by FY18, led by lower ‘non-store overheads’. We expect Spencer to

turn EBITDA positive by FY20E (which is conservative compared to management’s

guidance of FY18E). PAT loss is estimated to decline from INR1.4b in FY16 to INR1.2b

in FY18E (and INR0.8b by FY20E).

Losses to decline on

rationalization of non-

profitable stores, increasing

unit sales and cost

optimization

Exhibit 17: Spencer losses – INR b

PAT

FCF (post-interest)

-1,166

-1,516

FY15

-1,423

-1,344

FY16

-1,310

-1,189

-1,493

-1,016

-1,038

-995

-847

-763

FY17E

FY18E

FY19E

FY20E

Source: MOSL, Company

10 November 2016

CESC

Strong profit growth and FCF generation at Firstsource

Previously an underperforming debt-laden business when acquired in FY13,

Firstsource has improved considerably, with its PAT almost doubling in three years

to INR2.6b in FY16 and net debt declining by ~INR4b to INR7.6b. We expect PAT

growth of ~19% to INR3.7b over FY16-18E, and ~10% thereafter to INR4.5b by

FY20E, led by the acquisition of ISGN, the sole partnership agreement with Sky and

lower interest cost. We estimate Firstsource to generate annual FCF (post-interest)

of INR2-4b over FY17E-20E, representing close to half of the group’s FCF.

Exhibit 18: Firstsource PAT – INR m

4,091

4,495

3,009

940

1,272

Exhibit 19: Firstsource FCF – INR m

FCF post interest - INR m

3,213

2,093

3,634

4,390

1,466

620

1,930

2,343

2,650

3,194

3,751

Source: MOSL, Company

Contribution from less capital-intensive businesses to improve

We estimate contribution of less capital-intensive Spencer (retail) and Firstsource

(BPM) businesses to increase from ~1% of group PAT in FY16 to ~16% by FY20.

Exhibit 20: Share of group PAT from retail and IT

PAT from specner and firstsource - INR m

% of group PAT

-10

-202

FY15

FY16

FY17E

463

892

1,233

1,648

FY18E

FY19E

FY20E

Source: MOSL, Company

10 November 2016

CESC

Deleveraging visibility

CESC’s utility business generates a predictable stream of cash flows due to its

regulated nature. Firstsource FCF generation is estimated to increase led by

operating profit growth and decline in interest cost. We estimate the utility business

and Firstsource to generate annual FCF of ~INR5-9b and ~INR2-4b, respectively.

Predictability of cash flows of the utility business and growth at Firstsource provide

strong visibility for balance sheet deleveraging. We expect net debt to equity to

decline from an already healthy 1.8x in FY16 to 1.5x by FY18 and 1.0x by FY20. Net

debt to EBITDA is estimated to improve from 4.6x in FY16 to 3.5x by FY18 and 2.7x

by FY20.

Exhibit 21: Net-debt to equity (x)

1.63

1.40

0.80

0.45

1.79 1.76 1.82

1.52

1.25

1.00

2.46

3.98

Exhibit 22: Net debt to EBITDA (x)

6.50 6.58 6.63

4.59

4.06

3.49

3.12

2.72

Source: MOSL, Company

Strong cash generation in the utility business would also support Dhariwal’s

operations and Spencer’s turnaround. We estimate Dhariwal to burn ~INR1.1-2.3b

annually over FY17E-20E as the asset is likely to remain under-utilized. Spencer is

estimated to burn ~INR0.8-1.5b annually until operating performance improves

gradually. Balance sheet strength of the parent and healthy cash generation would

help unlock value from these assets in the long term. Dhariwal will be able to wait

for lucrative deals until the market balances and Spencer’s turnaround can be

funded due to the company’s strong balance sheet positioning.

Exhibit 23: FCF ex-Firstsource – INR b

Utility

1.0

Spencer

Dhariwal

Others

7.2

8.1

5.2

-1.5

-2.3

FY17E

7.7

-1.0

-1.4

FY18E

8.5

-1.0

FY19E

9.5

3.1

-0.8

-1.1

FY20E

2.1

1.0

FY17E

3.2

4.9

FY18E

Ex-firstsource FCF

4.9

6.1

Exhibit 24: FCF from Firstsource and ex-Firstsource – INR b

FCF ex-Firstsource

FCF Firstsource

11.5

9.8

3.6

6.1

FY19E

4.4

7.2

FY20E

Source: MOSL, Company

10 November 2016

CESC

Exhibit 25: Utility business operations cash flows…

19.9

16.1

10.0 10.2

16.3

17.9

13.3

17.4

15.8 16.6

Exhibit 26: …and capex – INR b

*Adj. for one-time payment of INR9b for captive

Source: MOSL, Company

*Adj. for one-time payment of INR9b for captive

Source: MOSL, Company

We have identified CESC as one of the few private companies in the utility sector

that has balance sheet strength to exploit inorganic growth opportunities.

Exhibit 27: Private sector power companies’ balance sheet positioning

CESC

JSWE

Tata Power

Adani

RPower

Rattan

JPVL

Net Debt / MW - INR m

Source: MOSL, Company, Bloomberg

10 November 2016

CESC

Integrated utility: Healthy cash-generating business

The integrated utility business includes Kolkata generation & distribution operations

(standalone) and Haldia generation operations.

Standalone: +25% RoE business delivering steady growth

CESC has roots as an integrated electricity utility company. It is the sole distributor

(although not exclusive) within a 567 sq. km area of Kolkata and Howrah in the state

of West Bengal. It served ~3m customers, had a distribution network of ~21k ckm

and integrated power generation capacity of 1,125MW as at end-FY16. The business

works on a regulated return model. CESC’s operating area is regulated by the West

Bengal Electricity Regulated Commission (WBERC), which typically sets return and

operating norms for a period of three years. The current block period is FY15-17.

Under the regulated return model, normative equity approved by the regulator is

the key source of earnings. Normative equity (which is driven by capex), however,

can be different from actual equity invested due to the nature of the business.

CESC is assured post-tax equity return of 15.5% in generation and 16.5% in

distribution on normative equity. However, RoE on normative equity it generated

over FY10-16 was ~18-20%. The top-up is from incentives and savings from efficient

operations (performing better than the normative level set by the regulator).

Incentives and savings from

efficient operations

contributed ~2-4% of RoE

(on normative equity base)

Exhibit 28: Standalone RoE build-up (on normative equity) – %

Return on normative equity base

18.7

2.7

18.5

2.5

19.0

2.9

19.8

3.7

Incentives & efficiencies (net)

19.8

3.7

20.1

4.0

18.0

1.8

16.1

16.0

16.1

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Source: MOSL, Company, Regulatory Filings

CESC’s standalone core business PAT (i.e. excluding other income) grew at a CAGR of

8.9% to INR6.1b over FY10-16.

10 November 2016

CESC

Efficient operations of

generation plants and

savings on AT&C losses

contributed ~INR3b to core

PAT of ~INR6b in FY16

Exhibit 29: Standalone – build-up of core (ex-other income) PAT – INR b

RoE (post-tax)

4.3

1.5

0.5

3.7

-1.4

FY11

AT&C savings

4.7

2.0

0.8

4.0

-2.0

FY12

Oprtg. eff. in Gen.

5.3

2.4

0.9

4.3

-2.3

FY13

Coal block -ve bid

5.7

2.3

1.0

4.7

-2.2

FY14

6.3

2.3

0.8

5.1

-1.4

FY15

Others & tax

6.1

2.1

0.9

5.5

-2.4

FY16

3.7

1.4

0.4

3.1

-1.3

FY10

Source: MOSL, Company, Regulatory Filings

Key drivers of earnings over FY10-16 are estimated to be:

(a) Normative equity earnings (RoE earnings) CAGR of 9.8% to INR5.5b. Although

normative equity recorded a lower 7.7% CAGR to ~INR35b over the period,

there is an increase in the distribution business share (which earns higher RoE)

in total normative equity of the standalone business from ~50% to ~65%.

Share of distribution

business, which earns

higher RoE of 16.5%, is

estimated to have increased

from 50% in FY10 to ~65%

in FY16 in total normative

equity of standalone

business

Exhibit 30: Normative equity – INR b

Generation

~50% share

FY09

FY10

FY11

FY12

Distribution

FY13

~8% CAGR FY10-16

FY14

~65% share

FY15

FY16

Source: MOSL, Company, Regulatory Filings

(b) Earnings from achieving lower-than-normative aggregate technical and

commercial losses (AT&C) are estimated to have increased at a CAGR of ~14% to

INR0.9b in FY16. Benchmark AT&C was 14.3%, while actual is estimated to be

11.6% in FY16. CESC earns cost of supply on units saved.

Earnings from AT&C

efficiency are estimated to

have increased at ~14%

CAGR over FY10-16 to

INR0.9b

Exhibit 31: Earnings from AT&C efficiency

AT&C savings - INR m

14.9

13.1

14.8

12.8

516

FY11

14.6

Normative AT&C - %

14.5

14.3

Actual AT&C - %

14.3

12.1

750

FY12

11.9

907

FY13

11.8

953

FY14E

11.8

772

FY15E

11.6

897

FY16E

383

FY10

Source: MOSL, Company, Regulatory Filings

10 November 2016

CESC

level – are estimated to have increased at a CAGR of 6.4% to INR2.1b. Station

heat rate (SHR) efficiency is the primary component. Fuel oil saving and lower

auxiliary consumption are the other components.

SHR is driven by Budge

Budge power plant, which

has SHR of ~2000-2,100kCal

v/s normative of ~2,400-

2,500kCal

Exhibit 32: Earnings from generating efficiencies – INR m

Secondary FO

1,966

1,425

1,121

252

FY10

1,458

1,529

1,192

218

FY11

350

FY12

469

FY13

432

FY14E

413

FY15E

340

FY16E

1,848

1,818

1,801

1,704

Auxiliary cons.

2,406

SHR

2,306

2,120

2,342

Source: MOSL, Company, Regulatory Filing

Exhibit 33: Budge Budge earnings from SHR (post 20% sharing in tariffs)

Earnings from SHR - INR m

2,560

2,530

2,500

Normative SHR - Kcal

2,480

2,160

2,470

Actual SHR- Kcal

2,470

2,028

2,094

2,075

2,100

980

FY10

1,148

FY11

1,410

FY12

1,261

FY13

1,515

FY14E

1,498

FY15E

1,575

FY16E

Source: MOSL, Company, Regulatory Filing

(d) Costs not allowed as pass-through in tariffs and certain corporate overheads

offset part of growth from above components of earnings. Such costs – which

increased at a CAGR of ~10% over FY10-16 – are estimated to have offset

INR2.4b from core earnings in FY16.

Normative equity to record ~7% CAGR over FY16-20E on demand growth

Electricity consumption growth in the company’s distribution area, along with an

increase in the customer base, is the key earnings driver, in our view. Demand

growth drives (a) distribution capex, (b) AT&C earnings on higher volumes and (c)

higher generation PLFs, which drive earnings from SHR, auxiliary and fuel oil as they

are based on units generated.

Peak demand in CESC’s distribution area has increased at a CAGR of 4.3% over FY10-

16 to 2,035MW, and is guided to increase to 3,000MW by FY25, implying ~4.5%

growth. Distribution network addition has seen a similar trend – network length has

increased at ~4% CAGR and transformer capacity at ~6% CAGR over FY10-16. We

estimate electricity demand in its distribution area to grow at ~3-4%. Normative

equity base is estimated to grow at ~7% CAGR over FY16-20E (as against ~8% over

10 November 2016

CESC

FY10-16) on demand/customer growth-led distribution investments. Normative

equity from the distribution business is estimated to represent ~72% of total

standalone normative equity by FY20.

Exhibit 34: Peak demand increased at ~4% CAGR…

Peak demand - MW

1,904

1,865

2,042

2,035

2.29

2.38

Exhibit 35: …on increase in customer base

No. of customers - mn

2.59

2.70

2.81

2.92

3.04

1,584

1,657

1,727

2.49

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Source: MOSL, Company

Exhibit 36: …which drives investment in…

Line length - ckm

21,065 21,531

19,538 20,480

17,832 18,683

16,330 17,213

Exhibit 37: …distribution network

132/33KV substation - MVA

2,307

2,532 2,532

2,757

1,932 1,932 1,932 2,057

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Source: MOSL, Company

Capex toward distribution

following improving

demand would drive

normative equity higher

Exhibit 38: Normative equity estimated to grow at ~7% CAGR over FY16-20E

Generation

Distribution

~13%

~9%

FY10/16

FY16/20

~1%

FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY20E

Source: MOSL, Company, Regulatory Filings

Unreasonable bid in coal block – around INR0.8b (pre-tax) annual impact

CESC bid a price of INR370/t to secure the Sarshatali captive coal block (CESC was

the previous owner). The bid price (along with the mining cost) is not allowed as

pass-through in tariffs leading to an annual impact of INR1.7b. CESC would be able

to offset part of the impact through sale of middling (~INR0.3b) and sale of

merchant power (INR0.6b). Mines won through bidding are allowed to use 15% of

10 November 2016

CESC

the coal for merchant power sales. We estimate margin of ~INR1/kWh on its

merchant sales. Post-tax, we estimate the net annual impact due to the captive coal

block is ~INR0.6b.

Exhibit 39: Impact (pre-tax) of negative bid in Sarshatali captive coal block

Impact of Sarisatolli coal block

Coal production

Bid price (negative bid)

Mining cost

Realn. From sale of midlings

Midling volumes

Merchant power sales

Gain per unit

INR m

INR/t

INR m

INR/kWh

FY17E

-830

2.2

370

400

1,000

0.34

561

1.0

FY18E

-830

2.2

370

400

1,000

0.34

561

1.0

FY19E

-830

2.2

370

400

1,000

0.34

561

1.0

FY20E

-830

2.2

370

400

1,000

0.34

561

1.0

Source: MOSL, Company

Standalone core PAT to grow at 5% over FY16-20E

We estimate standalone core business PAT to grow at ~5% CAGR to INR7.4b over

FY16-20E led by capex and increase in incentives, partly offset by the impact of

captive coal block. Sustainable RoE on normative equity is estimated to reduce from

a run-rate of 18-20% to 16-17% due to the drag from the captive coal block.

We expect ~5% CAGR

growth in standalone core

business PAT over FY16-20E

on capex and incentive

income due to higher

volumes.

Exhibit 40: Standalone: Core PAT build-up – INR b

RoE (post-tax)

6.1

0.0

2.1

0.9

5.5

-2.4

FY16

AT&C savings

6.1

2.1

1.1

5.9

-0.8

-2.1

FY17E

Oprtg. eff. in Gen.

6.5

2.0

1.1

6.3

-0.8

-2.1

FY18E

Coal block -ve bid

6.9

2.0

1.2

6.7

-0.8

-2.1

FY19E

Others & tax

7.4

2.0

1.2

7.1

-0.8

-2.1

FY20E

Source: MOSL, Company

Sustainable returns on

normative equity to decline

from ~18-20% to ~16-17%

due to captive coal block

Exhibit 41: Standalone: Returns on normative equity – %

Return on normative equity base

18.5

2.5

16.0

19.0

2.9

16.0

19.8

3.7

16.1

19.8

3.7

16.1

Incentives & efficiencies (net)

20.1

4.0

16.1

18.0

1.8

16.1

16.9

3.0

16.2

-2.3

FY11

FY12

FY13

FY14

FY15

FY16

FY17E

16.7

2.7

16.2

-2.1

FY18E

Coal block -ve bid

16.8

2.6

16.2

-2.0

FY19E

16.9

2.6

16.2

-1.9

FY20E

Source: MOSL, Company

10 November 2016

CESC

Capital structure advantage drives higher-than-normative RoEs

At standalone level, CESC operates on a regulated business model, which requires

minimum 70% debt for capex. However, the nature of the distribution business

(sticky customer deposits) allows the company to cheaply leverage more than the

normative levels. Thus, while it earns return on normative equity, actual equity

invested in business is lower. Customer deposits represented ~16% of invested

capital in FY16. We expect CESC to generate RoE (on equity actually invested) of

+20% (as against 16-17% calculated on normative equity) due to higher leverage.

Over last five years, deposits per customer have grown at ~6% to reach INR5,288 in

FY16. We estimate ~3% annual growth over our forecast period. Incremental

deposits are estimated to represent ~10-20% of its annual capex, a cheap source of

leverage.

Cheap cost customer

deposits represented ~16%

of invested capital, allowing

more than mandated

leverage and earning RoEs

higher than implied by

normative equity

Exhibit 42: Sources of funds in standalone core business – %

Net loans

Customer adv.

Adv. agst depr

Implied equity

FY11

FY12

FY13

FY14

FY15

FY16

Source: MOSL, Company

Exhibit 43: Standalone core RoE (on actual equity invested) – INR m

Standalone net worth

Adj.

Investments

Adv. to subs/associates

Cash

Core business net worth

Core PAT

Core RoE (on actual equity) - %

FY11

55,692

10,843

9,677

8,388

26,784

4,295

16.0

FY12

60,118

11,332

10,820

8,598

29,368

4,733

16.9

FY13

64,950

21,779

11,892

7,714

23,564

5,332

20.1

FY14

70,386

31,911

11,346

2,006

25,124

5,731

23.5

FY15

80,799

42,493

12,023

7,377

18,906

6,307

28.6

FY16

86,356

46,466

12,330

8,366

19,194

6,102

32.0

FY17E

82,918

50,006

12,330

6,217

14,305

6,126

36.6

FY18E

88,868

52,466

12,330

7,359

16,714

6,496

41.9

FY19E

95,345

54,466

12,330

9,440

19,109

6,949

38.8

FY20E

102,362

56,366

12,330

12,216

21,450

7,405

36.5

Source: MOSL, Company

Exhibit 44: Deposit per customer and growth

Deposit per customer - INR

7.9

4.0

7.8

5.8

change yoy - %

7.6

Exhibit 45: Incremental deposits to capex – %

Incremental deposits % of capex

3,839

FY11

4,141

FY12

4,308

FY13

4,644

FY14

4,915

FY15

5,288

FY16

FY12

FY13

FY14

FY15

FY16

Source: MOSL, Company

10 November 2016

CESC

Steady and predictable cash flow business

The regulated nature of the business and expectations of electricity demand growth

in its operating areas make cash flows steady and predictable. We estimate

operating cash flow (post tax, pre interest) of INR13-17b and capex of ~INR9b over

FY17-20.

Exhibit 46: Standalone: Operating cash flow – INR b

19.9

16.1

10.0 10.2

16.3

17.9

13.3

17.4

15.8 16.6

Exhibit 47: Standalone: Capex – INR b

*Adj. for one-time payment of INR9b for captive

Source: MOSL, Company

*Adj. for one-time payment of INR9b for captive

Source: MOSL, Company

Risks



Open-access/renewables: Increasing customer preference for open access/net-

metering is likely to impact its power offtake. Although base equity return is still

guaranteed, incentives and savings which are linked to energy sold would be

impacted. However, industrial consumers who have the load profile to shift to

open access represented less than 25% of its total supplies.

Carriage and content: The draft Electricity Act, 2015 calls for splitting carriage

and content promoting competition in the last-mile electricity supply business.

Although the proposal is being opposed, it is likely to be introduced as an

optional guideline rather than a mandatory one. Metros like Kolkata could be

encouraged to shift first.

Haldia: INR6-9b p.a. operating cash flow visibility over next decade

Haldia is a 600MW coal-based thermal power plant located in West Bengal. The

plant was commissioned at end-FY15. It has a long-term regulated return-based

arrangement with CESC’s Kolkata distribution business (standalone). The project’s

SPV also houses the 96km transmission line under the regulated return model.

Regulations and operating norms are set by the West Bengal Electricity Regulatory

Commission (WBERC) typically for a block period of three years.

Key project and operating highlights



Project cost is ~INR38b for the power plant, and ~INR5.7b for the transmission

line.

Normative equity is @ 25%, which earns post-tax return of 15.5%.

In its first full year of operations (i.e. FY16), it earned RoE of ~20%, driven by

earnings from incentives, primary related to station heat rate, in our view.

Of its PBT of INR2.9b in FY16, we estimate ~INR0.9b was from station heat rate

incentive. We conservatively estimate the regulator to squeeze the SHR norms

from FY21.

10 November 2016

CESC



The approved station heat rate is 2,345kCal/kWh, as against our estimated

actual heat rate (based on other coal plants) of 2,150kCal/kWh.

Exhibit 48: Haldia EBITDA – INR b

8.9 8.8

8.4 8.2 8.0

6.9 6.7 6.4

6.2 6.0 5.8

EBITDA - INR b

5.1 4.9 4.8 4.7

4.5 4.4 4.5 4.5 4.5 4.6 4.6 4.7

3.2 3.2

Source: MOSL, Company

Integrated electricity utility business at Kolkata to deliver steady 6-8%

earnings growth

Electricity demand growth drives earnings in the integrated electricity utility

business of Kolkata (including Haldia) in the form of capex and incentives/savings,

which are a factor of units sold. We estimate ~3-4% growth in peak demand (v/s.

4.3% CAGR over FY10-16 and guidance of ~4.5%). Regulated equity base is

estimated to grow at ~7% CAGR over FY16-20 v/s ~8% over FY10-16 on

demand/customer growth led distribution capex. We estimate ~INR0.8b p.a. (pre-

tax) impact from the unreasonable bid for the captive coal block, although the

company considers this as pass-through in tariffs (matter with the regulator). We

view the Kolkata business as a stable 6-8% annual growth business. Excluding the

impact of the captive coal block, we estimate PAT to grow from INR8.4b in FY16 to

INR9.6b by FY18E, implying annual growth of ~7%.

Integrated utility business

(ex-captive coal block

impact) to grow at steady 6-

8% p.a.

Exhibit 49: Integrated utility PAT (standalone + Haldia) ex-captive block impact

RoE - distri.

RoE - generation

8.4

4.6

0.6

1.8

2.2

FY12

5.1

0.8

1.8

2.5

FY13

5.5

0.9

1.8

2.8

FY14

6.4

3.3

3.2

-0.2

FY15

1.5

3.4

3.6

FY16

Incentives/others

9.1

1.8

3.4

4.0

FY17E

9.6

1.9

3.4

4.4

FY18E

10.2

2.1

3.4

4.7

FY19E

10.8

2.3

3.4

4.3

0.6

1.8

1.9

FY11

5.1

FY20E

Source: MOSL, Company

10 November 2016

CESC

Dhariwal: Noida PPA likely in 3QFY17

But drag would continue



PAT loss is estimated to halve to INR2.5b by FY18 as supplies commence under the

Noida long-term contract with the commissioning of Champa-Kurukshetra HVDC line

and full benefit of Tamil Nadu contract materializes.

However, with 50% of capacity connected to the surplus-Maharashtra state, we

believe offtake would be difficult and thus assume PLF of just 50%.

Interest and depreciation of ~INR6b would mean loss would continue unless PPAs are

signed for remaining capacity.

We believe strong support from the parent would help sustain operations until the

generation market balances and lucrative opportunities emerge.

Dhariwal (Chandrapur) is a 2x300MW coal-based power plant in the state of

Maharashtra. It is housed in CESC’s 100% subsidiary Dhariwal Infrastructure. CESC

had acquired the plant in 2009 (was under construction then) from the Manikchand

Group. The plant was commissioned in phases by end-FY15. It has coal supply

agreement with SECL. Furthermore, the plant has signed power purchase

agreements (PPA) for (a) 100MW with Tamil Nadu, under competitive bidding and

(b) 187MW with Noida, under a regulated return model. Project cost as per

regulatory filings is ~INR39b.

Commissioning of Noida and Tamil supplies to provide some relief…

In its first full year of operation in FY16, Dhariwal reported EBITDA loss of INR0.7b

due to the lack of PPAs, transmission capacity and coal availability issues (PLF was

7%). It reported PAT loss of INR5.9b on interest and depreciation charge. Supplies

have commenced (late FY16) under the Tamil Nadu PPA, and are likely to start from

3QFY17 under the Noida PPA with the commissioning of the Champa-Kurukshetra

HVDC line. We estimate EBITDA of INR1.2b in FY17 and INR3.1b in FY18 as full

benefits of these PPAs get reflected.

Dhariwal to turn EBITDA

positive with start of PPAs

Exhibit 50: Dhariwal EBITDA

EBITDA - INR m

1.3

-0.7

FY15

-0.7

FY16

FY17E

3.1

3.0

2.9

FY18E

FY19E

FY20E

Source: MOSL, Company

…but losses would continue due to exposure to surplus Maharashtra

Dhariwal has 300MW capacity connected to the central transmission unit (CTU), for

which it has already secured long-term PPAs (TN and Noida). However, the

remaining 300MW capacity is connected to the surplus state Maharashtra’s

transmission network. According to our estimates, Maharashtra would remain an

10 November 2016

CESC

electricity-surplus region at least until FY20E, based on our study of the state’s

demand-supply and tariff filings. We believe Dhariwal is unlikely to achieve more

than 50% PLF over our forecast period of FY17-20E, i.e. sales would be only under

PPAs.

Exhibit 51: Dhariwal’s cost competitiveness v/s. Maharashtra gencos thermal plants

Power plants

Koradi U-8,9,10

Chandrapur U-8,9

Paras

Bhusawal (4-5)

CESC - Dhariwal

Khaperkheda

Parli

Chandrapur

Bhusawal

Koradi

Nasik

VC (INR/kWh)

1.25

1.26

2.16

2.18

2.43

2.50

2.56

2.59

2.97

3.39

Source: MOSL, Regulatory Filings

As per regulatory filings,

Maharashtra plans to back

down ~6-8GW capacity in

FY17-20E

Exhibit 52: Maharashtra’s back down capacities – MW

Back down capacity - MW

8,961

6,379

7,257

6,463

FY17

FY18

FY19

FY20

Source: MOSL, Regulatory Filings

We believe PAT loss at Dhariwal would reduce from INR5.9b in FY16 to INR4.6b in

FY17E and to INR2.5b in FY18E, led by commencement of the two PPAs. However,

with 50% capacity estimated to remain open at least until FY20, the ~INR6b annual

burden of interest and depreciation would mean Dhariwal would remain a drag of

INR2-2.4b annually until FY20E.

We estimate net loss to

decline from INR5.9b in

FY16 to INR2.5b in FY18E on

start of PPAs

Exhibit 53: Dhariwal net loss – INR b

PAT - INR b

-2.5

-4.7

-4.6

-5.9

FY15

FY16

FY17E

FY18E

-2.7

Reducing on start of Tamil Nadu

and Noida PPA

FY19E

FY20E

-2.6

Source: MOSL, Company

10 November 2016

CESC

We estimate Dhariwal

would need equity support

of ~INR1-2b over FY17-20

Exhibit 54: Dhariwal FCF (post-interest) – INR b

FCF (post-interest) - INR b

-1.0

-1.4

-1.1

-2.3

FY17E

FY18E

FY19E

FY20E

Source: MOSL, Company

10 November 2016

CESC

Spencer: EBITDA breakeven by FY20

Losses have started reducing



Performance has improved with an increased focus on costs and closure of unviable

stores. EBITDA margin has improved from loss of ~7% in FY13 to 3.2% in FY16.

Unit sales are better than peers, while gross margins are broadly similar.

Higher overheads are dampening its performance. Given management’s focus on cost,

we expect EBITDA to breakeven by FY20.

CESC operates its organized retail business under the ‘Spencer’ brand (part of its

100% subsidiary Spencer Retail). It acquired the business in 2007 from Pathik Retail,

a promoter group company. Spencer had 118 stores with an area of 1,083k sq.ft as

at end-FY16. While India’s retail sector size is estimated to be more than USD600b,

organized retail represents just 10% of the market. Spencer is ~10% of the size of

the largest organized retail player in India in terms of store area.

Store optimization and focus on opex drive margin improvement

Spencer reported EBITDA loss of INR0.6b in FY16. Although still a drag, it has

improved from loss of INR0.9b in FY13 (and INR1.7b in FY11). Spencer has been

focusing on:

(a) Shifting to larger format stores, which according to the company are more

profitable – 77% of its store area was represented by >15k sq.ft stores in FY16,

as against 66% in FY13 (and 53% in FY11). The change is more an optimization

rather than expansion exercise as the shift is happening primarily through

closing of smaller stores (less than 3k sq.ft stores have reduced from 155 in FY11

to 92 in FY13 and to 70 in FY16).

Exhibit 55: Avg. store size and no. of stores

Average store size k.sq.ft

215

210

182

131

128

122

118

No. of stores (x)

Exhibit 56: Share of >15k sq.ft stores (in area terms)

Share of >15k.sq.ft stores (%)

4.2

FY10

4.5

FY11

5.5

FY12

6.7

FY13

8.4

FY14

8.7

FY15

9.2

FY16

FY10

FY11

FY12

FY13

FY14

FY15

FY16

Source: MOSL, Company

(b) Increasing unit sales and controlling non-store overheads: Same-store sales have

increased at a CAGR FY13-16 of 7% to INR1,584 sq.ft/m (and at a 10% CAGR over

FY11-16). Higher unit sales and better control over non-store overheads have

led to a 210bp reduction in non-store expenses from 11.2% of sales in FY13 to

9.1% in FY16.

10 November 2016

CESC

Exhibit 57: Unit sales increased at 7% CAGR over FY11-16

Sales - INR/sq.ft/month

881

FY11

1,021

FY12

1,182

FY13

1,239

FY14

1,304

FY15

1,450

FY16

FY13

FY14

FY15

FY16

change yoy - %

Exhibit 58: Non-store overheads as % of sales

11.2

Non-store overheads % of sales

10.1

9.2

9.1

Source: MOSL, Company

flat since FY11). Rent as a % of sales has declined ~80bp since FY13 to 4.9% in

FY16 (and 310bp since FY11).

Unit rent cost has increased

at just 2% over FY13-16.

From 5.7% of sales in FY13,

it has declined to 4.9% in

FY16

Exhibit 59: Rent per sq.ft. and % of sales

Rent - INR/sq.ft

8.0

7.3

5.7

5.3

5.0

4.9

Rent as % of sales

849

FY11

893

FY12

805

FY13

790

FY14

776

FY15

852

FY16

Source: MOSL, Company

Resultantly, EBITDA margin has improved ~380bp since FY13 to negative 3.2% in

FY16. Store-level EBITDA (as reported) has improved ~170bp since FY13 to 5.9% of

sales in FY16. Revenues have increased at a 12% CAGR over FY13-16 to ~INR18b, led

by 7% CAGR in store area.

Exhibit 60: Store EBITDA – unit and margin

Store EBITDA margin - %

Store EBITDA - INR/sq.ft/m

Exhibit 61: Implied EBITDA – unit and margin

Implied EBITDA - INR/sq.ft/m

-126

5.9

-83

-66

EBITDA margin - %

-57

-4.4

-46

-3.2

+INR 53/sq.ft/m

4.2

3.1

4.8

-7.0

-12.3

-5.3

+INR 80/sq.ft/m

Source: MOSL, Company

10 November 2016

CESC

Peer comparison suggests significant scope to improve margins

On comparing Spencer’s performance to peers (Reliance Retail and Heritage Foods,

where data are available and comparative), we understand that the company needs

to focus more on reducing cost to improve profitability. Spencer is generating

EBITDA loss, despite higher-than-peers unit sales and broadly similar gross margins.



Spencer generated revenue of INR1,450/sq.ft/month higher than Reliance

Retail’s ~INR1,400 and Heritage’s ~INR1,250 (in FY16)..



..But reported higher losses. Spencer EBITDA margin was negative 3.2% v/s.

Reliance Retail’s +ve 3.2% and Heritage’s loss of 0.7%..



..Even as gross margins were broadly similar at ~20%



Spencer has higher ‘non-store’ cost relative to peers. At 9.1% of sales compared

to Heritage’s 6.9%.



At the store level Spencer’s EBITDA of ~INR85/sq.ft/month is broadly similar to

Heritage’s.



We understand that Spencer needs to particularly focus on rationalizing ‘non-

store’ expenses to improve profitability..

Exhibit 62: Spencer has been underperforming peers…

Spencer

EBITDA margin - %

0.7

Heritage

2.4

Reliance

4.4

4.1

Exhibit 63: …despite similar gross margins

Gross margin - %

19.8

19.4

19.5

19.2

Spencer

Heritage

19.8

19.7

-0.5

-5.3

-3.6

-4.4

-3.2

-0.7

19.2

-7.0

FY13

Source: MOSL, Company

FY14

FY15

FY16

Source: MOSL, Company

Exhibit 64: ...higher unit sales

Spencer

Sales - INR/sq.ft/m

Heritage

Reliance

Exhibit 65: ...similar unit store EBITDA

Spencer

Store EBITDA - INR/sq.ft/m

Heritage

FY13

FY14

FY15

FY16

FY13

FY14

FY15

FY16

Source: MOSL, Company

10 November 2016

CESC

Exhibit 66: …and efficient capital deployed…

Spencer

Heritage

Reliance

Net asset - INR/sq.ft/m

11.2

10.8

10.1

9.5

Exhibit 67: …due to higher non-store overheads

Spencer

Heritage

Non-store overheads % of sales

9.2

9.1

7.6

FY13

FY14

FY15

FY16

FY13

FY14

FY15

FY16

Source: MOSL, Company

Spencer to turn EBITDA positive by FY20E

We estimate Spencer would turn EBITDA positive only by FY20E from loss of INR0.6b

in FY16 (or 3.2% of sales). Our estimates are conservative relative to management’s

guidance of EBITDA positive by FY18E. We estimate slow growth of just 3% in store

area by FY20E to 1,225k sq.ft with a further shift toward larger-size stores (84% of

total space). Unit sales are estimated to grow ~8% over our forecast period to

~INR1,970/sq.ft/month, broadly in line with ~8% growth in last four years to FY16.

Margins improvement would be primarily driven by a decline in non-rent overhead

costs from ~18% in FY16 to ~15% by FY20E due to operating leverage and cost

optimization. Spencer would continue to incur PAT loss (which should reduce from

INR1.4b in FY16 to INR0.8b in FY20E) on depreciation and interest cost.

We expect Spencer to turn

EBITDA breakeven by FY20E

on increase in unit sales and

decline in non-rent

overhead cost by ~300bp to

~15% by FY20E

Exhibit 68: Spencer: EBITDA and margin

EBITDA - INR m

EBITDA margin - %

-1.3

-306

-0.4

-112

119

0.4

-733

-596

-3.2

-466

-2.3

-4.4

FY15

FY16

FY17E

FY18E

FY19E

FY20E

Source: MOSL, Company

Spencer’s net loss is

estimated to reduce from

~INR1.4b in FY16 to

~INR1.2b in FY18E and

~INR0.8b in FY20E. It would

continue to rely on equity

support from parent to a

tune of ~INR1.5-0.7b over

FY17E-20E

Exhibit 69: Spencer: PAT and FCF (post-interest) – INR m

PAT

FCF (post-interest)

-1,166

-1,516

FY15

-1,423

-1,344

FY16

-1,310

-1,493

-1,189

-1,016

-1,038

-995

-847

-763

FY17E

FY18E

FY19E

FY20E

Source: MOSL, Company

10 November 2016

CESC

Firstsource: PAT to grow at ~14% CAGR over FY16-20E

Firstsource (FS) is the most recent diversification of the CESC group. It is into

Business Process Management (BPM) services. CESC acquired ~55% stake in the

business in October 2012, then a struggling debt-laden company, and has since

directed it on the path of revival. FS is listed on NSE/BSE under the ticker

FSL/532809.

FS recorded revenues of INR32b in FY16 (or USD485m), implying modest ~4% CAGR

since its acquisition in FY13. However, EBITDA has increased at ~12% CAGR over the

period to ~INR4b, driven by cost optimization. It had employee strength of 23.8k,

which has reduced at ~9% CAGR over FY13-16. Geographically, the US represented

55% of its revenue and 42% of EBITDA in FY16. The UK follows with a 37% revenue

share, but a higher 51% EBITDA share. Healthcare and telecom/media represent the

major end-use industries (~8% share of revenues each), followed by banking and

financials (at 24%).

Exhibit 70: Share of revenue by region FY16 – %

RoW

India

Exhibit 71: Share of revenue by sector – %

Others

BFSI

24%

37%

N. America

55%

Telecom/

Media

37%

Source: MOSL, Company

Healthcare

39%

Source: MOSL, Company

We estimate revenues to increase at ~12% CAGR over FY16-18E to INR40b (or

USD580m), driven by the acquisition of ISGN and the sole partnership agreement

with Sky. Thereafter, we estimate 7% growth in revenues, which is conservative v/s

NASCOM’s BPM market growth forecast of 8-9%. EBITDA margins are estimated at

~13% over the forecast period (FY17E-20E). We estimate PAT to increase 21% YoY to

INR3.2b in FY17 and 17% YoY to INR3.7b in FY18, and grow at ~10% thereafter due

to lower interest cost.

10 November 2016

CESC

Exhibit 72: Revenue – INR m and USD m

Revenue - INR b

518

514

497

Revenue - USD m

542

580

620

664

8.2

9.9

Exhibit 73: EBITDA (INR m) and margin (%)

EBITDA - INR m

11.7

12.5

EBITDA margin %

13.1

12.8

471

494

1,851 2,796 3,621 3,808 4,048 4,839 5,310 5,579 5,932

FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY20E

Source: MOSL, Company

FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY20E

Source: MOSL, Company

With strong free cash flow generation, FS is estimated to become a debt-free

company by FY19.

Exhibit 74: Strong FCF generation at Firstsource

FCF post interest - INR b

4,390

3,009

2,093

940

1,272

-1,316

-5,707

FY14

FY15

FY16

FY17E

FY18E

FY19E

FY20E

FY14

FY15

FY16

FY17E

FY18E

FY19E

FY20E

3,213

3,634

Exhibit 75: Firstsource to be net cash company by FY19E

9,998

Net debt

8,887

7,624

5,531

2,318

Source: MOSL, Company

10 November 2016

CESC

Distribution sector – apt for gradual privatization

Electricity distribution sector in India is predominantly state-owned (DISCOMs). In

our view, its size is more than USD3.9t. However, it terms of performance, it has

been extremely weak. It recorded operating loss of more than USD0.5t in FY15 (not

made profit at least for last 15 years, according to available data), has debt burden

of more than INR4t and rising, and is dependent on state subsidy of ~INR0.4t (in

FY15) to remain functional.

Exhibit 76: DISCOMs revenues – INR b

Revenue (w/o subsidy) - INR b

13% CAGR growth over FY02-15

Exhibit 77: DISCOMs operating losses – INR b

EBITDA loss - INR b

646

548

509

EBITDA loss % of sales

FY13

Source: MOSL, PFC

FY14

FY15

Source: MOSL, PFC

Exhibit 78: DISCOMs net cash loss (after subsidy) – INR b

DISCOMs net cash losses (after subsidy) - INR b

690

433

605

571

454

Exhibit 79: DISCOMs subsidy received – INR b

DISCOMs subsidy received - INR b

461

361

191

203

258

368

257

109

348

128

165

157

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Source: MOSL, PFC

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Source: MOSL, PFC

DISCOMs’ poor health can be ascribed to their high AT&C losses – more than 20%.

The losses are high due to less-than-adequate capital investments, malice in the

system (at times political or even operational) and declining share of consumption

by cross-subsidizing customers on account of high tariffs.

10 November 2016

CESC

Exhibit 80: AT&C losses of DISCOMs – %

AT&C losses - %

30.6

29.6

27.7

26.8

26.0

27.0

25.4

24.6

3.67

3.14

Exhibit 81: DISCOMs cost of supply and tariff gap – INR/kWh

avg. cost of supply

4.75

4.16

3.54

3.85

avg. tariff (incl. subsidy)

5.03

4.19

5.18

4.42

5.20

4.60

22.7

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15

Source: MOSL, PFC

FY10

FY11

FY12

FY13

FY14

FY15

Source: MOSL, PFC

The ‘UDAY’ scheme is helpful as it rightly shifts the past burden of DISCOMs to the

respective state government (although there are some loopholes, they are not much

relevant for our present discussion), lays a stern timeline for AT&C loss reduction,

provides subsidy for capex and mandates quarterly tariff revisions. Even on

optimistic assumptions, our all-India DISCOMs economics model suggests that

DISCOMs would still be making ~INR0.3t operational losses by FY19E.

Exhibit 82: All-India DISCOM economics – INR/kWh

Agricultural

Growth (%)

Residential

Growth (%)

Commercial

Growth (%)

Industrial

Growth (%)

Others

Growth (%)

Realization - on energy sold

Realization - on input energy

Growth (%)

Other income - on input energy

All-in realization - on input energy

Input cost (ex-Int/Dep)

Power purchase cost

Employee

Oth. Operating

Subsidy req. for EBITDA break-even

INR b

provided

FY13

1.46

14.5

3.54

10.0

7.32

13.9

5.93

3.6

5.47

42.9

4.39

3.63

18.2

0.37

4.00

4.81

4.02

0.42

0.37

0.81

647

361

FY14

1.76

20.8

3.83

8.3

7.74

5.7

6.65

12.1

5.06

-7.4

4.73

3.96

9.0

0.31

4.26

4.90

4.22

0.43

0.24

0.63

528

368

FY15

1.93

5.0

4.03

5.3

8.05

4.0

6.28

-5.6

6.73

5.0

4.90

4.01

1.5

0.36

4.38

4.94

4.34

0.45

0.15

0.56

509

461

FY16

2.04

5.3

4.29

6.4

8.32

3.4

6.50

3.6

7.07

5.0

5.10

4.16

3.7

0.37

4.54

5.12

4.46

0.46

0.20

0.58

577

FY17E

2.14

5.3

4.56

6.4

8.60

3.4

6.74

3.6

7.42

5.0

5.33

4.36

4.8

0.38

4.75

5.27

4.59

0.47

0.21

0.52

562

FY18E

2.26

5.3

4.86

6.4

8.89

3.4

6.98

3.6

7.80

5.0

5.57

4.63

6.1

0.40

5.03

5.43

4.72

0.48

0.23

0.40

470

FY19E

2.37

5.3

5.17

6.4

9.19

3.4

7.24

3.6

8.19

5.0

5.82

4.91

6.1

0.41

5.32

5.59

4.86

0.49

0.24

0.27

333

FY20E

2.50

5.3

5.50

6.4

9.50

3.4

7.50

3.6

8.59

5.0

6.09

5.28

7.4

0.42

5.70

5.75

5.00

0.50

0.25

0.05

Source: MOSL, Company

Although ‘UDAY’ is unlikely to get DISCOMs out of red, it along with certain other

developments in the sector lays the groundwork for acceleration in privatization of

the distribution sector.



‘UDAY’ limits ability to park losses

as banks are no longer allowed to fund

DISCOM losses. States earlier could build up on their inefficiencies by parking

them on DISCOMs’ balance sheets. ‘UDAY’ fills this loophole. This, in our view,

10 November 2016

CESC



would put pressure on state governments to make quick decisions on

underperforming/socially acceptable areas that can be privatized to reduce

losses.

Private DISCOMs have outperformed:

Although not universally, private entities

have demonstrated satisfactory performances. Targets such as ‘Power for All’

and increasing agriculture supply in areas where electricity supply economics

are unfavorable would put strain on state government balance sheets and their

ability to fund capex. Privatization is a way out, in our view.

Exhibit 83: Performance of private sector companies in distribution sector

Region

Bhiwandi

Nagpur

Sagar

Gaya

Delhi (Tata)

Agra

Kanpur

Jalgaon

Aurangabad

Ujjain

Muzaffarpur

Bhagalpur

State

Maharashtra

Bihar

Delhi

Maharashtra

Bihar

Takeover

Date

Jan-07

May-11

Dec-12

Jan-14

Apr-04

Apr-10

Nov-11

May-11

Aug-14

Jan-14

Before

61.4

30.4

42.0

58.0

45.0

42.0

47.0

29.1

20.2

AT&C

Latest

21.9

15.9

30.0

45.0

8.8

Latest

Data For

FY15

FY14

FY16

Licensee

Torrent Power

Essel

India Power

Tata

Remarks

Operating satisfactory

28.0

18.8

FY15

CGL

GTL

Essel

SMPL

Not satisfactory

Cancelled

Contract terminated

Terminated

Source: MOSL, Regulatory filings



Complexity in operations

has increased with a focus on renewables, net

metering and requirement for time-of-day tariffs. All these changes require data

analytics and technological upgrades. Our checks with public DISCOMs suggest

that this is one area where public DISCOMs have a major disadvantage (other

than capital availability). Public DISCOMs often get entangled in procedural

delays, scope issues and implementation with IT companies. Our interaction

with private entities suggests that data analytics (something which public

DISCOMs have not adopted well) is critical to understand the rationale behind

losses. With increasing complexity and the lack of technological prowess among

public companies, we believe the shift to privatization would only accelerate.

Draft Electricity Act proposal for splitting carriage and content

would

encourage competition in the content business as it splits the wire and supply

business. It does away with the current stringent licensing requirement in

distribution and opens the sector for competition. Although the proposal is

being opposed, it is likely to be introduced as an optional guideline rather than a

mandatory one.

Various other developments

like open-access, along with price transparency

through exchanges and oversupplied generation market, have made DISCOMs’

operations even more transparent. Measures like ‘Power for All’ would

gradually shift the focus from ‘availability of power’ to ‘quality availability of

power’, which cannot be accomplished by DISCOMs without incurring capex.

While various models are available for privatization, the input-based distribution

franchisee model has been generally preferred in all the recent bids.

10 November 2016

CESC

Exhibit 84: Various models for privatization of DISCOMs

Source: MOSL

The working of input-based franchisee model is:



Franchisee bids for the price at which it would buy power from the DISCOM

(called ‘Bulk Supply Price’); the highest bidder is the winner.



Franchisee raises bill at the tariff decided by the regulator and pays the DISCOM

for input energy at the bid price.



Franchisee keeps with itself the surplus revenue left after paying the DISCOM.

Thus, the faster it is able to reduce losses, the more is the surplus available.



Franchisee earnings are directly correlated to energy it bills/realizes. The more

the energy quantity billed, the higher is the surplus.



Franchisee makes the required investment in network infrastructure and

maintenance. All operations of the distribution area (like new connections,

billing and complaint resolution) are undertaken by the franchisee.

Our interactions with private companies and the past bid results suggest that

companies prefer to participate in urban areas, where agriculture load is very low.

Agriculture supply is generally perceived to come with political interference and is

difficult to manage. As per the Planning Commission study in 2011 on privatization

of DISCOMs, there are 255 cities in India where privatization can be adopted.

CESC secures Kota and Bharatpur in distribution franchisee bidding

CESC won the distribution circles of Kota and Bharatpur in Rajasthan in the recent

input-based distribution franchisee bidding. Competition was limited with Tata

Power being the only other eligible bidder.

Agriculture consumption is low in both the circles. Billed tariff is above INR5/kWh,

broadly similar to metro cities. AT&C losses are above 25%.

10 November 2016

CESC

Exhibit 85: Kota consumption by category (in MUs)

Others

Industry

20%

Domestic

47%

Exhibit 86: Bharatpur consumption by category (in MUs)

Others

Domestic

33%

Industry

48%

Agriculture

Commercial

Public

11%

works

Source: MOSL, Rajasthan DISCOM

Public

works

Commercial

19%

Agriculture

Source: MOSL, Rajasthan DISCOM

Exhibit 87: Kota distribution area – few operating parameters

Input Energy - MU

Unit Billed - MU

AT&C loss - %

T&D loss - %

Collection efficiency - %

Avg. billing rate - INR/kWh

Avg. realization - INR/kWh

FY11

937

682

26.8

3.69

2.70

FY12

919

724

28.0

4.29

3.09

FY13

FY14

FY15

937

974

1,088

712

731

765

29.2

26.0

29.7

100

5.24

5.52

5.62

3.71

4.08

4.07

Source: MOSL, Rajasthan DISCOM

Exhibit 88: Bharatpur distribution area – few operating parameters

Input Energy - MU

Unit Billed - MU

AT&C loss - %

T&D loss - %

Collection efficiency - %

Avg. billing rate - INR/kWh

Avg. realization - INR/kWh

FY11

242

194

22.5

4.00

3.10

FY12

262

212

21.1

4.63

3.65

FY13

273

213

23.6

5.47

4.18

FY14

287

226

27.4

5.81

4.17

FY15

317

230

27.4

100

5.93

4.31

Source: MOSL, Rajasthan DISCOM

There is limited guidance on these businesses, given their relatively small size and

management’s wait-and-watch stance. Based on our analysis of target AT&C loss

reduction to 15% in five years and input rates (Bulk Supply Price) available from the

bidding document, we estimate the gap earned (i.e. realized price less input price) is

likely to range between INR 0.5-0.8/kWh of input energy over the first five years in

both the distribution areas. Rajasthan DISCOMs and all-India DISCOMs average

power supply operating cost is ~INR 0.7-0.9/kWh. CESC believes that it can be

competitive compared to public DISCOMs. We consider supply cost of INR0.5/kWh

to increase ~4% annually.

10 November 2016

CESC

Exhibit 89: Kota realization and cost at input energy

Avg. realization - INR/kWh

4.50

3.56

Avg. purchase cost - INR/kWh

4.66

3.79

4.89

4.07

Exhibit 90: Kota gap earned and AT&C loss reduction

Gap - INR/kWh

AT&C reduction - %

4.07

3.49

4.27

4.13

29.7

26.1

22.1

0.70

19.1

0.60

15.1

0.76

0.58

0.71

Source: MOSL, Rajasthan DISCOM

Exhibit 91: Bharatpur realization and cost at input energy

Avg. realization - INR/kWh

4.31

4.57

3.85

4.74

3.93

4.06

Avg. purchase cost - INR/kWh

4.86

5.04

4.33

4.40

Exhibit 92: Bharatpur gap earned and AT&C loss reduction

Gap - INR/kWh

AT&C reduction - %

27.4

23.1

20.1

18.1

15.1

0.64

0.46

0.64

0.69

0.53

Source: MOSL, Rajasthan DISCOM

Based on our preliminary analysis, we estimate Kota to generate EBITDA of INR 95-

405m annually in the first five years. Bharatpur is estimated to generate EBITDA of

negative INR50–90b annually. CESC has committed capex of INR2b in these

distribution circles over next five years.

Exhibit 93: Kota EBITDA and capex

EBITDA - INR m

Capex - INR m

405

268

-458

275

-153

159

-532

-15

143

167

Exhibit 94: Bharatpur EBITDA and capex

EBITDA - INR m

Capex - INR m

Source: MOSL, Rajasthan DISCOM

We estimate PAT of less than ~INR150m p.a. in both these circles together. Given

that the quantum is insignificant and our estimates are only preliminary based on

market understanding, we do not incorporate the numbers into our model.

10 November 2016

CESC

Exhibit 95: Kota PAT

PAT - INR m

124

-19

-20

-31

Source: MOSL, Rajasthan DISCOM

147

Exhibit 96: Bharatpur PAT

PAT - INR m

Source: MOSL, Rajasthan DISCOM

CESC well placed to gain from privatization of DISCOMs

CESC is among the few companies in India with experience in electricity distribution.

The other notable companies are Tata Power, Torrent Power and Essel Utilities.

CESC is operating the Kolkata distribution circle for the past 100+ years and has

expertise in managing the unique issues related to operating in India (e.g.,

regulatory requirements, handling value-for-money customer class, subsidized tariff

structure and unionized operating environment).

The market potential is huge, while competition is limited. Our estimates do not

factor in the company’s advantageous position. CESC has the balance sheet strength

and considers distribution as a key growth area. Thus, we believe CESC is a well-

balanced play on the opening up of the distribution sector in India.

10 November 2016

CESC

Valuation

Initiating with Buy and TP of INR940/share

FCF of ~INR2-10b p.a.

represents ~11% of market

capitalization.

We expect CESC’s PAT/ROE to more than double in the two years on

commencement of long-term power supplies at Dhairwal and growth at Firstsource.

Earnings growth would continue on back of steady growth at the integrated utility

business and improvement at Spencer. CESC is of the few private power sector

companies with visibility and momentum of earnings growth. FCF generation is

estimated to be healthy at ~INR11b – an FCF yield of ~11%. The regulated integrated

utility business generates steady cash (FCF of INR5-9b p.a.) further aided by

improving performance at Firstsource (FCF of INR2-4b p.a), thus more than

absorbing the temporary losses at Dhariwal and Spencer. It provides deleveraging

visibility from an already healthy 1.8x net debt-to-equity in FY16 to 1.0x by FY20E.

For ~14% RoE and steady growth the stock currently trades at ~1.2x FY18E. The

valuations do not factor the long-term value potential of the untied capacity at

Dhariwal and potential at Spencer. At current stock price the market is probably

factoring that Dhariwal would remain under-utilized (continue to operate at 50%

PLFs) over its life.

At current stock price, the

market is probably factoring

in that Dhariwal would

perpetually remain at 50%

PLF

Exhibit 97: What is CESC’s current stock price probably implying

164

573

(164)

574

660

Source: MOSL, Company

The loss making business of

Dhariwal and Spencer have

long-term potential and

CESC has the ability to

unlock value.

We believe Dhairwal remaining untied for rest of its asset life it is highly unlikely for

the growth potential which Indian power market offers. While there are a number

of untied power generation capacities in the system, we believe, CESC is one of the

few that has the balance strength to play the cycle. It is significant better positioned

to wait for lucrative deals until the electricity market balances. This, in our view

deserves premium. Even the losses at Spencer are a drag on overall returns. CESC

has demonstrated cost excellence in past – ~380bps margin improvement over

FY13-16. We believe with continued focus on cost, optimizing stores and increasing

unit sales, Spencer can turn operating break-even by FY20E. Where we to assume

Dhariwal and Spencer turnaround by FY20E (refer Bull case scenario), CESC would be

generating RoE of ~20% and net debt-to-equity of less than 1x.

Considering the above factors we value CESC on SOTP – mix of DCF (for power

businesses) and relative (for other business) valuation. In our view SOTP best

captures the long-term value potential of the businesses. Moreover, earnings mix is

expected to diversify from ~1% of consolidated PAT in FY16 coming from less capital

intensive business (Spencer and Firstsource) in FY16 rising to ~16% by FY20. This

warrants SOTP to better capture value of different businesses, in our view.

10 November 2016

CESC

Exhibit 98: CESC’s target price build-up – INR/share

141

164

603

773

940

Power business represents

~80% of our target value

Standalone

Haldia

Dhariwal

Power

Spencer

Firstsource

Others

(rounded)

CESC TP

Source: MOSL, Company

While not captured in our valuation, we believe CESC also offers one of the best

plays on the privatization of electricity distribution sector in India. It has more than

100 years of experience in the sector and is amongst the few players in the sector.

Notably, it recent won the privatization round at Kota and Bharatpur.

Our SOTP based target price is INR940/sh. Power business represents ~80% of our

target value. The implied P/BV is 1.9x FY18E. We initiate coverage on CESC with Buy

rating with an upside of 60%.

Exhibit 99: CESC target price derivation

Business

Method

CoE

(%)

a. Power business

Standalone Gen. & distribution

Haldia

Gen. & transmission

Dhariwal

Generation

b. Spencer

Retailing

c. Firstsource

Business process o/s

Mall/renewable &

d. Others

others

Less: Cricket loss

PE FY18E

DCF based

EV/sales FY18E

PE FY18E

EV/EBITDA

FY18E

Rounded

11.6

Sus.

RoE Valuation Base Stake

Gr. FY17- Multiple Value

(%) 20E (%)

(x)

5.0

16.8

10.6

7,549 100.0

100.0

23,063 100.0

3,755 55.5

908 100.0

EV Debt &

Eq. cont.

INR m INR m

212,393 109,451

125,255 44,864

50,050 28,207

37,089 36,380

9,225 5,674

36,114 2,318

5,448

3,346

Value

0.40

9.0

6.00

INR m INR/sh.

102,942

773

80,391

603

21,843

164

709

3,551

18,771

141

2,102

-1,000

-8

940

Key risk:

(a) Slower-than-expected electricity demand growth in its distribution

license area leading to moderation in distribution capex investment, (b) Delay in

commissioning of the Noida PPA at Dhariwal and (c) Impact of ‘Brexit’ on Firstsource

– derives ~40% of revenues from UK.

Relative valuations

Rating

Powergrid

NTPC

JSW Energy

CESC

Coal India

Buy

Neutral

CMP

Upside

(INR) (INR)

180

154

599

318

209

199

940

327

MCAP

(USD M)

14,211

19,127

1,459

1,201

30,227

EPS

FY16

11.5

12.3

8.5

27.8

22.6

FY17E

14.2

11.9

4.6

40.9

17.0

FY18E

16.8

14.3

6.7

64.7

21.1

P/E (x)

FY17E

12.7

13.0

14.6

18.7

FY18E

10.7

10.8

8.9

9.3

15.0

P/B(x)

FY17E

1.9

1.3

1.1

1.4

5.7

FY18E

1.7

1.2

1.0

1.2

5.5

RoE (%)

FY17E

16.1

10.6

8.6

9.1

31.3

FY18E

16.6

11.9

11.8

14.1

37.5

10 November 2016

CESC

Bull and Bear case

Bull case



Dhariwal PPA for remaining capacity of 300MW is secured by FY19 on higher-

than-expected electricity demand growth in India.

Spencer turns EBITDA break-even by FY18 in-line with management’s guidance

and generates margin of ~4% by FY20E in line with Reliance Retail.

In the Kolkata utility business, distribution capex grows at the FY10-16 CAGR of

~13% as against ~9% growth estimated in our base case on higher-than-

expected demand growth in its circle area led by improvement in standard of

living.

Long-term sustainable growth in the Kolkata utility business turns to be higher

at 7% as against 5% in our base case estimate.

Bear case



Dhariwal power plants continues to operate at 50% PLF (remaining 300MW

does not secure a PPA) at least until FY25E as renewables become competitive.

Moreover, the 187MW PPA with Noida that is likely to start in FY18 gets delayed

to FY21E.

Spencer losses continue at current levels facing risk from online retail and

weaker than expected turnaround.

In the Kolkata utility business, distribution capex growth tapers down to less

than 3% as consumers shift to roof-top solar based power generation and

battery back-up reducing the requirement for distribution network.

Long-term sustainable growth in the Kolkata utility business turns to be at 3% as

against 5% in our base case estimate.

Firstsource revenues grow at just 3% v/s. our base case estimate of 7-10%

growth.

Exhibit 100: Bull and Bear case scenario

FY17E

136

5.4

1.8

9.1

14.6

1.4

Base case

FY18E FY19E

148

156

8.6

9.5

1.5

1.2

14.1

13.9

9.2

8.3

1.2

1.1

940

FY20E

164

10.6

1.0

13.7

7.5

1.0

FY17E

136

5.7

1.8

9.4

14.0

1.4

Bull case

FY18E

FY19E

148

164

9.1

14.7

1.6

1.2

14.8

20.5

8.7

5.4

1.2

1.0

1,140

FY20E

174

16.7

0.9

19.4

4.8

0.8

FY17E

133

4.6

1.8

7.7

17.3

1.4

Bear case

FY18E

FY19E

141

146

4.6

4.5

1.6

1.4

7.9

7.4

17.3

17.6

1.3

670

FY20E

152

4.4

1.3

6.8

18.1

1.2

Revenue

EBITDA

PAT

Net debt/Equity

RoE

P/E

P/BV

SOTP

Source: MOSL, Company

10 November 2016

CESC

SWOT ANALYSIS

STRENGTHS

•

Of the few private sector players in the

electricity distribution sector where it has

more than 100 years of experience.

Strong project execution capability

completing power plants within reasonable

cost estimates despite the regulatory logjam

in the last few years.

One of the best balance sheets in the private

power sector in India.

•

THREATS

•

Open-access and decline in

electricity demand in its

distribution area.

Squeezing of incentives (like

SHR efficiency, AT&C loss

target, Auxiliary

consumption) by regulator.

Machine learning and

artificial intelligence can

impact the opportunity size

of the BPM business.

Online retail is a major

threat to its organized retail

business.

WEAKNESS

•

Regulator has to approve

capital investment & operating

expenses (controllable and

pass-through). The expenses

can be disallowed if the

regulator is not convinced,

impacting earnings.

•

Unexpected sharp increase in

uncontrollable expenses (like

O&M costs) in generation and

distribution can impact returns.

Tariffs are set by regulator

which restricts the company’s

ability to pass-on the cost

increase on consumers.

•

OPPORTUNITY

•

Opening up of electricity distribution sector

in India.

Growth in electricity demand and

improvement in PLFs.

Penetration of organized retail which

currently represents just 10% of the market

size.

10 November 2016

CESC

Financials and Valuations

Income Statement

Y/E March

Net Sales

Change (%)

Total Expenses

EBITDA

% of Net Sales

Depn. & Amortization

EBIT

Net Interest

Other income

PBT before EO

EO expense

PBT after EO

Tax

Rate (%)

Reported PAT

Minority and Associates

Adjusted PAT

Change (%)

2012

58,917

13.8

49,195

9,722

16.5

3,401

6,321

3,451

1,323

4,193

257

3,936

1,492

37.9

2,445

2,716

5.6

2013

75,567

28.3

62,906

12,661

16.8

3,645

9,016

4,304

1,437

6,149

-418

6,567

1,758

26.8

4,809

-215

4,176

53.8

2014

101,109

33.8

84,883

16,226

16.0

4,714

11,512

5,660

1,734

7,585

1,856

24.5

5,729

-813

4,916

17.7

2015

110,666

9.5

91,721

18,945

17.1

5,889

13,056

9,565

1,490

4,981

1,992

40.0

2,989

-1,004

1,985

-59.6

2016

118,995

7.5

90,513

28,483

23.9

7,725

20,758

14,856

2,191

8,092

8,052

3,087

38.3

4,965

-1,301

3,704

86.6

2017E

135,582

13.9

103,942

31,640

23.3

8,717

22,922

14,699

2,163

10,386

8,989

1,398

3,396

243.0

-1,999

-1,543

5,447

47.1

(INR Million)

2018E

147,720

9.0

113,104

34,616

23.4

8,986

25,630

13,995

2,445

14,079

3,663

26.0

10,416

-1,790

8,626

58.4

Balance Sheet

Share Capital

Reserves

Net Worth

Minority Interest

Total Loans

Deferred Tax Liability

Capital Employed

Gross Block

Less: Accum. Deprn.

Net Fixed Assets

Capital WIP

Goodwill

Investments

Curr. Assets

Inventories

Account Receivables

Cash and Bank Balance

Others

Curr. Liability & Prov.

Account Payables

Provisions & Others

Net Curr. Assets

Appl. of Funds

2012

1,256

47,167

48,423

52,947

101,397

2013

1,256

50,180

51,436

7,425

96,608

285

155,753

146,690

60,502

86,189

51,097

22,938

976

51,937

4,342

16,201

14,314

17,081

57,383

5,775

51,608

-5,446

155,753

2014

1,256

55,094

56,350

9,079

119,164

332

184,925

185,350

65,631

119,719

53,117

25,392

737

50,798

5,383

15,302

12,422

17,692

64,838

5,318

59,521

-14,040

184,925

2015

1,332

58,958

60,290

10,004

142,020

832

213,146

258,955

72,685

186,270

4,102

22,417

735

65,858

6,625

17,066

16,453

25,714

66,235

6,007

60,228

-377

213,146

2016

1,332

61,345

62,677

11,497

149,053

795

224,022

270,708

79,807

190,901

5,130

22,907

801

66,632

6,967

14,146

18,182

27,336

62,350

5,981

56,369

4,282

224,022

2017E

1,332

56,205

57,537

13,040

148,428

795

219,800

279,646

88,524

191,123

5,130

24,692

801

62,429

7,437

16,550

20,095

18,348

64,376

6,967

57,408

-1,947

219,800

(INR Million)

2018E

1,332

63,232

64,564

14,830

145,372

795

225,561

289,992

97,510

192,482

5,130

24,692

801

68,493

7,826

17,737

24,583

18,348

66,038

7,607

58,431

2,455

225,561

82,696

24,542

914

39,719

4,077

9,941

14,283

11,418

46,474

4,342

42,133

-6,755

101,397

10 November 2016

CESC

Financials and Valuations

Ratios

2012

Basic (INR)

EPS

Cash EPS

BV/Share

DPS

Payout (%)

Valuation (x)

P/E

Cash P/E

P/BV

EV/EBITDA

Dividend Yield (%)

Return Ratios (%)

RoE

RoCE (post-tax)

RoIC (post-tax)

Working Capital Ratios

Fixed Asset Turnover (x)

Asset Turnover (x)

Debtor (Days)

Inventory (Days)

Leverage Ratio (x)

Net Debt/MW

Net Debt/EBITDA

Debt/Equity

21.6

48.7

385.5

5.0

23.1

2013

33.2

62.3

409.5

7.0

21.1

2014

39.1

76.7

448.6

8.0

20.4

2015

14.9

59.1

452.6

9.0

60.4

2016

27.8

85.8

470.5

10.0

36.0

2017E

40.9

106.3

431.9

10.0

24.5

2018E

64.7

132.2

484.6

10.0

15.4

40.4

10.2

1.3

10.9

1.5

17.0

5.5

1.0

6.8

2.1

14.6

5.6

1.4

6.6

1.7

9.2

4.5

1.2

5.8

1.7

5.7

6.6

6.3

8.4

6.8

10.3

9.1

6.7

10.9

3.4

6.3

6.0

9.1

7.4

9.1

9.8

-18.9

14.1

11.0

11.2

0.7

0.6

4.0

0.8

0.9

0.5

6.5

1.4

0.8

0.5

6.6

1.6

0.6

0.5

6.6

1.8

0.6

0.5

4.6

1.8

0.7

0.6

4.1

1.8

0.8

0.7

3.5

1.5

(INR Million)

2018E

34,616

-936

-3,663

30,017

-10,346

2,445

-7,902

-3,057

-13,995

-1,599

1,023

-17,628

4,488

20,095

24,583

Cash flow statement

EBITDA

Others

Direct taxes (net)

CF from Op. Activity

Capex

Interest income

Investments in subs/assoc.

Others

CF from Inv. Activity

Share capital

Borrowings

Finance cost

Dividend

Others

CF from Fin. Activity

(Inc)/Dec in Cash

Opening balance

Closing balance (as per B/S)

2012

9,722

-272

1,102

-1,445

9,108

-24,519

576

-406

-24,276

16,434

-3,642

-579

1,126

13,360

-1,809

16,091

14,283

2013

12,661

5,406

1,968

-1,479

18,556

-36,148

770

-5,127

2,581

-37,924

24,494

-5,465

-726

1,085

19,399

14,283

14,314

2014

16,226

7,301

1,125

-2,141

22,511

-34,209

670

912

-32,627

19,282

-11,134

-1,021

1,061

8,225

-1,891

14,314

12,422

2015

18,945

-10,274

2,729

-2,506

8,895

-19,509

550

-369

1,155

-18,172

5,021

20,980

-11,978

-1,168

454

13,309

4,031

12,422

16,453

2016

28,483

-4,025

3,132

-3,311

24,280

-12,675

329

-681

1,076

-11,952

117

6,420

-15,303

-3,009

1,176

-10,599

1,729

16,453

18,182

2017E

31,640

7,102

-8,989

-3,396

26,357

-10,724

2,163

-8,561

-625

-14,699

-1,599

1,039

-15,883

1,913

18,182

20,095

10 November 2016

REPORT GALLERY

RECENT INITIATING COVERAGE REPORTS

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CESC

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Varun Kumar

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10 November 2016

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