Should these critical PSUs be broken up or privatized? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Should these critical PSUs be broken up or privatized? 

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In this issue:
» Do fundamentals match up to the sentiments?
» RBI has a tough job of curbing rupee volatility
» Valuations of Indian stocks inching ahead of global peers
» Jewellery industry gets some respite
» ...and more!

The country's economic engine has been derailed as a number of infrastructure projects continue to starve for want of fuel. Coal continues to be the most widely used fuel for fuel intensive sectors such as power, cement and steel. And India has the fifth largest reserves of the black gold in the world. But still the country is not able to fully meet its coal needs.

What prevents the country from utilizing its own natural resources? This is partly because these resources continue to remain under the domain of the government. The coal sector was nationalized in 1972 and Coal India Ltd (CIL) was formed in 1975. Today Coal India Ltd (CIL) accounts for more than 80% of the coal produced in the country. The government wants to prevent misuse of the country's natural wealth through this reservation. But this in turn has turned into a bane for the sector. CIL's coal output has hit a roadblock due to hurdles such as delay in getting land clearances and environmental approvals. The company was unable to meet its production targets in both financial years 2013 and 2014.

CIL with its seven subsidiaries is spread over eight states of India. One way to cut down the turnaround time is to split the subsidiaries into independent companies and allow state governments to hold stakes in these entities. This kind of de-centralization and state-level ownership will increase accountability. At the same time, it will speed up approvals and improve efficiency of the company in the long run.

Splitting up may ease CIL's regulatory burden to some extent. However, the company continues to be plagued by low productivity. CIL derives 90% of coal from opencast mines and balance from underground mines. The labour productivity from open cast mines has improved over the years. However, productivity from underground mines has stagnated due to lack of technological advancement. Therefore access to latest mining technology is the need of the hour. This can be achieved by partnering with global mining companies for technology sharing.

To boost investments in mining, the government can also consider auction of coal blocks. Privatization can no doubt make the coal sector more competitive and efficient. Also to safeguard national interests, the government can stress on production targets and penalty clauses at the time of allocation of mines. But private companies have a poor track record in holding national interests above their own commercial gains. Therefore according to us, providing autonomy to individual subsidiaries by bringing state ownership could be a more successful way to ensure coal security in the country.

Do you think PSUs like Coal India with access to huge natural resources should be privatized? Or should they be split? Let us know in the Equitymaster Club or share your comments below.

Editor's Note: Today we are sharing with you an excerpt from Ajit's Honest Truth. Both for the message, and more importantly, for an introduction to some brilliant music! So, here goes...

"Don't be the Patanga, be sensible, be balanced!
Can the Index surge to 28,000 by December 2014?
It can: based on pure money flows, if people ignore the facts.
Or it can if a lot of things go right on the inflation and growth front and the "facts" indeed support a higher level of long term earnings.
But it may be better to invest carefully; maybe reduce your allocation to equities, or reduce the amount of money in your SIPs for a few months...stay invested but not fully invested. Again, on a very long term view of years - buying stocks is a great idea. But invest with that long term view and not because some talking head on TV said "the markets will zoom".

And while you mull over this: please hear the brilliant song from Patanga, which was sponsored by Quantum Mutual Fund and the National Streets for the Performing Arts."

01:35  Chart of the day
Promoters use the Open offer or the Buy-back route to consolidate their holdings in listed companies. Such a step shows increased confidence of promoters in the company's business, signaling towards better growth prospects. Apart from this, even multinational companies, that want to delist from the country's exchange, adopt this route to acquire full stake and complete management control. To safe guard the rights of minority shareholders in the event of a major change in shareholding of a listed company, SEBI has made open offer mandatory. Thus acquisition of 25% stake in a company either directly or indirectly automatically triggers an open offer to acquire further 26% stake from public shareholders.

To derive optimal benefit, open offers are usually made at a time when the company valuations are trading at a discount. The quantum of open offers shot up substantially during FY09 and FY12. Interestingly, the Sensex yielded negative returns of 38% and 11% respectively in these two years. In FY14, the total size of open offers surged to an all-time high of Rs 454 bn. The reason can largely be attributed to Hindustan Unilever's mega offer of Rs 292.2 bn, accounting for 64% of the total open offers made in FY14. Apart from this fifteen other multinational companies also made buyback offers totalling Rs 445.3 bn during the year in the light of lower valuations and a weak rupee. It is worth noting that a lion's share of 83% of open offers made in FY14 was for consolidation of shareholding.

What led to the sharp jump in open offers in FY14?

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The valuations of Indian companies are soaring high on hopes of reforms and investment revival. Ever since the Modi led NDA has won majority, stocks that were battered in the Congress era have got a new lease of life. Some are witnessing valuation multiples near 3 year highs. That too without any improvement in earnings! Leave alone earnings, the inefficiency in their operations and management are far from being resolved. Further, the possibility of reforms and investment revival are unlikely to impact their fundamentals overnight . PSU banks are fetching steep valuations in the hope of funding large corporate projects. The fact of the matter is that many large companies already carry high debt. As per an article in Hindu Business Line, total debt of 11 large corporate groups is at a staggering Rs 5.9 trillion or 7.3 times their EBIDTA. Further, the asset sales over the past two years form only 13% of the outstanding debt of the corporates concerned. So India Inc needs to focus on making balance sheets leaner before taking on more debt. Else banks will continue to carry the baggage of bad loans. Infrastructure projects, meanwhile, need to move faster and offer commensurate returns to be able to attract foreign and domestic investors. Without these the 'Modi-rally' in corporate India will illusion! We will write more on why we believe the valuations of Indian companies are far from being realistic... in tomorrow's edition of The 5 Minute Wrapup. Stay tuned!

Should the rupee appreciate or depreciate? When the UPA was in power, lack of policy reforms and stalled projects led to considerable money being pulled out of the country. This posed a big headache for the RBI because the value of imports rose at a time when inflation was already high. This in turn put pressure on the current account deficit. Even if this was good for exports, it was hardly enough to plug in the gap. Now the rupee has gained around 6% since March 2014 as considerable hopes have been pinned on the NDA government to deliver on its development agenda. However, this time the RBI is looking to restrict the currency gains. Indeed, it is buying up these dollars so that the rupee does not climb up too sharply. The idea is to ensure that exports are not impacted by the appreciation because it will once again have some impact on the current account balance. That is not all, the RBI has a tough job on its hand to maintain a balance. Because if it aggressively buys dollars and releases more of the Indian currency into the system, it will once again pile on the pressure on inflation. Having said that, we believe that in the longer run if India's GDP growth once again picks up pace, the rupee will eventually gain value.

The recent rally has no doubt made a lot of investors richer. Now here's another feather in its cap. A leading business daily reports how the surge in indices has once again catapulted India into the top 10 in the world in terms of market capitalisation. At US$ 1.42 trillion we are just a shade ahead of Australia, the country we displaced in the rankings. However, there could be more such surprises in store. A lot of experts seem to be of the view that there's still some steam left in the Indian markets in the near term. And by the time it runs out of it, we could be within striking distance of displacing even Switzerland, the country ranked just above us in rankings.

Well, while the stats do make us feel proud as Indians, our investment decisions certainly cannot be at the mercy of such landmarks. Our wealth creation will solely depend on how the companies we invest in perform. As a consequence, our approach should be bottom up where we invest in fundamentally strong stocks at valuations that are reasonable. And this will ensure that we continue to go past most investors irrespective of whether our markets goes past Switzerland or not.

The jewellery industry in India has been going through difficult times. Ever since the RBI put restrictions on Gold imports in August last year, the cost of funds for jewelers had increased significantly. Now there seems to be light at the end of the tunnel. The RBI has liberalized its 80:20 rule, under which 20% of the gold imported would have had to be exported. Although the ratio has been maintained, the central bank has now allowed designated export houses to import the commodity. Also, banks are now allowed to make Gold available to jewelers.

This is welcome news for the domestic jewellery industry. The restrictions had led to a sharp fall in Gold imports and this can now be expected to reverse. As per an article in the Business Standard, monthly Gold imports could double to 60 tonnes from 25-30 tonnes currently. This will increase the supply of the yellow metal in the country leading to a minor fall in prices. However the most important impact of this decision could be on Gold imports via illegal channels. With more gold available through legal imports, smuggling of the yellow metal should see a fall in the coming months.

The Indian stock markets, after opening firm, continued to strade above the dotted line. At the time of writing, the benchmark BSE-Sensex was up by 200 points (0.8%). All sectoral indices were trading in the green led by realty and consumer durables sector. Most of the Asian stock markets were trading in the green with Hong Kong and Japan being among major gainers. European markets have opened the day mainly in the green.

04:50  Today's investing mantra
"Price is what you pay. Value is what you get." - Warren Buffett
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4 Responses to "Should these critical PSUs be broken up or privatized?"

Sanjeev Kumar Singh

May 23, 2014

PSU's are suffering due to political interference and subservient officers. The leadership is full of corrupt and mediocre people. These people inherently cannot push for major reforms and actually will like status quo. Privatization of natural resources without checks and balances has only lead to massive manipulation ( RIL KG basin gas is an example) and substantial increase in prices. Breaking up of CIL is a mere restructuring and a typical "consultants"/"investment bankers" advice. Such advice's in past in majority of cases didn't added any value except increasing the bank balances of consulting companies and bonuses to their employees. It may not result in any increase in coal supply. The problem needs to be solved at basic level viz why we have concerns on environment and what could be done to solve it within a time frame. Restructuring is a cosmetic changes and may not be desired impact.

Like (1)


May 23, 2014

A combination of both splitting Coal India and part privatization (25-50%) to begin with appears better alternative. This step will also ensure competition between the two sectors which will go a along way to ensure fairness from the private sector. This will also expose any lack of good management by the public sector.

Like (1)


May 23, 2014

I dont think splitting up CIL is the answer to all problems.
Consider,who issues the clearances?mostly Govt agencies.Why cant they speed up the process?And environmental clearance issue may be on examination table as soon as project plg is taken up-thereby allowing modification of project in time to satisfy environmental necessities,.
Centralised plg,control and coordination as well as sales coordination ensures appropriate allocation and enhances efficiency-if honestly done.Regional bias,lax attitude and ineffective management may upset the system and make the companies lose if CIL is disbanded....kbgoswami

Like (1)


May 22, 2014

National resources like coal, minerals etc, need to be kept under public sector. Effective management and optimum use of these resources is the need of the time and performance of coal india can be improved by spliting it in to smaller units with more public participation and upgrading technology. MP varghese

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