Cash-rich PSUs may give stellar returns in next 2 to 3 years

Last week many listed public sector undertakings (PSUs) announced buyback (as much as 25% of paid up capital) of their shares from the shareholders. However, the domestic equity markets haven't reacted in any significant manner to a majority of these PSU stocks for two reasons.

Firstly, there is a wrong perception that the PSU stocks generally do not create wealth in the domestic stock markets. Secondly, some of the cash-rich PSUs, which have announced buybacks, made more profits through the interest income from the cash holdings rather than from the operating profits from the core business in the latest quarter. For example, for some of these companies, the interest income accounted for 55% to almost 100% of PBIT (Profit before interest and tax), based on annualised profits of the latest quarter.

In contrary to the belief of the PSUs not helping the investors in creating wealth, several times the PSU stocks have created substantial wealth over the last two decades. For instance, during the period 2001 to 2015, the market cap of stocks like Neyveli Lignite, NMDC, etc, moved up 8-35 fold. In the same period, the market cap of Bharat Electronics moved up 13 fold, and even a PSU bank like Andhra Bank saw its market cap jumping 10-fold.

The Lehman crisis in 2008 led to a crash in the whole domestic equity markets including the market cap of PSU stocks. However, when the markets recovered, the PSU stocks once again rose substantially. Over a block of a 5-year period ending 2010, the market cap of PSU stocks like Neyveli Lignite, Andhra Bank and NMDC rose 100%, 200% and 800% respectively. Even if we take the most recent example, Bharat Electronics has risen almost 4-fold now from its 2014 bottom price.

Thus, in the Indian equity markets, what matters is not the tag of private or public ownership. Rather the market cycle, sectoral prospects and balance-sheet strength are the key points in wealth creation. Since at present the core operating profit is negligible for the PSUs which have announced buybacks, the investors are worried that the free cash would be drained out for financing the buyback offers, and hence, the interest income would come down.

Therefore, many investors believe that these offers are not EPS accretive (no jump in earnings per share despite a reduction in equity capital). However, a simple arithmetic exercise would reveal that as and when the core business of these companies improves, their earnings from operations would jump 33% on per share basis for a 25% reduction in the equity capital. Hence, these buybacks along with improvements in the core business of select PSUs would lead to substantial wealth creation in the next 2 to 3 years.