You may love listed public sector companies for their dividends or hate them for their snail’s pace of growth. But in 2015 and for the next two-three years, you sure cannot ignore them. With the Government’s ambitious target of raising ₹58,425 crore from divestments in 2014-15, we are likely to see a slew of share issues — both new and follow-on issues from public sector firms. Also, SEBI’s mandate to bring public shareholding in public sector undertakings (PSUs) to at least 25 per cent by June 2017 will see the Government selling stake. So, with the PSU segment likely to be action-packed in the next few years, should you load up on them or give them a pass?

Lessons from history To answer that question, let us take a look at how PSUs that issued shares in the last five years have fared. Since 2010, six PSUs, including two banks, debuted on the exchanges; there were eight follow-on public offerings (FPO) and 13 offers for sale (OFS).

Not unsurprisingly, stock performance data shows that more often than not, PSU performance was, well, dismal. Many, such as Minerals and Metals Trading Corporation (MMTC), have left investors terribly poorer.

Imagine that you invested ₹1,700 to buy one share of MMTC in early 2010. Now you would be left with just ₹60 — 96 per cent value erosion.

The wealth destruction story is broad-based, with just a few exceptions. One such exception is National Building and Construction Company (NBCC), which has rewarded patient investors quite handsomely. NBCC’s stock listed in April 2012 for ₹106 and languished at these levels for over a year-and-a-half. But it picked up steam in late 2013 and is now nearly eight times its IPO price. Even Coal India has seen its stock price appreciate by 55 per cent from its listing price over the past four years.

So what lessons can an investor draw from state-run companies that have delivered good returns to shareholders?

Size does not matter Stellar performance by Coal India, a behemoth with a market capitalisation of ₹2,41,064 crore and NBCC, a mini entity with a market capitalisation of ₹9,928 crore, shows that size does not matter.

On the other end, NTPC, which towers high, as well as the small-sized State Trading Corporation (STC), failed to yield returns.

Takeaway: Danger lurks in all sizes

Discount dividends The assured handsome dividend paid by PSUs every year is one of the attractions for investors. But, data shows that companies that are generous in handing out cash have performed poorly on the bourses.

A case in point is NMDC with a dividend yield of 6 per cent currently. If you had bought the stock five years ago paying ₹427, you would be left now with just a third of the price you paid.

Takeaway: Rich dividend payment does not mean good health

Timing matters Investment pundits discourage timing the market, but right timing makes all the difference for PSU investments. Sample this. The BSE PSU index, which includes 61 public sector companies and banks, had a spectacular one-year return of 43 per cent last year. But five-year returns are a negative 12 per cent. As most PSUs operate in cyclical sectors, their performance is subject to large swings. Therefore, investing when the tide turns can help you beat the broader market returns.

Takeaway: Look for a good entry point

Be selective on sectors PSUs tend to be concentrated in a few sectors such as power, banking, oil and gas, metals and mining.

Clearly, a few sectors such as oil and gas did better than others, such as mining and agriculture.

Non-banking financial companies such as Power Finance Corporation and Rural Electrification Corporation (REC)served their investors better than the rest of the pack, averaging 5 per cent annual returns.

Takeaway: Take note of the sector’s prospects

IPOs beat follow-on offers Contrary to the wisdom that a known devil is better than an unknown angel, IPOs fared better when compared with follow-on offers. Four non-banking entities listed in the last five years — Coal India, NBCC, Satluj Jal Vidyut Nigam (SJVN) and MOIL. Of these, investors who subscribed to Coal India and NBCC were richly rewarded. While SJVN’s share price languishes near its IPO price, investors received 4 per cent annual dividend in this period. Investors in MOIL were not so lucky, losing around 3 per cent annually even after taking dividends into account.

In contrast, only four of the 17 FPOs and OFS turned out positive.

That said, IPOs of banks — United Bank of India as well as Punjab and Sind Bank — were not very successful. These banks raised capital in 2010, when the market was hot, to meet the higher capital requirements that were to come into effect in 2013.

Takeaway: Follow-on offers not very successful

Look beyond numbers

Stocks of companies such as NMDC with net margins of 50 per cent lost value, even as others such as BPCL with low margins (1.5 per cent) performed well. Likewise, other financial litmus tests, such as strong cash position, do not seem to influence returns. One example is National Aluminium with a hoard of cash, but the stock has not performed well.

Good earnings growth did not necessarily translate into stock price appreciation as in the case of REC. Its earnings per share grew 24 per cent annually during 2010-14 but the stock price moved up only 6 per cent annually in that period. Value PSU picks — those with attractive earnings multiple — also do not seem to pan out. Shipping Corporation of India (SCI), which was trading at a trailing earnings multiple of 13 times at the time of its FPO in late 2010, turned loss-making in the last three years.

Takeaway: Companies that sport good numbers may still not guarantee returns

Action plan Being armed with these lessons should help you when the floodgate of divestments is opened. There are 36 entities where the Government holding is above the SEBI mandate of 75 per cent.

Stake sale is mandatory to meet the SEBI norms by June 2017. While selling stake in profit-making entities may be easy, how the Government will handle the loss-making ones, such as HMT, is not known.

New faces

Three IPOs are said to be planned for completion in 2014-15 and are expected to mop up ₹6,000 crore.

These include ₹3,000 crore from the aeronautical major Hindustan Aeronautics (HAL), ₹2,500 crore from steel maker Rashtriya Ispat Nigam (RINL) and a smaller issue of ₹500 crore from hydro-power producer Tehri Hydro Development Corporation (THDC). Of these, steel maker RINL has filed its Red Herring prospectus.

The company makes steel products for the construction and infrastructure sectors. Operating margins have been healthy but have been falling. Also, lack of captive mines exposes it to volatility in raw material prices. Lack of other products such as flat steel also adds to the risk. Its listing may be deferred as the company’s operations were hit by last year’s cyclone.

The prospect for HAL, which develops aircraft for the defence department, does not appear too bright. Given the sensitive nature of its operation, the company does not plan to disclose all the information in its prospectus and may also bar foreign investors. Future growth depends on the success of its new product developments.

There are lingering doubts about the future of THDC. A proposal to merge four central hydro-power companies — National Hydroelectric Power Corp (NHPC), North Eastern Electric Power Corp (NEEPCO), THDC and SJVN — into a single unit, is currently on. Investors can wait on the sidelines till clarity emerges on this front.

Cash cows

In the near term, however, the Government may tap its regular cash cows rather than try its luck with new debuts. This includes companies such as ONGC, Coal India and NHPC, which top the list of potential candidates.

Of these, Coal India’s output is likely to see improvement, given the Government push.

Also, emphasis on underground mining and labour productivity improvements could boost production over the next few years. The company will also benefit as better rail linkages are created to transport coal.

Likewise, oil and gas major ONGC seems to be on a firm footing. However, there is one significant aspect that investors need to watch out for — the Government’s policy on subsidy sharing. Stay away unless there is a clear, transparent and firm policy stance on subsidies. Hydro power producer NHPC’s growth may be watered down due to operational issues, such as cost over-runs due to project completion delays, as has happened in the past. Also, there are no major upcoming capacity additions.

It is also likely that the Government may divest stakes in refiners such as HPCL, BPCL and IOC. These may be good bets for investors. Another strong PSU that may be tapped is SAIL. In spite of weak demand for steel, the company’s volumes increased in the half-year ended September 2014.

SAIL is at an advantage compared with other steel makers as it has access to captive iron ore mines. Currently, however, there are concerns about weakness in global steel price and lack of meaningful pick-up in domestic demand. Nonetheless, given its prospects, it offers a good buying opportunity. Likewise, investors can consider Bharat Electronics in the capital goods sector, Engineers India (EIL) in services, Power Grid Corporation of India and NTPC in the power segment.

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