A Repurpose for our PSUs

Thought for the day

Background: 

The Central Public Sector Enterprises were set up with the purpose of promoting “national interest” and “public investments in large industries” – something which could not be done by the private sector. This was done way back in the 1960s and 70s.
Forty years on, a lot has changed in the economic and business environments. Private sector lead by Reliance, Tatas and Bharti Group has surged ahead and shown them quite capable of setting up and handling global scale industries. Even the holy grail of “Defense” production is now being handed over slowly to Indian private sector firms. So why should GoI own large swathes of sectors like Oil & Gas, steel, other metal producers, telecom, banks, FMCG, pharma, even Indian Railways? In fact govt. ownership has actually allowed a lot of firms to fall back and wither away in terms of competitiveness and financial health (Air India!!??).

The Repurpose: 

The GoI appears to be relooking at our national “family silver” in this new environment and gearing up to repurpose our CPSEs. We feel the main purposes now should be:

  1. Just retain a few PSUs of strategic and national importance in the long run.
  2. Wherever the CPSE is in good health, is listed, and serves no major national interest, monetize these assets quickly. This can be through dividends, divestment and/or strategic sales (like Maruti !!??).
  3. Improve the health of the others, and set them up for listing, divestment and/or strategic sales.
JainMatrix Investments, CPSE

Please … not the Taj Mahal

The Capital Restructuring: 

The Central Govt. has issued comprehensive guidelines on capital restructuring of CPSEs by way of buyback, dividends, issue of bonus and splitting of shares to rake in more revenue. The finance ministry issued fresh norms which are as follows:

  • CPSEs having surplus cash can no longer invest funds in FD’s in banks, which generate a poor post-tax return of 4-5%. Every CPSE having net worth greater than Rs 2,000 crores and cash & bank balance of over Rs 1,000 cr. would have to buy back their shares.
  • Related to dividend, the new guidelines mandate that every CPSE would have to pay a minimum annual dividend of 30% of PAT or 5% of the net worth (whichever is higher) subject to the maximum dividend permitted under the current regulations.
  • CPSE’s will have to issue bonus shares if their reserves and surplus is equal to or more than 10 times of its paid up capital. Further, all CPSEs have to consider issue of bonus shares if their reserves and surplus are more than 5 times of the paid up capital.
  • The order has replaced the general guidelines on splitting of shares, by mandating that every CPSE, whose market price or book value of its share exceeds 50 times of its face value, will have to split its shares to make it affordable for retail investors. (Source Financial Express)

A quick look at some of the CPSEs we track reveals that many of these firms meet the stated criteria. The chart indicates likely corporate action by these PSUs.

  • In green are the firms that pass the criteria for the corporate action.
  • We have also calculated the dividend payable threshold, in crores, for the firms per these guidelines. It is still subject to the maximum dividend permitted regulations.
JainMatrix Investments

The new norms applied to a few PSUs

Benefits:

  • Most of these new norms are very good and uniformly benefit all shareholders. Buy backs improve the Earnings per Share of the firm, and should soon raise their market prices. Dividends, splits and bonuses are shared by both GoI promoters and all other shareholders.
  • This is also superior to the Follow on Public Offer method of encashing the GoI’s PSU shareholding, which was damaging to the share price and generally manipulated by the market participants.
  • Funds raised from these divestments/ sales should be used for infrastructure, education and capital expenditures rather than mere funding of deficits. Of course one can only hope for this kind of discipline from the GoI.

Open questions:

The real challenge before the government is to decide if it wants the CPSEs to become:

  • Independent institution and public owned firms, like ITC and L&T, benefiting the broad investing public, or
  • Owned by strategic partners/ new owners, like Maruti Suzuki, where they take over the firm for a large ownership premium, benefiting the coffers of GoI.

Either way, I have a feeling the CPSEs, PSUs and who knows, maybe even PSBs, may once again become valuable for the public shareholders !!

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DISCLAIMER

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an Investment Advisor. Punit Jain is a registered Research Analyst (SEBI Registration No. INH200002747) under SEBI (Research Analysts) Regulations, 2014. JM has been publishing equity research reports since Nov 2012. Any questions should be directed to the director of JainMatrix Investments atpunit.jain@jainmatrix.com.

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CPSE ETF – Unlocking Value, Slowly

The CPSE ETF NFO was launched in March 2014, and JainMatrix Investments had evaluated this offer and rated it a BUY. See this report – LINK. See post NFO note – LINK. We now review this ETF for its performance so far and evaluate it as an investment today.

Summary

  • The ten CPSE ETF firms are well known, high dividend, asset rich Indian PSUs’.
  • Investors have got a return of 27% (absolute) and 18.8% (annualized) in 17 months.
  • The prospects of the ETF firms look good. The govt. is executing on long pending structural reforms such as oil prices decontrol, subsidy reduction, power sector refocus, etc. On the whole, the CPSE ETF firms are expected to perform well.
  • The 20% fall in the last 45 days gives investors an opportunity to enter at better value.
  • BUY the CPSE ETF with a minimum 1 year perspective.

Introduction

  • Date 14th Sep-2015
  • Mutual Fund Nature – Large and Mid Cap PSUs ETF
  • Issue Price – Rs 17.45 post discount for retail category (FV – Rs 10, Premium – Rs 7.45)
  • NAV – Rs 20.8
  • Advice: Buy

CPSE ETF Description

  • The Central Public Sector Enterprises ETF Index was started to help the GoI disinvestment.
  • The Fund Manager, Goldman Sachs listed the CPSE ETF in a New Fund Offer on 4th April 2014.
  • The ten firms included in this ETF are well known, high dividend, asset rich Indian PSUs’.
CPSE ETF, JainMatrix Investments

Fig 1 – Sector weights, JainMatrix Investments

CPSE ETF, JainMatrix Investments

Fig 2 – CPSE Performance, JainMatrix Investments

  • We can see from the Price history of CPSE ETF, Fig 2, that within 2 months of launch, it hit its high of Rs 27.95. It was steady at 24+ levels till early Aug 2015, but has fallen almost 20% to 20.8 today.

Performance Review and ETF Outlook

Now here is a look at the ETF performance since the NFO listing.

CPSE ETF, JainMatrix Investments

Fig 3 – Investment Performance , JainMatrix Investments

CPSE ETF, JainMatrix Investments

Fig 4 – CPSE Shares and Outlook, JainMatrix Investments

  • Investors have got a return of 27% (absolute) and 18.8% (annualized) on the ETF. Fig 3.
  • Being an ETF, this fund invests in and tracks a weighted average of share prices of the stocks listed in Fig 4. In addition, we capture the share price gains and dividend over 6.5 years.
  • JainMatrix Investments had pegged an expectation of 24% from this ETF for the first year. This was achieved, but in the last 2 months, the ETF NAV fell due to the to the Coal India, ONGC and GAIL shares fall.

Pros of ETF

  • The GoI is making efforts to energize these firms to achieve production & revenue targets that will achieve national objectives. This will benefits investors also.
  • Many of these firms own wonderful assets, the family silver of the Govt of India. These firms may also enjoy monopoly status, and may be the implementation arms for govt. initiatives.
  • We can see that the GoI is in the process of dismantling the Administered Price Mechanism in Oil & Gas, and allowing Coal India, ONGC, etc to truly work freely without govt constraints and subsidy systems. If this is done, the massive assets and value of these firms can be unlocked.
  • The CPSE ETF has a low management charge at 0.49% as the stocks and weightage is fixed.
  • The weighted average share price appreciation over last 6.5 years is 11.8% for the firms. See Fig 4. This of course can vary widely from year to year. Dividend yield for these stocks is 3.67%.
  • Tax benefits: Individual resident investors would gain from nil tax on Long term capital gains, which kicks in at 12 months for this equity oriented fund.

Cons of CPSE ETF 

  • The ETF is dominated by the Oil & Gas, Power and Coal sector, where we have seen in the last one year a rapid fall in global commodity prices. This has affected the ETF performance.
  • This fund is Oil & Gas heavy with a 60% weight. If one extends the description to Energy Sector with Coal, Power, Oil & Gas and related financing, it increases to 92%. This is a high sector risk.
  • The GoI is in the process of disinvestment in PSUs, including some of the CPSE firms. This typically lowers share prices in the short term, till this process is complete. There is also talk of a second CPSE fund.
  • Decontrol of prices in petrol /diesel sector has affected Oil E&P while benefiting OMC firms.
  • Power sector reforms are crucial for financial improvement and debt reduction. This has started, but even so the power sector financial firms may see uneven performance.
  • Most of these stocks are asset heavy and resource rich firms. Their performance depends upon revenue growth, which has slowed down in recent years.
  • Another sharp fall in global oil prices can again depress the CPSE ETF performance.

Overall Opinion

  • There should be a stabilization and recovery in the ETF from here basis the following:
    1. There has been a massive fall in Oil prices globally. However now, it does not appear that there will be a further sharp fall. Thus ONGC share should not fall much further.
    2. Coal India and GAIL disinvestments should be complete in the next 3 months.
  • The prospects of the ETF firms post the above events look good. The government is cleaning up on long pending issues with structural reforms such as oil prices decontrol, subsidy reduction, etc.
  • Coal India performance (with Railways support) has improved of late. They are tasked with utilization of massive coal deposits and good supply which will reduce the need to import coal and waste forex.
  • On the whole, the CPSE ETF firms are expected to perform well.
  • BUY the CPSE ETF with a minimum 1 year perspective.

DISCLAIMER

This document has been prepared by JainMatrix Investments Bangalore (JM), and is meant for use by the recipient only as information and is not for circulation. This document is not to be reported or copied or made available to others without prior permission of JM. It should not be considered or taken as an offer to sell or a solicitation to buy or sell any security. The information contained in this report has been obtained from sources that are considered to be reliable. However, JM has not independently verified the accuracy or completeness of the same. Punit Jain has a small retail investor holding in CPSE ETF since NFO. He also has small holdings in the firms CIL, IOCL and EIL mentioned in this report. Neither JM nor any of its affiliates, its directors or its employees accepts any responsibility of whatsoever nature for the information, statements and opinion given, made available or expressed herein or for any omission therein. Recipients of this report should be aware that past performance is not necessarily a guide to future performance and value of investments can go down as well. The suitability or otherwise of any investments will depend upon the recipient’s particular circumstances and, in case of doubt, advice should be sought from an independent expert/advisor. JM has been publishing equity research reports since Nov 2012. JM has applied for certification under SEBI (Research Analysts) Regulations, 2014. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com.

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