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PSUs: The untouchables - Views on News from Equitymaster
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  • Sep 28, 2000

    PSUs: The untouchables

    Consider this: India’s No. 1 listed telecom company Mahanagar Telephone Nigam Limited (MTNL) trades at its 52 week low at a paltry P/e multiple of 4 times in FY00 earnings. India’s No. 1 engineering and power equipment company Bharat Heavy Electricals Limited (BHEL), which has supplied generating equipment for 65% of India's total generating capacity, is also sharing the same fate as MTNL on the bourses.

    Apart from their performance on the stock market both companies share another common tag; that of being state run (or government owned). But MTNL and BHEL are just the tip of the iceberg. Take any sector, be it aluminium, refining, energy or steel, the story is the same.

    A huge workforce, nosing government, unclear policies, being government dependent are the common features that plague all of them. Lack of accountability has made the PSUs irresponsible towards the states’ assets and the hard earned taxpayer’s money, which goes for their upkeep. India’s industrial policies have traditionally been governed by the ‘Public Welfare’ considerations. Of course, public welfare meant subsidies, meant lower tariffs and being totally averse to the idea of earning profits. These draconian ways of running industries as political fiefdoms, which were devoid of economic sense contributed to the ‘babu’ style of functioning among its employees.

    Let’s check out the oil companies. BPCL has free reserves to the tune of Rs 35 bn, on an equity share capital of Rs 1.5 bn and long term debts of Rs 9 bn. The oil behemoth gets a paltry P/e ratio of 3.5 on the bourses. Why? Because inspite of everything, the company didn’t know where to employ its vast funds. This company, which is nearly completing 5 decades of operations, has a crude processing capacity of 7.5 million tonnes per annum. Take HPCL, another oil behemoth. Its capacity: 10.5 million tonnes, years of operation: nearly 50 years, free reserves: Rs 54 bn, long-term debt: 6.5 billion, equity capital: 3.4 bn but P/e multiple: 3.8 times.

    (Rs bn) IOC HPCL BPCL Reliance
    Sales 958 338 334 250
    Gross profit 55 16 16 24
    Total Assets 430 132 104 188
    Gross margins 5.7% 4.7% 4.9% 10%
    EPS (X) 31.5 31.2 48.8 3.0
    P/e ratio (X) 4.1 3.7 3.8 15.0
    *E indicates estimated

    Compare this to Reliance Petroleum. Construction of plant started around 1996-97. Commenced commercial production in the current year. Long term debts: Rs 76 bn, equity capital: a whopping Rs 52 bn. Its P/e multiple: 15 times its estimated FY01 earnings. The reason for such high valuations: it’s a private sector undertaking with efficient operations, a world class plant and a massive crude processing capacity of 27 million tonnes.

    And pray tell us how did this private group raise money. Well, the public invested in the company and institutions backed its projects. Very proactive management, wouldn’t you say? The Group saw the opportunity and went all out to create India’s largest refinery in a record time. Wonder what BPCL and HPCL were doing all this time?

    In petrochemicals, take a look at Reliance Industries vis-à-vis Indian Petrochemicals (IPCL). Both started off at more or less the same time (1966 and 1969 respectively). Today Reliance towers way above IPCL.

    (Rs bn) Reliance IPCL IPCL/Reliance
    Sales 206 49 23.8%
    Gross profit 41 9 22.0%
    Total Assets 294 92 31.3%
    Gross margins 19.7% 18.7%  
    EPS (X) 22.8 8.2  
    P/e ratio (X) 13.8 6.8  

    It has built up world-class capacities in all the segments it operates in and is even bidding for IPCL should the government decide to divest.

    Take Steel. The government owned Steel Authority (SAIL) is in such a rut that the government had to give it a loan waiver of a whopping Rs 55 billion. Any other company in the industry would have been dead by now. The privately held Tata Iron and Steel Company has meanwhile improved and consolidated its position.

    The point of all these comparisons is not to take away anything from the private sector; rather this is an exercise to do some soul searching about why investors’ view PSUs so negatively. The aim is also to underline that being a PSU should not relegate a company to the investor doghouse.

    MTNL HughesTele
    Mumbai 2,012,410 27,000
    Delhi 1,641,503 Nil
    Total 3,653,913 27,000
    Employees 62,000 500
    Employees/1000 subscribers 17 19
    Revenue (m) 50,325 638
    Market Price 138 12
    No. of shares (m) 630 1,553
    Market Cap 86,940 18,636
    Revenue/Subscriber (p.a.) 13,776 23,635
    Market Cap/Subscriber 23,800 690,222

    Public sector undertakings (PSUs) bear the cross of being government run, even if they are efficient. This statement is apt for MTNL. This state owned telecom company has the distinction of managing the most lucrative circles in India (Delhi and Mumbai). The company earns profit margins to the tune of 40% upwards, despite its 60,000 strong workforce. Such is its scale of operations (infrastructure includes over 3.5 million direct exchange lines), that if given a free hand, the company can turn the heat on the cellular providers and the new era Internet Service Providers (ISPs). But slow moving government policies and dependence on regulatory commissions has hampered its growth. A look at the table below, which compares MTNL with new entrant Hughes Tele.com underlines the cold shouldering the bourses have given MTNL as a result of its PSU status (and please take a closer look at employee/subscriber ratios between the two).

    Another glowing example of PSUs outperforming private companies is the National Aluminium Company (Nalco). Nalco, a PSU is one of the lowest cost producers of alumina worldwide. The company’s returns on equity, operating margins, sales per employee, dividend payouts all are way above the industry leader, Hindalco. But still its valuations on the bourses suffer.

      Hindalco Nalco
    EPS Rs 85.3 7.9
    P/e x 9.9 5.9
    OPM % 40.7 44.2
    Dividend payout x 11 28.3
    ROE % 11.7 15.8
    ROCE % 11.6 12.9
    Sales per share Rs 267 28.4
    Sales per employee Rs m 1.3 2.8

    The lack of initiative shown by the PSUs is one of the major reasons for their lost fortunes. But a large part of this initiative has been government dependent for too long. So what does the government do? It decides to divest its stake in these companies, realising rather late that it cannot run the affairs of the country and the country’s businesses too.

    A lot of water has flown since the divestment panel was set up. Till now, none of the major companies (except Modern Foods) have been put up on the block for divestment. The government seems stuck between various lobbies that are fighting over which company is a national asset and therefore cannot be divested. And so the argument continues and precious time gets wasted. PSUs keep losing market shares to private companies and in the end lose all their strategic advantages. By the time they will be up for divestment, their values might have just hit new lows. The same smaller private companies which were just a speck on corporate India’s horizon just a few years ago, will get ready to gobble up these PSUs at relatively cheap valuations.

    But the point everybody seems to be missing is that a major chunk of these companies are not wasted assets. Companies like MTNL, BHEL, BPCL, HPCL, IOC, Indal and so on have a vast pool of assets in terms of infrastructure, distribution channels, brands and most important of all a technically skilled manpower.

    These companies are quite efficient (as the tables above suggest). All they need is freedom to operate, as business entities should. For achieving this, a total divestment by the government is not necessary. Even if the government were to divest only 25-35% stakes to a foreign strategic partner and quickly, just see how these companies’ valuations skyrocket. The government in this case could act as any large investor, with a place on the board of the company.

    These companies are national assets, valuable contributors to our country’s progress so far. So it is in our own interest that these companies progress, not by subsidies or grants or by government nepotism but by leveraging their skills. It is not anti national to divest stakes in them if it is for their own progress, if it is for growing bottomlines, if it helps them develop better products.

    For India to bridge the gap from ‘developing’ to ‘developed’ will be decided by how it handles its PSUs, and that is probably an understatement.



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