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Jul 01, 2014, 04.58 PM IST | Source: Moneycontrol.com

PSUs-Reforms a better play than just disinvestments: Emkay

Improved markets and fiscal imperatives will likely place PSU disinvestments and relate reforms at the centre stage of government policies. Expect government to frontload disinvestment mobilization in excess of Rs600bn in FY15, says Emkay.

Emkay's report on India Strategy

Improved markets and fiscal imperatives will likely place PSU disinvestments and relate reforms at the centre stage of government policies. We expect government to frontload disinvestment mobilization in excess of Rs600bn in FY15. Amid increase supply and rich valuations, we identify PSU plays and high dividend candidates.

Disinvestments and non-tax revenues critical for fiscal management: In the context of declined tax elasticity, due to weak corporate profits growth hurting direct tax collections, NDA-II government will need to contain expenditure growth. Our simulation (based on nominal GDP growth of 11% over next 3 years, tax elasticity of 0.9 and higher mobilization through disinvestment plus non-tax revenue) suggest that growth in revenue expenditure should ideally average 6.5% for fiscal deficit/GDP to decline to 3% by FY17. However, our base case assumption is less drastic; revenue expenditure growth of 10%, (implying 150bp higher FD/GDP in FY17 over the 3% target). Higher than optimal spending growth will hence, necessitate large fund mobilization through disinvestments and dividend payouts and other non-tax revenues (spectrum sales etc).

We project cumulative realization from non-tax revenues (65% contributed by dividends, spectrum sale) and disinvestments rising to around 32% by FY17 of net tax collections from 22% in FY13, implying annual average mobilization of Rs 3000bn under these two heads during FY15-FY17

PSU disinvestment requirement expected to be large, approx Rs 600bn: Given the strain on operating cash flows amid weak profitability and large dividend payouts in the recent years imply that additional funding requirement will need to be met by higher disinvestments. Alternately, if government thinks of improving profitability before divesting, such companies will become dividend candidates. We expect average annual disinvestment requirement over the next three years at Rs 600bn, ex PSU banks (vs interim budget target of Rs519bn). Given that average mobilization has been 57% of the target in the past 4 years, the targeted amount could be much higher

PSU index jumped 43% riding on reforms expectation, Valuations look rich: BSE PSU index has doubled since Aug’13 and risen 43% YTD in the hope that reforms will reverse the somnolent earning cycle for PSUs. FY15/16 earnings estimates have moved up 16% and 15% respectively since Mar’14, implying YoY expansion of 33% and 11% respectively. The current PE discount of 24% to Sensex for our PSU index is close to 15-year low. Given this recent run-up and ripe valuations, government may consider front loading disinvestment in FY15 and balance out the burden subsequently

How do we play the Indian PSU stocks? In our view, while the current valuations for PSU companies are favorable for the government, having priced in the optimism, it will be paramount for the investors to look for exact measures that can create value in the wake of potential large supplies of PSU equities.

Theme 1: Disinvestments unsupported by structural reforms will likely underperform in the face of higher supplies. Avoid BHEL , SAIL

Theme 2: Large disinvestments backed by structural reforms to create win-win situation for government and investors. Prefer ONGC , Oil IndiaIOCL and to lesser extent  Coal India (rich valuation)

Theme 3: Privatization of low hurdle (minimal union issues, profitable operations and clean balance sheet) non-core PSUs to create significant value opportunities like Balmer Lawrie, Concor, and Tide Water Oil. Privatisation of non-core businesses but having significant hurdles unlikely to materialize. Avoid Hindustan Copper , Nalco , National FertilizerOrissa Minerals & Rashtriya Chemicals

Theme 4: Based on our Dividend payout-RoA and Dividend yield-payout matrices we identify key contenders for dividend plays viz Concor, BEL,  MOIL and NBCC , Neyveli Lignite , GAILNMDC and Coal India .

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BHEL SAIL ONGC
Oil India IOC Coal India
Hind Copper NALCO NFL
Orissa Minerals Rashtriya Chem MOIL
NBCC Neyveli Lignite GAIL
NMDC

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