Is value unlocking a distant dream for PSUs?

Disinvestment

Coronavirus pandemic has thrown India’s finances into complete disarray.

On one hand, the country has breached its full-year fiscal deficit ceiling in just 4 months; on the other hand, the disinvestment plan of the government is making progress at snail’s pace. The success of the disinvestment plan is crucial for curtailing the fiscal deficit, which many experts believe is going to balloon to 6.5%-7.5% of GDP, against the target of 3.5% for FY21.

The disinvestment target for FY21 is Rs 2.1 lakh crore against which the government has managed to collect just Rs 5,696.63 crore as of now. Besides the steep target, the disinvestment plan for FY21 is strikingly different even in its approach.

Many market experts and even fund managers have opined that taking the strategic route versus ETF route has been the key change in government’s stance. It is expected to help Public Sector Undertakings (PSUs) unlock tremendous value. As you would know, PSUs is one of the few undervalued pockets in the markets at present.

The government has decided to take the route of strategic sales to offload its holdings in three listed companies—Bharat Petroleum (BPCL), Container Corporation (Concor) and Shipping Corporation of India (SCI). Plus, it intends to launch a massive Initial Public Offer (IPO) of LIC and sell stake in Air India as well.

Are mutual funds upbeat on government’s strategic sales?

Disinvestment

(Source: ACE MF)

Going by holding trends, mutual fund houses seem to be betting on value unlocking through the strategic sales of BPCL and Concor. That said, they haven’t shown much interest in adding SCI to their portfolios as yet.

20 schemes with highest exposure to BPCL

(Source: ACE MF)

What’s the on-ground progress?

 If you remember, the government communicated its intent to privatize BPCL in November 2019. Following this, there was tremendous brouhaha among market participants.

On March 07, 2020, the government had invited potential buyers to submit their Expression of Interest (EoI) for buying out its stake in BPCL.  May 02, 2020 was the initial deadline to respond. Owing to coronavirus pandemic, the deadline has been postponed thrice with September 30, 2020 being the latest.

Now that the deadline to file an EoI for BPCL is nearing and apparently there’s no response from any major player as yet, many experts are raising doubts about whether the government will be able to achieve the disinvestment target in FY21. BPCL has been the poster boy of the government’s new disinvestment approach.

Policy strategist and former Economic Affairs Secretary, Subhash Garg recently stated, “It seems that the Government would be at best able to sell BPCL this year (FY21) and would be able to do some small minority stake sale. With BPCL, the Government might end up with about Rs. 70,000-80,000 crore of disinvestment revenue and without BPCL, the realisation might be only in the range of Rs. 20,000-30,000 crore. 2020-21 is likely to be a washout year for privatisation and disinvestment of public sector enterprises and banks.”

And he’s not alone.

 Fitch Ratings recently termed the delay in privatizing BPCL as an event risk.

The slow progress has been due to a near halt in international travel to India and a generally cautious investment approach by most entities in current market conditions, in our view,” mentioned the independent rating agency in its report dated September 08, 2020.

“There is little information about bidders, valuation, and the potential transaction structure, especially as BPCL owns assets across many verticals and bidders may not be interested in all of them,” it pointed out further.

The essence of the BPCL story…

Despite the massive potential for renewables, India is likely to remain one of the world’s fastest growing fuel markets in which BPCL is a key player. With its 31.9 MMT (Million Metric Tonnes) refining capacity, BPCL enjoys 13% share in India’s total installed refining capacities. And amongst PSU oil marketers, BPCL’s market share was 24.5% in FY20.  Besides, BPCL also holds 12.5% in Petronet LNG and 22.5% stake in IGL.

Needless to say, any potential buyer with a huge upstream presence; i.e. any oil producing company investing in BPCL might kill two birds with one stone. One, it will become one of the key players in the Indian markets. Two, India being one of the largest importers and consumers of petroleum products will provide a hedge to its upstream business back home and in other markets.  

The government has set the net worth criteria of USD 10 billion for potential bidders. This has led to various grapevines pertaining to bids the government might be eyeing for its 52.98% in BPCL. At present, BPCL’s market cap is Rs 83,400 crore (close to USD 11.5 billion).

Is BPCL undervalued?

Last year, Aramco decided to pick up a 20% stake in the O2C (Oil-to-chemicals) business of Reliance Industries, which was valued at USD 75 billion. The O2C business of reliance includes oil refinery, petrochemicals and oil marketing business.

Face-to-face

O2C business of Reliance Industries includes oil refinery, petrochemicals and oil marketing business.
FY20 data considered
(Source: Company annual reports)

Going purely by numbers, it’s evident that BPCL might be undervalued at the current market price but numbers also talk a lot about the massive scope for improvement in operations. In FY20, BPCL failed to beat even the Singapore Complex GRMs.

On this backdrop, the lack of response from bidders to such hot cake could be startling for many. It’s noteworthy that the market cap of BPCL has eroded nearly 30% from its November high as the initial excitement about privatization fizzled out.

Big international players giving it a cold shoulder has now put a question mark on the entire disinvestment drive of the government.

The possible reason could be that there are too many moving parts to the privatization of BPCL.

The government has clarified that it will offer guidance on key issues such as employee protection, business continuity, lock-in of shares and asset sale, only to qualified interested parties at a later stage of bidding.  Approximately 60% of non-management staff went on a 48-hour strike at Kochi Refinery early this month—a sentiment dampener for potential overseas bidders.

Lately, government relaxed the definition of net worth. Is government signaling a softer stance and showing readiness for even bigger bargains?

360-degree analysis of BPCL’s progress on the disinvestment front suggests that the value unlocking may not come upfront and privatization could just be the beginning (and not the end) of a long-drawn value unlocking process.

Privatization may result in:

  • Better governance practices
  • Cost optimizations
  • Focused growth

Many experts opine that the disinvestment of BPCL is happening at a time when the refining margins could perhaps be bottoming out. If an international player of high repute picks stake in BPCL, the premiumization of products might happen at a faster pace. Adoption of international practices in cost and resources management could be value accretive as well.

Bottom line

Investors shouldn’t get swayed by the disinvestment theme.

PSUs might offer you a deep value, but they have their own legacy issues as well. Streamlining operations and optimizing the resource utilization is the key metrics they often fall short to meet.

Investments in PSUs should be made only if long term fundamentals and core competencies of the company make sense. Gains of privatization might take a while to come through. As BPCL is the poster boy of India’s new disinvestment policy approach, the eyes of savvy investors would be glued to developments on this front. It will be equally crucial to track the activity of mutual funds.

Please Note (read as a disclaimer): None of the stocks discussed in the article are recommendations to buy, hold or sell. This could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.

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Disclaimer

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

Consult your financial advisor before taking any investment decision.

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflicts of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

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