CESC (CESC.BO) Upgrade to Buy – Four Solid Reasons to Buy the Stock  Citi Research

CESC (CESC.BO)
Upgrade to Buy – Four Solid Reasons to Buy the Stock
 Upgrade to Buy — And we increase our target price to Rs369 to factor in: EPS
revision; increase in target P/BV multiple to 1.0x (0.85x) on RoEs expanding from 7.6%
in FY12 to 12% in FY15E and roll forward of target P/BV to Sep14E (Mar14E earlier).
Our target P/BV is well supported by cons EPS CAGR of 28% with average RoE of
10%. The key reasons for our upgrade are……
 Reason # 1: Underperformance — Post FSL acquisition in Oct 12, the CESC stock
has declined 13% and underperformed the BSE Sensex by 16%. This
underperformance more than makes up for the unrelated diversification. It might be of
interest to investors that pre-FSL in the first ten months of CY12, the stock had
outperformed the BSE Sensex by 42% (with absolute gains of 63%), which implies, ex-
FSL, investors were rewarding the business performance.
 Reason # 2: Unrelated diversification is EPS accretive — The FSL diversification
might not be positively viewed (and overall valuations might be better off without the
same), but unlike retail: (1) the businesses is not a cash guzzler, (2) is EPS accretive
from FY13E itself. We expect FSL to contribute 5-15% of CESC’s consolidated profits
over FY13E-15E post acquisition interest cost and (3) should generate a return on
investment of 18-20% from FY14E onwards.
 Reason # 3: Pessimism on parent business — In 9mFY13 the parent has averaged
Rs1.2bn/quarter which worried investors that PAT would decline YoY in FY13E if the
same average is maintained in 4QFY13E. We believe this fear might be unfounded as
we expect PAT to rebound QoQ in 4Q to Rs2.3bn to end FY13E at Rs5.9bn up 6% YoY.
 Reason # 4: Doubling generation capacity over next 2 years— Over next 2 years,
CESC will add 1.2GW which would double the generation capacity. Unlike other IPPs
CESC has not tied itself up in unrenumerative PPAs. 600MW is on regulated RoEs and
remaining 600MW is open. Yes, on the open portion there is a possibility of losses in
the 1st year, but from 2nd year onwards this plant has the ability to generate 15% RoEs

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