>CESC (CITI)

Retail Limits Power Value & Upside Potential – Downgrade to Sell

■ Power business continues to add value — Aided by a benign West Bengal Electricity Regulatory Commission (WBERC) and its reasonable tariff orders, CESC’s power business continues to create value. The power business has turned around from losses of Rs1.3bn in FY99 to profits of Rs4.1bn in FY09E.  Retail limits power value and upside potential — CESC extended loans/ advances of Rs2.5bn to SRL in FY08. We estimate Rs5.5bn and Rs8bn will be extended in FY09 and FY10-12, respectively. In the absence of Rs8bn of investments over FY10E-12E, CESC would be worth Rs58/share more and if Rs8bn had not been invested over FY08-09E its value would have been higher by Rs64/share). Not only does retail limit power upside, but there is an opportunity cost in not investing these cash flows into productive power assets.

■ Stock looks expensive - Downgrade to Sell (3M) — A look at just the parent P/E multiples could mislead investors into believing that the company is trading at an inexpensive P/E multiple of 10.3x FY10E. But if one incorporates the retail business losses, the company looks expensive at 17.9x FY10E. As a consequence we downgrade CESC to Sell/Medium Risk (3M).

■ Target price hiked to Rs369 — We factor in a higher power business value of Rs388 (vs. Rs333 previously) on our: (1) earnings revision; and (2) lower WACC of 12.1% (13.1% previously). Negative NPV for power business support to retail is Rs58. We increase EV/Sales multiple for the retail to 1.0x FY08 (0.75x) in line with other peers.

■ Upside risks — Divestment, shutdown, and/or equity fund raising in SRL.

To see full report: CESC