Invest in PSUs but not due to Modi factor

Central PSUs outperformed those in Gujarat in past decade, both on revenue and capex

Government-owned companies are on fire at Dalal Street. In the past month, the market value of public sector companies (PSUs), excluding the banking & finance and oil & gas sectors, is up 41 per cent, compared to a 21 per cent rise in the benchmark S&P BSE Sensex during the period.

The bulls are betting on faster growth in government-owned companies. The optimism is based on assumption of a general revival in economic growth under the new government in Delhi and a good show by Gujarat government-owned companies under Modi rule.

Betting on a Modi touch for a sharp turnaround in PSU fortunes seems ambitious. There is no conclusive evidence to suggest that Gujarat PSUs grew faster than central PSUs during Modi rule in Gandhinagar. In fact, central PSUs (excluding oil & gas and financials) outperformed Gujarat PSUs on both revenue growth and capex. During the 10 years ending March 2013, central PSU revenues grew at a compounded annual growth rate (CAGR) of 14.9 per cent from around Rs 1.25 lakh crore in FY03 to 4.36 lakh crore in FY13. During the period, Gujarat PSUs revenue grew at a CAGR of 13.5 per cent to reach Rs 17,188 crore in FY13 from Rs 5506 crore in FY13.

At 17.7 per cent, the Gujarat PSUs' operating profit grew faster than central PSUs (15.3 per cent). However, this was largely due to Gujarat State Petronet Ltd (GSPL), incorporated in 1998 and having begun operations in 2001. Excluding GSPL,the operating profit of Gujarat PSUs, grew slower at a CAGR of 13.3 per cent in the past qo years. The analysis is based on 41 listed central PSUs and six Gujarat PSUs. Central PSUs were also more aggressive in capacity expansion. Their gross block (cumulative investment in plant & machinery) grew at a CAGR of 11 per cent during the 10 years ending FY13, faster than the 9.7 per cent reported by their Gujarat peers during the period (see chart).

The gap remains the same even if we take five years data. Gujarat PSUs are, however, ahead of central PSUs in terms of leverage ratio and return on equity. With a debt to equity ratio of 0.9, the latters balance sheet is nearly twice as leveraged as the former (0.5). In FY13, Gujarat PSUs reported a return on net worth of 15.2 per cent, ahead of central PSUs (14.9 per cent). The difference is due to loss-making central PSUs such as HMT and MTNL, and the poor profitability of Steel Authority of India, National Aluminium and Hindustan Copper due to a global slump in metal prices. Besides, Power Grid Corp with a debt to equity ratio of 2.5 accounts for nearly a fifth of the debt of all central PSUs.

The message is clear. Bet on PSUs if you want to gain from a secular revival in growth and a global upturn in the commodity cycle but discount the Modi factor. In last ten year, PSUs have quadrupled their balance sheet but growth eluded them due to a slump in domestic demand.

An economic upturn will flow directly into their bottom line given their conservative finances and market leading position.