Investors can hope for some action in PSU (public sector unit) stocks, after a long and disappointing period of underperformance. The BSE PSU index has fallen 13% since January while the Sensex rose by 18%, but that may be about to change. Recent news of the government’s in-principle approval for stock buy-backs in PSUs could be a boon to the share prices of Bharat Heavy Electricals Ltd (Bhel), NBCC (India) Ltd and NTPC Ltd. Most PSU stocks have been languishing as a result of lacklustre performance and buy-backs could be the pick-me-up the doctor ordered.
If the buy-back is at a premium to the prevailing market price, which is normally the case, it may trigger a short-term rally. The Bhel stock, believed to be the most promising candidate among the PSUs for a buy-back, shot up 9% on 7 September, when the news hit the Street.
Another reason adding to the attraction of a stock buy-back is that the idle cash lying with the firm is used to reward shareholders. A buy-back up to 10% of the net worth can be done without shareholder approval. PSUs such as NBCC, Bhel, Coal India Ltd and the recently listed Hindustan Aeronautics Ltd have enough cash on their books and a 10% buy-back is unlikely to disturb cash flow for these firms.
On the other hand, a buy-back is also likely to help the government in many ways. It will extinguish equity permanently to the extent of shares bought back. This will boost earnings per share and consequently improve the valuation of the firm. Return on equity (ROE) will go up too. This may support PSU stock prices. Note that most of these shares have turned north only in the last one month, as news of buy-backs started doing the rounds on the Street.
A report by Nomura Research underlines the benefits: “For years, PSUs have suffered from poor capital allocation practices in India, with accumulated cash which is used either for unproductive or poorly planned capex. As such, cash distribution through any form is a welcome change, in our view, and boosts ROE near-term and makes a case for a structural re-rating."
The government will, of course, kill two birds with one stone. One, stock buy-backs can pull up valuations. Two, the government will get money into its kitty—the need of the hour, given the pressures on the fiscal deficit and the pressures a higher fiscal deficit will have on the external account, especially in these turbulent times in the market.
Also, the other route of garnering funds through disinvestment of equity may not be appropriate at the moment, as markets are in poor shape, with macroeconomic pressures weighing on sentiment. Buy-backs would then probably be the best way to raise money for the government.
Of course, the fact remains that even if buy-backs lift the stocks of these PSUs temporarily, the performance of these companies needs to improve before the Street takes a sustained interest in them.