Invest talk: Privatisation offers investment opportunity in PSUs

Public Sector Stocks have not been my cup of tea. They have been, at best, trading opportunities. My stance is that I will look at them only after ownership changes. Promoter quality is important. PSU ownership has resulted in inefficiencies and leakages that have translated in to low ROCE.

Commercial expediency is overtaken by political goals. The PSU stock prices follow a pattern of optimism and despair. So far, since the first issuance of PSU stocks to UTI in the nineties, there have been at least four swing cycles in prices of PSU Stocks. I have always looked at them as Balance Sheet plays (take the replacement cost of the assets and the debt) and used a substitution of the Price to Book ratio as buy/sell indicators. There is always some noise around them, so there is a cycle of hope and giving-up-hope which causes the price swings. Forget the earnings and other things. Just look at these price trends and take a dip. Use Price to Book as the anchor and track trends for last ten years or more. Buy when it comes close to the historical lows and sell off before it touches the historical highs.

This is what I advocate and the limitation is that the wait for a turnaround could be long. The bottom can never be precise. Selling will be probably before the top. However, I am fairly confident that this strategy fetches positive returns that should be decent. Remain focused on price. Buying an asset for below cost price will fetch returns so long as the underlying business is good. Companies like SAIL, NALCO, BHEL, etc are natural candidates for this play. Of course, some companies where the government policies are extremely hard on the business may not behave well. Mining is one such example. Or power.  Recall the case of Indraprastha Gas. The government suddenly put a cap on the rates and then after a long wait, the matter was decided in favour of the company by the Supreme Courts.

Regulatory risks are high. Looking now at newly elected state governments cancelling the contracts that the previous government signed, the risk is spreading to the private sector also. Companies in infrastructure are the worst sufferers.

PSUs have enjoyed a natural monopoly. The private sector, then, was shy of waiting for profits and hence the government was forced in to business. One would think that they would be money spinners. Alas, corruption and poor staffing plus lack of management skills have made them all in to mediocre companies. Maybe one or two have done well, but still most have very poor ROCE or ROE.

Privatisation is the new hope that is giving these stocks another lease of life. Some companies have been identified for privatization — In other words, the government will sell its stake and also hand over the Board Room keys to the buyer. This is a big game changer, if executed well and the new owners are capable businessmen. Ideally, the stake sale should be through global tenders. The government can insure itself against underpricing, by giving itself some structured paper that gives it a play on the upside up to a period of one to two years from sale.  However, in a global tender sale, it will not be needed.

Yes, there will be obstacles. The trade unions are going to fight. The challenge of working for the private sector, in a performance-driven milieu, is anathema.

They are used to fixed annual increments irrespective of talent and performance, undue perks that could include subsidised housing in prime locations, pensions etc. And of course, overstaffing. No private owner will tolerate this. Maybe there could be a standstill agreement for a few years, but a good owner will know how to get rid of surplus or unwanted labour. The new owner will need to get far higher ROCE.

Political challenges will come in the way. If we recall previous PSU exits, I can think of IPCL (which was acquired by Reliance and then merged in to itself), Hindustan Copper (still a battle for the price of final exit), VSNL & CMC Ltd (acquired by Tatas) are some which come to mind. So it is not impossible.

We have to hope that the disposal is done through a transparent and optimal route, where global players have a chance to bid for them. The bogey of foreign ownership should not come in the way. After all, the infrastructure is in the country and the power to legislate is with the government.

In this environment, the challenge for the new owners will be to improve the ROE to good levels. The older the PSU, the better are the chances. With privatisation, the other important condition is to let go of price controls and distribution controls. If something is being let loose in to the private sector, it should be under free and open market conditions.

It is tough to take a call on investing in anticipation of privatisation. The wait could be long and there could be a lot of ups and downs before the actual event. I would like to see who the new owners are before I take a call. The prices may be higher, but I would be on surer grounds. For those who are impatient, the advice is to go slow.

(The writer is a veteran investment adviser. He can be contacted at balakrishnanr@gmail.com)