Market Manna

WHEN SHYAMAL CHHEDA (name changed on request), a senior executive with an information technology (IT) firm and a resident of Mumbai, invested ₹3 lakh in Rural Electrification Corporation (REC), a public sector undertaking (PSU), in August 2022, the price was around ₹138 per share. REC was about to give bonus shares and when that happened, his effective price became ₹99 per share. REC gave good dividends, something he had factored in. Within a year of his purchase, REC had paid about ₹15 per share as a dividend, which meant he got far more annually from his capital than what he could get out of a fixed deposit (FD). But why doesn’t everyone then buy REC shares instead of putting their money in FDs? Because, usually, the stock of such companies doesn’t move up too much, and the reason most people get into equities is because they want a rise in share prices. Also, there is no guarantee that a company will continue to pay such high dividends in future. Someone who had invested in REC in 2014 would have seen the stock remain flat until the beginning of 2023. Chheda’s earlier ventures into the stock market had been so-so and he hadn’t factored in any extraordinary jump in REC’s price curve. And that seemed to be how this one was also panning out. Then something unusual happened. REC’s price began to go up and up until he saw that it was close to five times what he had paid. His profit was 400 per cent in less than two years.

“It has been my most successful investment and it came purely by chance,” says Chheda.

To him, maybe it was chance, but REC is not an isolated phenomenon. An entire basket of PSU stocks has taken off in recent times. Historically, companies owned by the government didn’t get the same ratings as the private sector. Markets equate government control with inefficiency or subject to policies where the end objective is not profit optimisation. PSU stocks have often left stockholders exasperated because they always look very cheap and at a tremendous discount to private companies but never quite catch up. Now, it is as if they have been put on steroids.

To get an idea of the scale of this boom, take some of the best-performing stocks in the PSU basket between Febru­ary 1 of 2023 and 2024. The Indian Railway Financial Cor­poration went up from ₹31 to ₹170; IFCI Limited from ₹12 to ₹62; Housing and Urban Development Corporation Ltd from ₹46to ₹206; RECfrom ₹117to ₹494; Rail Vikas Nigam from ₹72to ₹297. As many as 47 PSUs had doubled their stock prices in that period.

Several factors are attributed to it by market observers. There is the immediate trigger of last year’s Union Budget, but, be­hind it, are the long-term changes instituted in PSUs since 2014, when the National Democratic Alliance (NDA) came to power. Anirudh Garg, partner & head research, INVasset PMS, a portfolio management service, was one of those who spotted the trend early. When their Growth Fund launched at the beginning of 2020, they had around 25 per cent in PSU stocks. Late 2022, they began to in­crease the PSU component to 80 per cent currently. The returns of the fund over the last year sit at 96 per cent, as per their website, in comparison to 40 per cent over three years. Garg says that the trig­ger point for the PSU boom was last year’s Union Budget which gave a huge boost to capital expenditure (capex), pegged at ₹10 lakh crore, an increase of 37 per cent over the previous year.

“Where will the government spend ₹10 lakh crore on capex? It is either going to be used in railways, defence, upgrading PSUs, and things like that. As soon as they announced the capex, it changed the entire thing. Imagine it like a big wheel. When the massive gov­ernment funds came, that big wheel started to turn. And when that big wheel gains momentum, a lot of smaller wheels in terms of private capex join in. And when the private capex comes in, then the government doesn’t need to do it anymore,” says Garg.

If the capex announced in last year’s Budget was what flagged off the boom, the groundwork for it was laid almost as soon as the new regime took over. “The change didn’t happen now. It happened from 2014 itself. This government looked at the loop­holes making PSUs inefficient and started to fix them,” says AK Prabhakar, head-research, IDBI Capital Markets & Securities Ltd. One major reform that he thinks doesn’t get enough attention is how appointments of those heading PSUs changed, starting with instituting long tenures. “When someone has only six months, what they want is a safe retirement. When you give them more responsibility, more timeline to perform, give them five years— now, there is a gun to their head to prove themselves. There was also another aspect. The employee costs of PSUs were bloating. This government said you are not adding employees, only improving efficiency. Productivity of employees started to improve. There was deep debottlenecking of many of the units,” Prabhakar adds.

Professionals from the private sector were also brought in to lead units. The first public sector bank (PSB) to do this was Bank of Baroda in 2015 when a former Citibank senior executive came in as its head. PSUs also focused on modernisation and compe­tency that the markets recognised. Prabhakar cites the example of conference calls with investors of companies like NMDC Ltd, a mining PSU: “NMDC said they have appointed three consultants to give a road path to improve. This is what private companies do, appoint consultants and have a roadmap. Your PSU company is now doing it. They are moving to other countries to mine. They are behaving like a private company. On the concalls, you listen to anyone—PSU bank people or railway companies or defence com­panies or the mining companies, they talk like professional CEOs in the private sector. That is the difference which has happened. There is continuity of the policy. There is accountability for the policy. They are forced to meet investors and analysts; so, when they say something, they have to stick to that. The performance on the ground has improved. Their profitability has improved, and their cost has been reduced. Productivity per employee has improved. That is why the rerating has happened.”

ONE OF THE LEADERS of this rally has been several com­panies related to the railways. The last Economic Survey gives some idea of how much funds have been flowing into railways as compared to the past. The average annual capex between 2009 to 2014 on railways was ₹45,980 crore; from 2014 to 2019, it stood at ₹ 99,178 crore. Consider what it was for 2022-23. A whopping ₹2,45,800 crore, almost five times what it had been a decade ago. A research report by the wealth tech company Fisdom analysed some of the causes behind the railway stocks’ rise. These included the government’s plan to attract foreign manufacturing firms to make components locally, making standardised passenger coaches of two types from the present 28, revamping of rail infra­structure and redevelopment of over 500 stations. They pointed to the National Rail Plan that “outlines a comprehensive roadmap for expanding the railway network’s capacity by 2030, with a vision to accommodate growth up to 2050. The plan aims to transform the railway system into a future-ready infrastructure capable of not only meeting passenger demands but also increasing the railway’s share in freight transportation to a target range of 40-45 percent, a significant increase from the current 26-27 percent level.” All this is reflected in the order book of companies connected to the railways. Take the example of Rail Vikas Nigam Limited. An HDFC Securi­ties report on it says: “It has a strong order book visibility. RVNL has diversified into non-railway projects and over the past 2 years it has won orders worth ₹32,000cr through competitive bidding. It has also forayed into other geographies and is executing a project in Maldives and signed a [sic] MoU with Govt. of Kyrgyzstan. The proportion of orders won through competitive bidding has been increasing, thereby reducing its dependence on Ministry of Rail­ways nomination… Its orderbook of ₹ 67,000cr at the end of Q2FY24 gives a visibility of 3 years.”

Another sector among PSUs that has seen a big leap is power. REC, which Chheda had invested in, belongs to that group. Here, too, reforms have played a key role in these companies being re­rated by the stock market. A written reply by the Union Minister for Power and New & Renewable Energy RK Singh to a question in Rajya Sabha last December listed measures that led to a reduction in distribution losses. They included carrot-and-stick incentives for fiscal discipline, such as: “Putting in place revised Prudential Norms providing that no DISCOM [distribution company] or GENCO [generation company] of a State Government will be able to get loans from PFC/REC if the DISCOM is making a loss, unless the DISCOM, with the approval of the State Government, works out a plan for loss reduction and files it with the Central Government, and adheres to that loss reduction trajectories; Putting in place an incentive of an additional borrowing space of 0.5% of GSDP (Gross State Domestic Product) if the DISCOM puts in place loss reduction measures; Providing that loss making DISCOMs will not be able to draw funds under any Power Sector Scheme of GoI unless they put in place measures for loss reduction.”

Defence PSUs saw a run-up in their stock because the government pushed for domestic production. In five years, the price of Hindustan Aeronautics Limited (HAL) has jumped up close to 10 times. Last year, for instance, it signed a contract with Airbus to create a maintenance, repair and overhaul (MRO) facil­ity for the latter’s A320 family of aircraft. HAL’s press release said: “This collaboration with the largest European aircraft manu­facturing company will strengthen Make-in-India mission by achieving self-reliance in the aircraft Maintenance, Repair and Overhaul (MRO) industry in India. HAL intends to establish an integrated MRD services in India and seeks to provide the com­mercial airlines a one stop MRO solution.”

Garg says, “The Modi government was adamant about chang­ing two things when it came to defence. A lot of foreign exchange was going out for defence purchase which they wanted to stem. And also, we were not becoming aatmanirbhar when ordering from outside.” He thinks that the market attributes a “Modi premium” to PSU stocks. “In a company when we talk about annual reports, management and board meetings, we talk about the vision of the promoter. Then why not the vision of the pro­moter, the current CEO of India? If he has a vision, why not give a little bit extra factor to that? So, that premium is there.”

With such a big run-up in stock prices in a short duration, many of these stocks have swung from be­ing deep-value options to richly priced. Prabhakar advocates cau­tion for new investors wanting to get into the PSU boom. He cites the example of NBCC, formerly known as National Buildings Construction Corporation, whose stock price has quadrupled from around ₹35 to ₹150 in a year. ”They hardly make ₹300 or ₹400 crore of profit now for which you know the market cap is a little under ₹30,000 crore,” he says. If you divide the market cap by the profits, you get the price-to-earnings (PE) ra­tio, a popular metric used to evaluate whether a stock is cheap or expen­sive. NBCC’s PE comes to around 73. Prabhakar asks for that to be com­pared with the State Bank of India, which makes ₹65,000 crore in profit and has a market cap of just over ₹6,00,000 crore; its PE is only 9, despite being one of the biggest banks in India and also a consistent profit churner. He says NBCC trading at a PE of 73 is not reasonable. “There is froth in certain pockets of PSU stocks,” he says. He describes it as the “tsunami pulling along some stocks which shouldn’t see such high prices.”

Garg is more optimistic but says that there will be periods of correction where these stocks will see drawdowns. However, the story itself, he thinks, has some way to go until they reach valuations where it is not supported anymore. “Now, how long will that take? It’s a question that we need to contemplate and ask from time to time.”

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