Product Focus

1st Dec 2009

Sundaram BNP Paribas PSU Opportunities Fund

J. Venkatesh, Fund Manager Sundaram BNP Paribas PSU Opportunities Fund

WF:  In your presentation,  you have talked about the valuation gap that exists between PSUs and private sector players and you talked about PSU’s being at a 40% lower PE compared with their private sector players. What in your view would be the key drivers that will help  PSU’s  close this gap over the next couple of years.

Venkatesh:  The driver could be the increasing realization on the part of market players, that PSU’s as an asset class are having a lot of strong points playing with them.  Like if you look at, PSU’s are a good proxy for India’s long term growth story, because they are having monopoly or dominant leadership in many of the key sectors like, Energy Financials, Securities and Materials, which form core of India’s growth story.

So people would realize and the most of the PSU’s are growth companies, like if you look at SAIL would move from 13 million tones capacity to 25 million tones capacity in 2 years time.  If you look at NTPC will move from 30 thousand Mega Watt to some  50 thousand Mega Watts in next 2 years time.  There are lot of growth opportunities that are available in the PSU side. When people start realising that these companies are good growth companies and are a proxy to India’s long term economic growth story, there would be a realization that these valuation gaps are unjustified. These companies are having higher dividend yield and good corporate governance and very good land value, there are lot of positives that goes for these companies.   With the Government now committed to the divestment process, there is an increasing realization on the part of the owners mindset that they should interfere less or even if they do something, to mitigate the economic impact. If you look when Mr. Chidambaram announced the farm loan mela, he has not spelt out where the money is going to come from, there was a fear that the bank’s balance sheets would be utilized for paying the amount but it has not happened – the entire burden was taken by the Government.

If you look at the PSU’s financials, most of the PSU’s financials are at maybe 1.2 to 1.5 times book value when compared to private sector peers which are going at 2.5 to 3 times book. Infact if you look at ROE’s of these companies,  several PSU banks have Return On Equities that are higher than the private sector players.

At some point of time there will be a realization that these valuation gap is unjustified. Take the case of ONGC :  if you value ONGC on EV per BOE basis ( Enterprise Value per Barrel Oil Equivalent) basis its going at just around 5 dollars, globally the bench mark is between 8 to 13 dollars.  Cairn India today it is 12 dollars per BOE.

WF:  Sure, and in your opinion one of the catalyst for that would also be the divestment program – which will throw a spotlight on these companies.

Venkatesh :  See most of the companies are not been well understood by the market players, there is not much sell side research on these companies. Once these companies come out for divestment,  there will be a lot more visibility for them.  When NHPC came for listing,  people began to realise what are the projects they are into and what will be the kind of revenue they will have. There is a lot of information sharing that happens from the PSU’s which were not there earlier. So these things will help in re-rating these stocks.

WF:  When we talk about divestments, there is one issue that some people were little worried about. Your view is that increased free float will help increase institutional interest in the stock, which can help re-rate it. On the other hand, there is a concern that the increased free float may actually depress the PE and depress the share prices atleast in the near term, because the floating stock has increased. To what extent do you think that these fears are justified?

Venkatesh: We don’t share the views that the increase in floating stock will depress the valuation.  A lot of FII money that comes in by way of investments by ETFs and MSCI Index trackers are weighted on the basis of available free float.  As the free float increases, the weightage of that stock in the index will rise – and automatically, all money that comes into index trackers, will allocate more funds into those stocks – to stay aligned with the index.  This will enhance demand for that stock, which can help it get re-rated in the market.

WF:  There is one aspect which your presentation was a little silent on, which is about State Government PSU’s.  Would your fund also be looking at state government owned PSU’s which are also embarking on a similar process or would that be outside the purview of your fund?

Venkatesh: We will definitely look at the State Government owned private sector enterprises. There are a few companies in select states which are interesting. But, we will take a view based on the stands taken by respective Governments and underlying valuations and the attitude of the state governments towards these PSU’s

WF: A lot of the buzz around PSU is directly related to the government stated intentions to kick start the divestment program. Could you just tell us, what in your view are the some of the interesting divestment stories that you might be keen on tracking and what is the investment argument that excites you about these stocks?

Venkatesh:  There are lot of interesting companies which would come up for divestment in the near term. There are 110 public sector enterprises have are profit making companies which will go in for listing, over time.  There are a number of very interesting ideas within this set.

For example, we don’t have a large listed natural resource play in India today. If Coal India gets listed, with its size, it could easily command a market cap of Rs. 1 lakh crores.  Any increase in realizations can significantly enhance the company’s bottom line, given its size and scale.

Another interesting play could be Hindustan Aeronarutics Limited which is an aircraft manufacturer. We don’t have any listed companies in that space today. Think of a situation where the Government decides to list Airports Authority of India Limited. Today, we have companies that manage single airports like GVK and GMR.  But, Airports Authority, which is already into profits, can easily get a good market cap and substantial investor interest.

At some point of time, think of a possibility of LIC getting listed. The list is endless, the opportunities are plentiful.