The PSU opportunity

 

The PSU opportunity

Jitendra Kumar Gupta / Mumbai January 18, 2010, 0:06 IST

 

Investing in public sector companies could be rewarding as the government is speeding up the divestment process and taking measures to give them a free hand

Many would have reservations about investing in public sectors companies (PSUs) due to reasons such as government interference and so on. However, the public sector as a category (and despite having laggards) has done better than the broader markets over the long-term. In the last ten years, the BSE PSU index has given an annual return of 20 per cent as against the Sensex’s 13.85 per cent.

 

With the government talking of lowering its stake in public sector companies, PSUs have now come under the spotlight. And, the market seems to be recognising their strengths and growth prospects. The markets’ confidence towards PSUs seems to be increasing on the back of the government aiming to speed up the divestment process as well as allowing companies greater operational flexibility. Although the PSU index has outperformed recently, there is still a lot to be made in the long-run as many of the listed PSUs are trading at relatively lower valuations or even below their intrinsic value, and importantly, operate in growth potential segments.

“I think it is a nice theme to play as many of the PSUs offer good value. And, since now, the government is focusing on the disinvestment there could be more re-ratings. Post disinvestment these companies will become more accountable and responsible,” says Ramesh Damani, Member BSE.

The PSU edge
Apart from higher stock returns in the past, an important fact is that most of these companies have a strong advantage in their core business and enjoy leadership position. Today, companies like BHEL, Power Grid, NHPC, NTPC, ONGC, Indian Oil, State Bank of India, BEML, Bharat Electronics, Shipping Corporation and Concor are the largest players having a lion’s share in their respective industries. Some of these companies have created huge entry barriers in the form of their manufacturing capacities, distribution networks and consumers, which cannot be easily replicated. This gives them a clear advantage, particularly in a growing economic and increasingly competitive environment. Notably, most of these companies operate in industries like power, engineering, banking, logistics and so on, where the growth prospects are enormous. All this will help them not only grow their businesses bigger and generate huge cash, but also distribute the latter in the form of dividends, which makes PSUs an attractive investment.

Analysts also believe that many listed PSUs are trading at low valuations compared to their private peers, while a few of them are also available at below their intrinsic value.

What’s changing for the better
An important indication that is available from the government’s actions is its intension to provide higher flexibility to PSUs and strengthen the sector. Recently, the government announced a new policy under which selective top-performing PSUs will be given more flexibility in terms of financial and managerial powers. In this direction, the government has also created a new category of ‘Maharatna’ under which PSUs with an annual net worth of Rs 15,000 crore or more and net profit of over Rs 5,000 crore in the last three years will get the Maharatna status. This will allow such companies to take investment decisions to the tune of Rs 5,000 crore without prior approval of the government, and help them act fast on their business decisions an essential in a fast changing environment.

While it is no secret that the government needs funds, its move to divest its stake in PSUs will provide some help in this direction. However, experts also believe that companies (and its shareholders) will also benefit through higher accountability and transparency, which should lead to better performance and stock returns.

To start with, the government has decided to lower its stake to at least 90 per cent in all the listed companies. This trend is expected to gain momentum with about 50 unlisted companies likely to come out with an IPO. Among companies that are expected to tap the market by March 2010 include NTPC, Engineers India, REC, NMDC and SJVNL among others.

With many PSUs lining up an initial or follow-on public offer (IPO or FPO), it would also mean higher participation of institutional and retail investors. Also, today public sector companies have a combined 28.58 per cent weightage in the S&P Nifty in terms of market capitalisation, but their actual weightage (based on free-float) is just 14.18 per cent. Analysts believe that this anomaly will get corrected once the free-float of PSUs improves as a result of divestment.

How to grab this opportunity
Despite all the positive changes taking place, investors need to be careful while selecting stocks. “Within the PSU theme, I think one can approach in three ways – one investing in some of the new PSU IPOs; second, investing in those PSUs where there are opportunities unlocking due to deregulation like in the case of oil companies; and third, PSUs companies which have large land bank and could benefit when the same is monetised to unlock the shareholder’s value,” says Damani.

As experts suggests, there are opportunities on account of deregulation – in sectors like oil and gas, banking, power, insurance, mining and so on. Similarly, many companies also have huge cash, investments or land bank in their books, which the government is now willing to monetise. Analysts say companies like RCF, MTNL, BPCL, HPCL and FACT have significant land bank. But, should you merely buy into this theme, wherein there is uncertainty regarding the timing (of monetising such assets) and quantum of gains?

“Investors will have to look at the core business and its strength rather than just focusing on the value. Look at MTNL, despite people talking about value, its stock price has not moved anywhere. That is more to do with the problems in the core business and its growth. In comparison, consider the case of GAIL, whose prices have moved significantly in line with the growth in its core business,” says Vetri Subramaniam, head equity funds, Religare Mutual Fund.

Clearly, there are different themes to play in the PSU space. We looked at a host of listed PSUs to figure out companies that could deliver sustainable long-term returns on the back of growth in their core businesses, unleashing of reforms and so on, but are available at attractive valuations. Many of them also have a lot of cash in their books (and are virtually debt-free), which can be used to fund growth plans. Read on to know more.

BEML
BEML, which generates about 80 per cent of its revenue from the mining and construction segments, will be a major beneficiary of the economic growth and higher mining activities in the country. It also produces equipment for the defence and railways, which are equally growing business on the back of increased investments. Although at a nascent stage, BEML has also entered the aerospace business. With an order book of Rs 6,000 crore (2.2 times its 2008-09 revenues), revenues are expected to grow at 15-18 per cent over the next two years.

Bharat Electronics
Bharat Electronics (BEL) is the largest defence equipment supplier with 57 per cent market in India. Consistent growth, regular and growing dividends over the years coupled with large cash (about Rs 482 per share or 23 per cent of current share price) in the books make BEL a good investment. Besides, it is investing in new technologies to participate in new areas especially where the government wants to reduce its dependence on imports. BEL’s strong order book of Rs 12,500 crore, almost 2.7 times 2008-09 revenue, provides good visibility and analysts expects its revenues to grow at 17-18 per cent annually over the next two years.

BHEL
BHEL would benefit on account of multi-fold increase in investments in the power sector and pick-up in industrial capex over the next several years. It is apparent, BHEL, which is the leader in power and engineering equipments, currently has the largest order book of Rs 125,000 crore which is almost 4.6 times its FY09 revenues. To tap the opportunities, it is expanding equipment capacity from 10,000 mw to 20,000 mw by the end of 2012. No wonder analysts expect net profits to grow at 35 per cent annually over the next two years. Notably, with BHEL winning super-critical power equipment orders, the concerns over its ability to deliver such equipments (an area with huge potential) is also waning.
 

UNLISTED PSUs
in Rs crore	Sector	Net sales	Net profit	Total Assets	Net- worth
Coal India	Material	38,790	5,740	N.A.	N.A.
IFFCO	Fertilizers	32,930	360	20,550	3,960
Bharat Sanchar	Telecom	30,270	570	122,900	81,130
Food Corp. of India ***	Trading	22,980	-	47,670	2,440
Rashtriya Ispat *	Metals	10,520	1,940	15,520	8,540
Hind Aeronautics *	Engineering	8,630	1,630	38,410	5,280
General Insurance *	Insurance	7,230	990	36,010	20,970
South East Coal Mining *	Coal Mining	7,150	950	8,680	3,440
NABARD	Banks	7,000	1,390	38,750	34,470
Indian Posash ***	Trading	4,420	20	2,160	110
United Bank	Banks	4,310	180	6,580	2,360
GCMMF **	Consumer	4,240	10	490	100
Airport Authority *	Transport	3,150	1,080	12,080	5,800
EXIM Bank	Banks	3,130	480	7,140