Public sector enterprise (PSE/PSU companies) offer a compelling pocket of opportunity for investment
These companies are focused on sectors that are core to the economy and often have dominant position in their area of business. However, these companies are currently going through a low phase of market cycle with depressed stock prices.
Valuation of NIFTY PSU Index is more than 30% below its long-term average. On the other hand, the spread of Earning Multiple, with respect to the private sector peers is at a historic high.
Valuation has been subdued, because Govt. has been selling stake at discount through the ETF route. It has also been subdued because there has been concern that Govt. may force these companies to buy other PSE entities at expensive valuations. (For instance, ONGC acquired 51% stake in HPCL at a significant premium).
We also feel that in today’s trend following market, they do not find favour. This leads to further selling and reduction in prices.
However, dividend yield of close to 6% & Earning multiple of around 10 (for most companies) provide, strong valuation support. In view of this, I see little further downside from current levels.
At the same time, I see trigger for significant re-rating of PSU/PSE enterprises, if strategic divestments take place.
In the wake of sharply slowing economy, Govt. is likely to go for strategic investors rather than just incremental divestments. Divestment will not only help mobilise funds for stimulating the economy, but also help it to boost the efficiencies/productivity levels in the economy by handing over management control to the strategic investor.
Our segment wise take on PSU/PSE companies is outlined below:
- Upstream OIL (ONGC/OIL): At earnings multiple of 7, both these companies trade at very attractive valuation. Valuation is attractive even if one accounts for the fact that after 10/15 years Electric Vehicles may lead to significant slowdown/decline in oil consumption.
- Refineries (IOC, BPCL, HPCL): At Earning multiple of less than 10, these too are very attractively priced. Their oil marketing business is protected by a natural moat. Further, as we do not expect the global oil consumption to decline over the next 10 years because of Electric Vehicles, we do not expect margins to be under great pressure.
- GAS Value Chain (GAIL, Petronet LNG, MGL/Indraprastha Gas): Companies in GAS value chain will benefit from following GAS demand going up in the coming years: (1) Emphasis on cleaner fuels will lead to higher demand for CNG (2) Piped Natural Gas will increasingly replace LPG as cooking medium (3)As renewables gets integrated into GRID, there will be greater need for adding Gas based power plants to enable GRID stability
- Power (NTPC): Downside is protected as it has all cost plus PPA arrangements. Further, It will get opportunity to acquire assets cheap in the NCLT process as well.
- Defence Equipment’s, Aeronautics, Shipbuilding (Bharat Electronics, Hindustan Aeronautics, Garden Reach Shipbuilders): Increasing Demand for modernizing defence equipment as well as focus on make in India, will keep their order books healthy and growing.
- Mining companies such as NMDC, Coal India too are trading at attractive valuation (earning multiple) of between 7 to 10. However, growth in-case of Coal India will be subdued as more and more renewable capacity comes into play
- PSU Banks/PFC/REC: While we don’t see much value in PSU banks in general, SBI at current price trades at an attractive valuation. It has valuable subsidiaries as well – SBI Life, SBI Card, SBI Cap, SBI Mutual Fund etc…,
Companies with dividend yield of around 6% :
ONGC, OIL, GAIL, NTPC, NHPC, SJVN, NALCO, COAL India, PFC.