MOSL: CESC (Buy)-Unlocking value through demerger-Value of Distribution + Generation > MCap

CESC: Unlocking value through demerger; Value of Distribution + Generation > MCap; reiterate Buy

(CESC IN, Mkt Cap USD2.1b, CMP INR1061, TP INR1440, 36% Upside, Buy)

We met the management of CESC for an update on the progress of the demerger and outlook for the business. Besides our key takeaways from the meeting, in this note, we also present our estimates of the Distribution and Generation businesses in their demerged form, as we approach the demerger.

 Distribution and Generation: Combined value greater than the current MCap

We expect the Distribution entity to generate PAT of ~INR6.5b in FY18, increasing to ~INR7.5b by FY20, driven by growth in regulated businesses and improvement in franchisees. The Generation business should generate PAT of ~INR4b in FY18, increasing to ~INR5.5b by FY20 on lower losses at Dhariwal. On peer valuation basis, the Distribution business could be valued at INR90b-110b and Generation business at INR50b-60b. Both businesses should generate strong double-digit core RoE and healthy FCF. The combined estimated value of the two demerged entities (INR140b-170b) is greater than the current market capitalization of CESC.

 Spencers: Focus turning to growth; target to increase margins to ~5%

After turnaround of operations, the focus is shifting to growth to capture the opportunity in organized retail in India. The management is targeting sales growth of 15-20%, aided by 10-13% store space addition. It will be adding new stores in existing areas of operations to capitalize on customer understanding and existing infrastructure. The target is to improve EBITDA margins by ~100bp annually to ~5% (FY18E: ~1%). We are conservative and expect ~10% sales CAGR and EBITDA margin of ~2% by FY20. At ~1x sales we value Spencers at ~INR25b.