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India Inc.: Public Vs Private...

Oct 13, 2006

The markets eagerly wait for the heavyweights of India Inc. to announce their first half performance numbers in the coming days (the same having been initiated by Infosys on a brilliant note) and churn out numbers for the expected EPS. In the meanwhile, we try to defy some myths that the investors hold in their minds about the public and private sector players. The PSU entities that are typically looked at with apathy and bear the brunt of investor apprehension with regard to their valuations, given the scope of political interference, have, as per the following analysis, historically given a tough competition to their private sector counterparts. Sales - Playing the catch-up game?
The public sector enterprises, given their larger balance sheet size and lesser autonomy have done a commendable job by catching up with their private sector counterparts in terms of the year on year growth in turnover. The same has been aided by economic reforms, fiscal incentives and better access to funds. The private sector players, nevertheless, have lesser volatility and exhibit more visibility in terms of future earnings potential.

Operating margin: PSUs score over private!
The growth in operating profits (EBIDTA) for the public sector enterprises has incrementally decelerated over the past couple of years, having peaked in FY04. As against this, that of their private sector counterparts has remained reasonably steady. While this can be ostensibly attributed to the higher employee cost and operating inefficiency, what one needs to notice is that despite this, their average EBIDTA margins continue to rest nearly 400 basis points higher than the average of their private sector counterparts.

Net margins: Depreciation and interest costs bleed the private
The scenario on the bottomline front is, nonetheless, heavily skewed in favour of the PSU entities, although one may have anticipated otherwise. While one may argue that the private sector entities have set higher benchmarks in terms of growth in profitability, their trend in the same has been much more volatile as compared to their PSU counterparts. Similarly, their average net profit margins continue to linger nearly 200 basis points lower than the average of their PSU counterparts.

Investors must, however, read between the lines here and understand that the cause for the private sector enterprises lagging behind the PSUs - is not due to operating inefficiency, but primarily led by higher depreciation (aftermath of the capex boom) and interest costs. While the gross fixed assets of the PSU entities already stand heavily depreciated, their private sector counterparts are bearing the burden of heavy depreciation in the initial years. Also, during the erstwhile benign low interest rate scenario (that lasted until late 2005) the private sector entities have got themselves heavily leveraged, thus adding to their interest costs. Nevertheless, once the investment phase concludes, one may see them surpassing the PSU heavyweights.

The need is to be selective!
The time is thus ripe for investors to shed myths about public sector enterprises not being able to catch up with the private sector enterprises. While the fact remains that the government's whims and fancies will continue to have a bearing on the fortunes of the former, investors could discount their valuations to that extent. However, if one is selective in terms of fundamental strength and spots a PSU entity with a compelling long-term growth story, myths about lethargic governance should not hold you back!

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