PSUs Under Focus

The public sector undertakings’ (PSU) unique selling proposition can be summarized in the three words: Undertaking, Safety and Profit (USP).

When the reported accounts and profits are no longer reliable, dire conditions hidden in the business contracts unavailable to ordinary investors and doubts are raised about the credibility of the private entrepreneurs, the market is expected to sway the investor sentiment towards Indian public sector undertakings.

Recent corporate fraud has shaken the foundation of the Indian private sector. The questions are now being raised about the corporate governance practices in private companies where even the mandatory independent directors have been unable to detect a fraud of such a large magnitude for such a long period. The trust on private blue chip companies is slowly evaporating and an urgent need for adoption of stringent corporate governance norms has emerged.

In the light of this, we expect the market to offer premium and re-rate the public sector undertakings, which is based on multi-layered standards of accounting, departmental checks and balances and transparent accounting methodology. We believe that investors would put more emphasis on the leading public sector companies, which will hold strong during the tough and difficult times. By and large, their accounts are rigorously scrutinized even by the CAG and they also hold a conservative approach as compared to their private peers.

Creating growth by reducing government stake
Apart from the premium for quality of accounts and size of business and intrinsic worth they command, the stocks of the PSUs are expected to get a fillip on the back of disinvestment trigger once the new government is in office by the middle of the year. Nominal divestment in some of the PSUs (without losing majority control) would provide boost to the sector and trigger re-rating of the target companies. Disinvestments will trigger growth in the economy and bring in further reforms and profits in the PSUs.

The privatisation drive, by whichever government is at the centre, is expected to accelerate as the government would need to mobilize alternative resources in the wake of fall in revenues in the last quarter. Further, to fund the economic stimulus packages, the need for privatisation would be felt.[PAGE BREAK]

Intrinsic Value
The net sales of all the listed PSU, excluding banks, have improved 36 per cent for the trailing twelve months (TTM) period ended September 2008 over the previous period, while the earnings deteriorated 11 per cent over the same period. While the topline has grown significantly, their gross profit kitty has depleted marginally. But their aggregate market capitalisation has eroded more than 51 per cent at the end of December 2008 from the previous year’s level. They maintained the total dividend payout at Rs 18,022 crore and increased the net block by 65 per cent to Rs 2,01,592 crore from Rs 1,89,017 crore. Many of the companies in various industries are leaders in their respective fields such as NTPC in the power sector and SAIL in the steel sector.

Despite erosion in market capitalisation of nearly 60-70 per cent from the previous year, SAIL and Chennai Petroleum’s TTM EBITDA has risen 20-35 per cent over the previous period. The stock prices of eight PSUs have dropped more than 70 per cent, out of which five have registered more than 16 per cent EBITDA growth on TTM basis.

The total market capitalisation of BSE has been fallen nearly 56 per cent, but the correction in PSUs is only about 51 per cent. As a result, the total weightage of PSUs in the entire market capitalisation has inched up to 25 per cent from 22 per cent.

We believe the current enterprise valuations of these PSUs do not take into account the replacement cost of such gigantic assets and the underlying return on those assets, which again have manifold hidden reserves. When the private sector landscape is shrinking, major government orders would flow to these large PSUs which have the necessary track record, execution capabilities and also the financial backing of the government. They will be able to bid for large projects and outbid already weakened private players.

Low on P/E and P/BV, High on ROE
Many of the PSUs are trading much below their industry average P/E. PSUs are trading at attractive dividend yield, some as high as 10.2 per cent. Despite generating higher RoE, these companies are, by and large, ignored by the market. It is interesting to note that 13 out of 29 PSU are trading below their industry P/E out of which five PSUs are trading below 1x P/BV. SAIL, Shipping Corporation of India and Chennai Petroleum appear cheap at the current P/E ratio.

It is expected that the market will soon catch up with the superior profits, underlying growth, relative peer valuations and also the sheer attractiveness of these stocks on replacement cost basis. This realisation is expected to lead to re-rating of stocks over the longer term.