CESC Ltd. Bottoming out: Initiate at OW -Barclays Capital

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CESC Ltd. Bottoming out: Initiate at OW We initiate coverage of CESC, a power-focused conglomerate with an Overweight rating and a SOTP-based price target of Rs629. CESC has core operations in power generation and distribution, with interests in retail, IT services and property. The shares are out of favour due to coal block deallocation, the subsequent winning of new allocations at aggressive bids and PPA/FSA issues at its Dhariwal power plant. However, given the share price correction of 35% since coal block deallocation in September 2014 (vs the 1% Sensex decline), we believe that current valuations reflect these risks. We expect consolidated earnings to trough in FY16, but see progress on coal supply/PPAs for Dhariwal and the recovery of levies leading to potential upside beyond our price target. Regulated business is the key driver: Continued growth in the subscriber base for its Kolkata distribution business and startup of the Haldia power plant should help offset losses from coal block wins which were at aggressive pricing. Fuel supply issue resolution an upside catalyst: Assuming a no offset from merchant sales we calculate the earnings impact at a negative Rs2.3bn and total losses equivalent to less than Rs100/share, which we believe has been more than fully reflected in the recent share price decline. We have also not factored in a recovery of the cRs90bn levy on past coal block usage, but management expects a favorable verdict from the regulator (Rs1bn has already been charged to customers in FY15). Fuel supply issues at Dhariwal are also yet to be resolved. Conservatively, we factor in losses until FY18E. Non power business on a recovery path: We expect slowing losses from the retail business (Spencer) on scale economies. The BPO business, First Source has been weak but its pipeline appears healthy, and we expect further improvement from FY16E, with revenue CAGR of over 8% (FY15-18). Other businesses though small should gradually stabilize. Earnings to trough in FY16E: Post the 60% decline in consolidated earnings in FY15 we expect a further 4% decline in FY16. However, we expect earnings to rebound in FY17E on the improved contribution from Haldia and see further loss reductions for its retail business. Key downside risks include higher than expected losses on coal blocks, if coal supply and PPA issues at its Dhariwal power plant remain unresolved; and slower than expected improvement in the retail business.