| Summary of Contents STOCK UPDATE CESC
Recommendation: Hold
Price target: Rs355
Current market price: Rs319 Another tariff hike to boost core business Key points Latest tariff hike to add around Rs60 crore on top line
Regulators have allowed CESC to hike the electricity tariff by 1%, around 6 paise per unit, with a retrospective effect from April 2012. This would be the third hike taken by the company during FY2013. The first hike took place at the beginning of April, as per the multi-year tariff plan, where the tariff increased by 69 paise (13%) from Rs5.19 per unit to Rs5.88 per unit. Followed by that, CESC again took another 15 paise hike in May, taking the average tariff to Rs6.03 per unit, to factor in the monthly variable cost adjustment formula, factoring in the increase in fuel prices, freight cost and excise duty revision on power purchase. The current hike would be to the tune of 6 paise per unit, taking the average tariff to Rs 6.09 per unit. The revision is effective from April 2013, which will be recovered in eight instalments.
The current tariff hike would add around Rs55-60 crore to the company's top line and around Rs6 crore to the bottom line. Effectively, this would add around Rs0.5 per share to the company's earnings. Leveraging distribution expertise; to sign an agreement for Ranchi region
CESC has been selected by Jharkhand State Electricity Board (JSEB) for managing the electricity distribution business in the city of Ranchi, on a franchisee model. On the other hand, Tata Power has been awarded the electricity distribution business of Jamshedpur city. We learned from the management that CESC would sign an agreement with the JSEB on December 5, 2012 for taking over power supply to the state capital, Ranchi. Under Ranchi area, circles include Ranchi, Gumla and Daltonganj, with a distribution capacity of 300MW.
The JSEB intendeds to hand over power supply, maintenance and distribution of bills to the franchisee (CESC) to check the transmission and distribution (T&D) losses. We learned that incentive of the business lies in reducing the T&D losses, as annual revenue required and average cost are pre-determined. Hence, the challenge remains with how successfully CESC could reduce the T&D losses, which would translate as benefit of CESC. At present, the T&D losses in Jharkhand are estimated to be around 33-35%. We believe CESC should be able to encash its rich experience of power distribution to bring down the T&D losses, which could be a recurring business as the duration of the franchisee is 15 years. Extended distribution expertise in overseas too
Recently, CESC extended its expertise to the overseas market by way of offering fee-based advice to a consortium of local investors on managing a state-owned distribution company in Nigeria. CESC's role will be as a technical service provider in network planning, supervision of implementation plan and improvement of efficiencies of the discom. It is a huge distribution area covering 48,000 square kilometres with an annual turnover of $180 million.
The consultation fee will be approximately $2.5 million per year (five-year renewable). It will be entitled to incentives on achievement of more than 80% of loss reduction target (each five partners getting 12.5% of additional revenues). Further, CESC had an option to invest up to 6% in the distribution company through a special purpose vehicle. View and valuation-maintain Hold
After the announcement of First Source acquisition by the company, we have revised down our price target from Rs410 to Rs355 (also revised rating from Buy to Hold). The revision was done because we believe the diversification was unrelated and would hardly add any strategic value for the company or the investors. We believe the unrelated diversification would remain as an overhang in the near term. However, we continue to like the stock due to its cash-generating utility (core) business, which is performing well. The recent tariff hikes and expansion in its distribution business would further strengthen the performance of its core utilitiy business. Currently, the stock trades at ~0.6x FY2014E book value (stand-alone). We retain our Hold rating on the stock with a price target of Rs355, based on sum-of-the-parts valuation.
VIEWPOINT Liberty Phosphate Timely capacity expansion augurs well We interacted with the management of Liberty Phosphate, which is among the few pure single-sulphur phosphate (SSP) manufacturers in the country, to know the recent development and performance of the company. Liberty Phosphate provided an absolute return of 249% against the Sensex return of 14% since we introduced the stock with a positive stance on September 7, 2011. We maintain our positive bias on the stock after the interaction with the management of the company.
The key highlights of our interaction with the management of Liberty Phosphate are as follows:
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High realisation lead to strong quarterly performance: In Q2FY2013, the revenues of Liberty Phosphate were largely in line with our expectation. The total revenues in Q2FY2013 increased by 27.5% to Rs140.8 crore compared with the same period last year. On margin front, an increase in the price of raw materials led to a slight contraction in the margin. During Q2FY2013, the operating profit margin stood at 15%, which was 140 basis points lower than same period last year. During Q2FY2013, the reported profit after tax (PAT) stood at Rs13.1 crore, which was 22.3% higher than Q2FY2012 and includes a one-time gain of Rs1.8 crore. The adjusted PAT stood at Rs11.3 crore. The total volume of the SSP declined by 10% to 1.15 lakh tonne as compared with Q2FY2012. The decline in volume was due to a lower and uneven rainfall in Gujarat and some parts of Rajasthan. -
Margin improvement to fuel earning growth: Looking at the declining price trend of key raw materials (rock phosphate and sulphuric acid) in the international market on back of a lower demand from countries like India and China along with rupee appreciation will help the Indian fertiliser manufacturers (non-urea) to import raw materials at a low price compared with that of last year. The declining price of the key raw materials along with a stable realisation will lea to an improvement in the margin of SSP business going ahead. -
Capacity expansion to drive company performance: An expansion in its capacity from 7.26 lakh tonne to 9.24 lakh tonne by the end of FY2013 will help Liberty Phosphate to improve its volume and register good revenues and earnings growth going ahead. Improved utilisation of current capacity would also contribute in achieving higher volume in the coming years. An increase in the capacity with minimum capital expenditure (capex) and optimum utilisation of the resources will help the company to bring operational efficiency, which will improve the margin. The company is doing a marginal capex of Rs16 crore in FY2013. -
Outlook for SSP industry: Going ahead, we believe that the demand for SSP will pick-up in the coming months on back of better sowing acreage in the rabi crop season (helped by a late revival of monsoon) and an increase in the level of water in the reservoirs. The price of SSP will also play an important role in its demand because SSP is one of the cheapest non-urea fertiliser available in the market, which provides phosphorus, sulphur and calcium to the crops. A revival in demand will help the big players with strong brand name to increase their volumes. Players such as Liberty Phosphate, Rama Phosphate and Khaitan Chemicals and Fertilizer will benefit the most. -
Valuation: Liberty Phosphate is the largest SSP manufacturer, which can grow by capitalising on its capacity addition, brand name and distribution network. Given the aggressive expansion of its manufacturing capacities, the company can potentially grow at a compounded annual growth rate of around 19.3% over the next two years. In terms of valuation, the stock trades at around 4.0x FY2014E rough-cut estimates. At the current valuation, we believe that Liberty Phosphate has the potential to move on the upside from here as it is the cheapest non-urea fertiliser company as compared with other fertiliser companies. Liberty Phosphate provided an absolute return of 249% against the Sensex return of 14% since we introduced the stock with a positive stance on September 7, 2011. We maintain our positive bias on the stock.
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