Shares of state-run countries rally on reform hopes; some urge caution

By Sumeet Chatterjee and Tony Munroe

MUMBAI (Reuters) - Shares in unloved state firms are soaring on hopes Narendra Modi, the country's next prime minister, will push reforms to inject efficiency into underperforming giants like Coal India .

Industries including banking, oil marketing and coal are dominated by state firms, a legacy of the country's socialist past. They tend to trade at deep discounts to private sector rivals, but propelled by hopes for reform and an improving economy, the index of state companies is up 37 percent since the start of March, outperforming the 14.2 percent gain in the BSE Sensex. (http://link.reuters.com/wyg49v)

As Friday's vote-counting showed a resounding win for Modi's opposition Bharatiya Janata Party, the state companies index was up 3.6 percent, while the Sensex index was up 0.9 percent - even though the state index trades at 10.4 times forward earnings, compared with the 15.2 times forward price-to-earnings for the broader market.

As chief minister of Gujarat, Modi was credited with reforming bloated government firms such as Gujarat State Fertilizers and Chemicals Corp and Gujarat Alkalies and Chemicals Ltd .

State firms, known as public sector undertakings or PSUs, are often overstaffed and used to dole out jobs and other political favours.

"One of the things Mr Modi did after coming to power here as chief minister is to get the politicians out of the boards of the state PSUs," said Ram Mohan T.T., who teaches finance and accounting at the Indian Institute of Management in Ahmedabad.

"They were in trouble partly because of the pronounced political interference and he got rid of the politicians and brought in professionals. If he can do that, that will be a big move," he said.

PSUs are also vulnerable to industrial disputes and project delays - as are many private sector firms.

Coal India, the world's biggest coal miner, often falls short of output targets due to employee strikes, delays in approvals to expand mines and India's inadequate railways.

"Outlook for PSUs should improve significantly, because of a lot of operational improvements that could happen in government companies," said S. Naren, chief investment officer at ICICI Prudential Asset Management Co, whose biggest state holdings are State Bank of India and Power Grid Corp .

RISE SUSTAINABLE?

Despite the current enthusiasm for PSUs in the market, plenty of investors remain wary of state companies.

"I do not get the rally in state-run stocks. Most of them have run up on valuations and (stake sale) hopes, which is not sustainable," said Phani Sekhar, fund manager at Angel Broking.

Premal Madhavji, head of India equities at Espirito Santo Securities, said the rally is driven by sentiment and that operational improvements are unlikely for at least a year: "I would not recommend a buy at this level on these stocks."

The financial sector in one area where change is expected.

Bad loans at state banks are far higher than in the private sector. Modi is expected by some watchers to push for selling down government stakes in state banks and reducing state influence in their management.

An improving economic outlook under Modi would also help restore the health of bank balance sheets.

Meanwhile, oil marketers Indian Oil Corp , Bharat Petroleum Corp Ltd and Hindustan Petroleum Corp Ltd have borne the brunt of fuel subsidies that were a hallmark of the outgoing Congress government.

"They (state firms) have been sub-optimally managed by the government for many years, but Modi operates differently. He will make them more accountable to public shareholders," said Tarun Kataria, chairman of advisory firm Cityspring Management.

(Reporting by Sumeet Chatterjee and Tony Munroe; Additional reporting by Abhishek Vishnoi and Himank Sharma; Editing by Kenneth Maxwell)