Will CESC’s pivot towards green energy resolve its valuation woes? 

Highlights

• In a shift in strategy, CESC decided to explore possibilities of substantial investments in renewable energy


• Currently the company’s power generation base has miniscule contribution from green energy


• Successful diversification into green energy helped re-rate stocks of peers Tata Power, JSW Energy, NTPC


• Tepid growth in the mainstay Kolkata electricity distribution business remains a headwind

CESC has had a change of heart. After refraining from building large green energy projects, the company received board approval to explore possibilities of substantial investments in renewable energy generation with capacity up to 3,000 megawatts (MW). As of September 2023, CESC had 2,143 MW of power generation capacity with miniscule contribution from renewable energy.

After a bad experience with Dhariwal power station, CESC refrained from building or acquiring large power generation plants. The Dhariwal power station was under-utilised and weighed on CESC’s earnings for several years. To expand business, CESC focused on adding electricity distribution franchisees outside Kolkata. The company won bids for three electricity distribution franchisees in Rajasthan and Malegaon in Maharashtra. However, the new units are yet to contribute meaningfully to CESC’s earnings.

In the meantime, peers such as JSW Energy, Tata Power and NTPC found new growth avenues in renewable and conventional energy segments. The companies built sizeable green energy portfolios. This reassured investors about the energy transition re-rating the stocks. On the other hand, CESC’s valuations languished.

So much so that CESC is the least valued stock among the large electric utilities now. The stock is valued even lower than the perennially under-priced state-owned utilities NTPC and NHPC. One reason behind low valuations is lacklustre earnings growth. The company’s profit after tax grew by less than 4 percent per annum on average in the four years to FY23. Analyst estimates imply no major expansion in net profit in the current fiscal year also.

Will expansion into green energy rerate CESC’s stock, similar to its peers? Much depends on execution. The company should show its resolve by winning a sizeable number of projects and build a good project pipeline. Competition for large projects is high.

Crucially, the delay in cost recovery and tariff hike in the mainstay Kolkata power distribution business is weighing on CESC’s earnings growth. Regulatory assets have risen and working capital intensity increased, show calculations by analysts. As per IIFL Securities, delay in tariff orders has led to deterioration in CESC’s cash flows and weighed on return ratios.

Regulatory asset is an amount the company is yet to recover from the business—awaiting approval from authorities or other reasons. “In our view, tariff hike for FAC (fuel adjustment cost) under-recovery is a key variable for CESC to revive cash flows. Despite stable core operations and earnings, we find limited growth triggers,” analysts at Nuvama Institutional Equities said in a note.

So, even as CESC reassess its growth strategies, it is crucial the company receives favourable regulatory orders for the mainstay Kolkata business. This and steady scale-up of green energy assets will add new momentum to its stock valuations.

(Please write in with your views on CESC to rimmalapudi.ram@nw18.com)