Back in the Reckoning

Investments in PSUs, whether direct or through the mutual fund route, are gaining momentum amid improving economic conditions.
Tanvi Varma/Money Today        Print Edition: August 2014
Back in the Reckoning

The arrival of the NDA government at the centre has been cited as a major reason for bringing cheer to the stock markets. The positive impact on the markets has impacted the Public Sector Undertakings (PSUs) too, which have been in the reckoning for some time now.

After underperforming the broader market for a majority of last year, the BSE PSU Index has seen a major rally after the elections: since May 2014, the PSU index has gained 33% compared to 15% return delivered by the BSE Sensex as on 4 July 2014. The PSU index has returned 47% this year till July 4 compared to 22% rise in the broader market.

But if we take a closer look, it becomes evident that the difference is much higher in the case of individual PSU stocks. While Engineers India returned close to 90%, BEML topped with 228%. So what has led to this outperformance?

Beating the benchmark

According to Vetri Subramaniam, CIO, Religare Invesco Mutual Fund, PSUs operate largely in cyclical industries like banking, energy, industrials & materials: sectors that stand to benefit from a pick-up in economy. PSU banks have suffered due to NPA (non-performing asset) issues, which in turn were a result of significant economic slowdown.

There are other fundamental issues that have helped these companies gain traction. Shiv Chanani, fund manager-equity at Sundaram Mutual Fund, believes that valuations played an important role as most of the PSU were trading at a significant discount to private sector peers as also to their own historical valuations. "With the new government in place, that discount has narrowed to some extent," he says.

The government seems to be keeping up to its promise of introducing market-oriented policies, with the announcement of extension in tax holiday for new power projects commissioned up to 2016-17. This, along with measures to augment domestic coal availability, and raising the FDI limit in defence to 49% are being taken as positive signs by the market.

HIGHER PUBLIC HOLDING

The Securities and Exchange Board of India (Sebi) has stated that rules for the market should be uniform across all the companies and should be promoter neutral. Under the current rule, non-PSUs are required to have a minimum of 25% public shareholding. For PSUs, it stands at 10%, which according to Sebi is discriminatory. Hence, even the PSUs will now be required to maintain a minimum public shareholding of 25% within three years.

Nitin Jain, CEO, capital markets, Edelweiss Financial Services, believes this could lead to stake sale in about 36 governmentowned companies and the divestment amount is likely to be Rs 60,000 crore to Rs 65,000 crore in 2014-15.

The top 10 PSU's are expected to raise more than Rs 54,000 crore. These include Coal India, NMDC, SAIL and Hindustan Copper. This will help in fiscal consolidation without the government having to compromise on plan expenditure. The government is also likely to be aggressive in taking the divestment option due to pos-itive market sentiments which will offer them good valuation and fulfil their fiscal requirement.

"In fact, 2015-16 earnings estimates have also moved up 16% and 15% respectively since March 2014, implying year-on-year expansion of 33% and 11% respectively," says Dhananjay Sinha, head, research and strategist at Emkay Global. The current PE discount of 24% to Sensex for our PSU index is close to a 15-year low. Given the ripe valuations, government may consider front-loading disinvestment in 2014-15 and balance out the burden subsequently.

"Historically the average rate for offer for sale (OFS) has been 3-5% discount over the market price. The government is likely to offload these shares at a 5% discount to attract interest in the offering," says Jain. Sinha adds that if the government thinks of improving profitability before divesting, such companies will become dividend candidates. In fact, the budget has assumed high PSU dividend payouts, implying that cash-rich companies such as Coal India and NMDC may again give out higher dividends. Based on the dividend payout-return on assets and dividend yield matrices, Sinha's key contenders for dividend plays are Concor, Bharat Electronics (BEL), Neyveli Lignite, GAIL, NMDC and Coal India.

PSUs that gained the most

PICKING THE RIGHT PSUS

PSUs with less than 25%public holding
According to Subramaniam, many PSU's enjoy competitive advantages, reflected in their dominant position in the industries in which they operate. "Parameters like free cash flow, return on capital, competitive business advantage, scalability of business and valuation are the key cornerstone for any investment," adds Chanani.

Jain adds that one can find quality businesses with a strong moat on the banking and capital goods side, adding that he prefers State Bank of India due to improved asset quality.

The good run, however, does not mean that investors need not be careful while treading the PSU space. "It will be paramount for the investors to look for exact measures that can create value in the wake of potential large supplies of PSU equities," says Sinha.

Further, the discount of PSU's PE to Sensex has reduced substantially in wake of the current rally. During financial year 2000-2003, the PE discount of PSU index to Sensex was high at 60%, while the current 24-27% discount is also lower than 36% during the strong growth periods of financial year 2004-2011 when strong tax collections precluded the need for disinvestment. "So, disinvestments unsupported by structural reforms will likely underperform in the face of higher supplies; investors could avoid BHEL and SAIL," says Sinha, who prefers companies like ONGC, Oil India and IOC due to the expected reforms in the sector. Privatisation of low hurdle non-core PSUs may create significant value opportunities like Balmer Lawrie, Concor, and Tide Water Oil. "Privatisation of non-core businesses but having significant hurdles: companies like Hindustan Copper, Nalco, National Fertilizer, Orissa Minerals & Rashtriya Chemicals are best avoided", he adds.

In case direct equity is not the ideal route for you, PSU equity funds offer investors the option to take exposure to these companies. These are Sundaram PSU Opportunities Fund, SBI PSU Fund, Religare Invesco PSU Equity Fund and Baroda Pioneer PSU Equity Fund. These funds have delivered returns ranging from 40% to 50%. Having said that, PSU equity fund is a thematic offering and investors should understand how they work. "It is not a substitute to a diversified fund and we would always recommend diversified funds to be at the core of an investors equity allocations," says Subramaniam. "Given current valuations and expectations of a cyclical recovery in the economy the PSU funds are well placed to benefit," he adds.

Chanani adds that Indian PSU companies have enormous potential. With right policies and vision, these companies can play an important part in driving investments in the country and hence creating significant value for all the stakeholders.

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