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CESC demerger: investors check in for valuation gains

LiveMint logoLiveMint 11-09-2017 R. Sree Ram

CESC Ltd’s shares, which lost 15% when the company first revealed its four-way split plan in May, are back above the pre-demerger announcement levels.

The stock recouped the losses as the general uptrend in the equity markets and articulation of the demerger benefits by the management helped investors eye valuation gains.

The scheme is effective 1 October though the actual demerger and listing of the entities will take time as CESC will have to take several approvals.

The demerger per se does not lift CESC’s earnings. But it simplifies the holding structure, which can help its power utilities business attain better valuation.

“This is because the power business funded the diversification initiatives under the earlier structure, which depressed valuation multiples. Considering growth opportunities such as distribution franchising, the business will arguably command a premium over a plain-vanilla generation business,” IIFL Institutional Equities said in a statement.

The second benefit is the value unlocking opportunities.

The retail business, which till now was losing money, will become debt free.

As the unit improves its operating metrics, it is expected to break even and derive better value upon listing.

“CESC expects the change in product mix to boost margins and expects Spencer’s to cash break-even in FY2018 and PAT (profit after tax) break-even in FY2019,” Sharekhan Ltd said in a note.

The other pain-point—Chandrapur power plant—which is also losing money due to insufficient power off-take agreements is estimated to ease as CESC is scouting additional contracts.

“The company is confident of signing the entire capacity of Chandrapur on long-term PPAs in FY18 and achieve PBT break-even,” IIFL adds.

PPA is short for power purchasing agreement and PBT is profit before tax.

That said, given the history of losses and missed targets, everybody is not convinced about the timelines.

Many brokerages, including IIFL, are not pencilling in the Chandrapur power plant break-even in the current fiscal year.

In the retail segment, much depends on the extent of loss reduction. If the break-even gets delayed, then it can constrain the value accretion that the Street is taking for granted.

While expectations are running high on the retail business, for now, the creation of the pure electricity distribution business unburdened from the loss-making units remains the most promising outcome of the ongoing exercise.

The power unit already generates strong operating cash flows and can support its future growth plans by itself.

“Cash flows of the power business will be further used to scale up that business given until now retail business was a drag on the former’s cash flow,” ICICI Securities Ltd said in a note last month.

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