With the top 10 PSUs sitting on a net cash of Rs1.4 trillion, Kotak Institutional Equities believes that the government can easily meet its fiscal targets without conducting ‘forced’ divestments
It is commonly known that there are ‘forced’ divestments of equity from public sector units (PSUs) simply to meet the fiscal targets of the government. Kotak Institutional Equities hence poses the question as to how to realise better value for public sector units. It suggests that the government (a) meet its divestment and fiscal targets for FY2014 through enhanced dividends from PSUs and (b) divest them later after improving their financials through a better policy framework.
The research firm adds that with the top 10 PSUs sitting on Rs1.4 trillion of net cash (as of 30 September 2012), the government can easily meet its fiscal targets without conducting ‘forced’ divestments.
The government should explore the option of higher dividends from cash-rich PSU companies. In particular, there is little logic for selling Coal India at depressed valuations when its stock price has come off due to the market’s expectation of an OFS (offer for sale) and coal pricing uncertainty. Coal India’s capex plan at Rs50 billion for FY2014BE is quite small relative to its humongous cash balance (Rs750 billion; end of FY2013E). More important, Coal India’s cash balance will keep on rising over the next few years despite its capex plans. Coal India can easily give Rs200 billion of dividends and dividend distribution tax (DDT) of Rs34 billion, with the government receiving Rs214 billion for its 90% holding.
One of the reasons for the weak performance of PSUs over the past one to two months has been growing concerns about use of cash. The government intends to use the cash balance of the PSUs as a way to kick-start the capex cycle. PSUs seem to be investing sensibly based on their core plans. Dalal Street has fears of PSU companies being made to invest in non-core businesses; this is true for NMDC with concerns about it being forced to invest in downstream steel plants.
Kotak argues its case on better valuations for PSUs (where there are divestments) as: “We believe clarity on pricing of output of PSUs (coal, iron-ore and oil) will provide investors more comfort on the earnings of the PSUs. In some cases, it could also lead to a meaningful re-rating of multiples and divestment proceeds for the government. In the case of the oil sector, the government can provide clarity on the subsidy provisions for FY2013RE and FY2014BE, which may address the market’s concerns on the subsidy-sharing arrangement for FY2013. Similar, renewal of small periodic increases in diesel retail prices will restore the market’s confidence in the reforms process. We do not think the government can afford to give the wrong signals to overseas investors by temporarily suspending reforms due to political compulsions.”
Kotak feels that the oil and gas sector is a classic example. The government can raise prices of natural gas without any major impact on the critical fertilizer and power sectors. The government will recover around 90% of the increase in fertilizer subsidy arising from higher gas prices through higher income tax, dividends, DDT and royalty. The earnings of ONGC and OIL will increase meaningfully concurrently, allowing the government to divest stakes in them later at much higher prices.