For Shipping Corporation of India, it was a case of the wind filling its sails, with 50 per cent growth in net profit for the year ended March 2011. Yet the stock lost more than 36 per cent over the year. ONGC, on the other hand, lost 10 per cent, on account of regulatory uncertainty on subsidy-sharing even as the crude prices were rising. Many PSUs stocks suffered a similar fate in the last year.
The BSE PSU index over the last year lost 6 per cent in value, even as the broader market gained 5 per cent.
Going by the maxim that one should buy the stocks nobody loves, are PSU stocks a good investment now? Here are four key themes on which investors can look to capitalise on the beaten-down PSUs.
After proving more ‘defensive' during the market fall of 2008-09, PSU stocks failed to keep pace with their private sector peers in the boom years of 2009-10 and 2010-11. Earnings disappointments, regulatory uncertainty, the higher commodity tilt in PSUs, and execution delays are a few reasons that led to the under-performance by some PSUs.
Additionally, the battering stocks received in the run-up to their follow-on public offers (FPOs) too added to the woes. This pushed most of these stocks below their average historic valuations.
Becoming cheaper
Over the past year, PSU stocks have turned cheaper, both in absolute terms and relative to the market. The current price-earnings multiple of BSE PSU index is 14.4, against 16 times a year ago. It is also at a discount to the 15.7 times average multiple clocked over the last three years. During the same time the broader market, captured by the BSE-500, saw its price earnings multiple shrink to 18.2 from 19.6 times.
The widening gap between the BSE PSU index and BSE-500 is explained by private sector companies witnessing a better earnings growth than the PSUs as a class. In 2010-11, the standalone net profit growth of the listed PSUs, put together, moderated to 10.3 per cent, down from 17.5 per cent clocked the previous fiscal.
Private sector companies in contrast, did much better, with a 23 per cent growth in profits. . Rising employee expenses in banks and a fall in the ‘other income' contributions were a few reasons for the moderate performance of PSUs even as their sales grew in line with private peers.
The moderation in profits for PSUs, however, was magnified by large profit declines of 27-57 per cent for PSU majors such as SAIL, Indian Oil Corporation, BEML, Dredging Corporation, MMTC and State Trading Corporation.
However, some companies within the PSU pack did deliver strong growth. Rural Electrification Corporation, PowerGrid and Shipping Corporation each recorded a profit growth of 28-50 per cent and yet saw their stock prices fall. Thegovernment had divested its stake in all three companies over the last 16 months. This is one set of PSU stocks that investors should seriously consider buying today.
Near-monopolies
With input cost pressures being the key risk looming over India Inc, PSUs that are market leaders or hold a near monopoly in their respective businesses also appear to hold promise. Coal India, PowerGrid, MOIL, Engineers India and Bharat Electronics all are near-monopolies in their business with competition yet to challenge them in a serious way. Other companies such as ONGC, GAIL, NTPC, SAIL, SBI and NMDC continue to be market leaders in their sectors.
A near monopoly status imparts many advantages to the players. Given that the barriers of entry for private sector in select sectors continue to remain high (for e.g.: coal or transmission) the dominance may continue for some time. Investors can, therefore, consider investments in GAIL India, NMDC and BHEL (despite Chinese competition, BHEL has a strong order book) with a long-term investment horizon.
A cash-rich status and low debt on the books can also make PSU stocks attractive relative to private peers in some sectors. For instance, the net debt-equity ratio of BHEL was -0.32 (indicative of cash net of debt), while a private sector peer BGR Energy systems had a 0.32 times net debt-equity ratio.
The bank theme
Public sector banks had a dream run till last November, thanks to strong traction in their loan books, low valuations and recapitalisation hopes. What has changed is the sudden requirement of provisioning for employee pension, new concerns on asset quality and a hawkish central bank, which has imposed margin pressures on banks.
These have levelled the valuations of public sector banks to a 1.87 times from 2.5 times in November 2010. While employee provisions may continue to be a drag on public sector banks, the current valuations offer a good investment opportunity for investors with a long-term horizon of three years.
Apart from low valuation, most PSBs have been recapitalised over the last few months, strengthening these banks. While margin pressures may persist, high rate of credit growth (19 per cent estimated by RBI) would neutralise the effects due to margin pressure.
The high provisions for NPAs, which were set aside during the previous quarters, would also come down, given that the banks need not maintain 70 per cent provision coverage.
Given that the PSU banks corner three-fourths of the banking sector market share, one can consider owning the whole universe. PSU Bank Bees, an ETF tracking CNX PSU Index can be considered. It has higher allocations to SBI, PNB and Bank of Baroda, which are among the strong banks.
Delivering on earnings
Companies like BHEL, Bharat Electronics and Engineers India have come up with good earnings growth but have yet under-performed over the last year. These companies continue to be among the preferred picks in our coverage universe and investors may reap benefits from these stocks going forward. On the other hand, companies such as Oil India, CPCL and MRPL, despite coming up with modest set of earnings, have bright prospects for the future.
Non-banking finance companies such as PFC and REC are also trading at a steep discount to their historic valuations. For them, loan book growth may offset any margin pressures.
Our Recommendations :
The best of the lot are
Coal India - buy around Rs.400 for a target price of Rs.500 holding period 1 year
SAIL / ONGC - apply for FPO while retail investors could get 5% discount !
Avoid Banking stocks for next 6 months as the outlook is -ve
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