PSU Stocks: Deep Value Or Value Trap?
There is a general feeling among investors that PSU stocks make for a safe bet during economic downturns due to the high dividend yield they provide. However, after years of underperformance, do these stocks still hold the promise of good returns? Join Anthony Fernandes as he looks at what is in store for this largely beaten down segment.
When a storm hits the sea, it is the land that seems to be the safest. In that context, when the virus pandemic hit the world, investors around the country looked towards safe sectors to protect their capital. Out of the many sectors one can stay invested in during these tough times, public sector units (PSUs) are often considered safe bets by many. The high dividend payout that often characterise these stocks is a much-needed relief during times of economic downturn, and hence many investors look to allocate a certain percentage of their portfolio to PSU stocks at any given time. That being said, these stocks have been far from safe havens.
The Sensex rose from the levels of 17,570.82 to 33,780.89 during the past decade, generating an absolute return of 92.26 per cent and an annualised return of 6.75 per cent. But people who invested in PSUs have been left disappointed. The BSE PSU index shrank 47.87 per cent on an absolute basis or 6.31 per cent on an annualized basis during the past 10 years, falling from 9,204.33 to 4,798.04.The performance of the PSUs has not been any different over the short term as well. While the Sensex has dropped by around 15 per cent on a one-year basis, the BSE PSU index lost a massive 37.37 per cent during this period.
On a YTD basis, the BSE PSU index has fallen by 31.35 per cent whereas the BSE Sensex has fallen 18.22 per cent. It was only over the last month that PSUs outperformed the bellwether index. It has been a similar story when it comes to mutual fund investors who relied on the PSU theme. Over the long term, PSUs have not given investors anything to cheer about. Even though some of the PSU-themed mutual funds did better and generated positive returns during this period, these were too meagre to offer any comfort.
Of the total 57 PSU companies included in the BSE PSU index, only four companies have managed to deliver positive returns to the shareholders as yet in this year whereas the stocks of the remaining 53 have tumbled significantly. Of these, 24 companies have been correcting by over 30 per cent in the above mentioned period. Out of the top performers was Gujarat Gas which gained 22.07 per cent on an YTD basis and remained relatively unaffected by the pandemic crisis that gripped the nation.
Other performers included Ircon International and MOIL Limited which saw comparatively modest gains of 9.08 percent and 4.01 per cent respectively. Majority of the PSU banks were hit the worst during this period and that can be seen when looking at the bottom performing PSU companies. Bank of Baroda, Canara Bank and Punjab National Bank saw their value erode by around 50 per cent during this period.
Does this mean that PSU stocks are worthless? The answer to that question is a firm ‘No’. Many PSUs have wider economic moats and play a pivotal role in nation-building, so much so that they cannot be easily replaced. One need not look further than the banking space in the country to see why. Given the recent fiascos that some cooperative and private sector banks have experienced, it’s safe to assume that PSU banks are going to be pretty much relevant for a considerable period of time.
So, considering that these stocks have fallen by a large extent, it is crucial to know whether this fall is justified or are the markets overreacting as they do on many occasions. Do PSU stocks really offer a great value at this juncture? Or is there a value trap? Going by the simplest metric of valuation – the price to earnings (PE) ratio – PSUs have become cheap. The PE ratio of the BSE PSU index in June 2020 was 7.83x as compared to the five-year average PE ratio of the index which is 19.47x.
The price to book (PB) ratio during June 2020 for the index was 0.76x, indicating that most of the stocks are even trading below their book values. The dividend yield during this period has remained an impressive 4.58 per cent. The financials of PSU companies in oil, power, banks, the NBFC space, etc., suggest that the performance of the majority of these companies has been largely stable. The key issue, therefore, is why these PSU stocks sharply underperformed and if this underperformance is not warranted by fundamentals, what can explain the sharp fall in the prices of these stocks?
Privatisation: The Buzz Word
The current government’s plan to privatise some of the big PSUs has been seen as a bold step at a time when the economy is experiencing significant economic downturn during the virus outbreak with revenue collection targets under stress. In the recent economic stimulus package, the government stated that there will be a maximum of four public sector companies in strategic sectors, and state-owned firms in other segments will eventually be privatised. The centre has fixed a budget target of Rs 2.10 lakh crore from disinvestment in the current fiscal, of which Rs 1.20 lakh crore is expected from CPSE disinvestment.
The privatisation of state-owned firms is likely to fill in the management gaps, unleash capital, and facilitate wealth creation opportunities for investors. There is a very good chance that ownership change could help companies to become more focused on return optimisation, which is an essential part for investors. The problem does not lie here. Rather it lies with the path chosen by the centre to go about with the divestment. The piecemeal divestment by the government is seen by many as one of the reasons that can explain the poor performance of PSU stocks.
Like any commodity, the price of the stock is decided by demand and supply. Piecemeal divestment over a period of time increases the supply on a regular basis. As this continued selling pressure remains, the price of the stocks is forced downwards. The privatisation of several big companies is also politically sensitive and therefore the government has chosen to do it in a way of exchange-traded funds (ETFs), especially CPSE ETFs. Under this route, a pre-decided mix of PSU stocks is offered at a discount, which in turn incentivises the arbitrager or short sellers to invest in ETFs and exit after the ETF is listed. Since mutual funds have to sell PSU stocks to redeem their units, they end up creating more supply of the PSU stock.
Fortunately, there appears to be a shift in government stance from ETFs back to the NDA era policy of strategic divestments, according to Tuhin Kanta Pandey, Secretary, Department of Investment and Public Asset Management (DIPAM). This change should remove the overhang of the regular supply of PSU shares through ETFs in the market. Strategic divestments could unlock significant value over the medium term, as was the case in strategic divestment done in 2002.
In the recent economic stimulus package, the government stated that there will be a maximum of four public sector companies in strategic sectors, and stateowned firms in other segments will eventually be privatised.
Conclusion
The truth is that neither all PSU stocks are bad nor are all private sector stocks good. While it is true that PSUs have certain limitations like rule-driven decision-making, alignment for the greater good of society and limitations on hiring and compensation, some of the most successful companies in India in power generation, transmission and oil refining have come from the public sector. On similar lines, a large number of problems and significant wealth erosion has even occurred in several private sector companies, especially in the NBFC space, banking and telecom. Hence, it is not right to make blanket judgements on a stock based solely on ownership.
An investment should be based on the sustainability of the business, its competitive advantages, growth prospects and valuation. As of now, whether or not the trend of underperformance of PSU stocks ends remains to be seen. In our view, significant underperformance by a sector despite stable financial performance leads to undervaluation and will ultimately create an opportunity for the future. This underperformance should end in the long run, because just like water finds its own level, stock prices eventually converge with the business fundamentals.