Markets
Will PSUs lose their thunder in Modi 3.0?
Summary
Formation of a coalition government exposes the stocks of PSUs to certain risks. Coalition members would have at least some say in politically-sensitive sectors such as fuel and power that affect almost the entire population directly.
The shares of various public sector undertakings (PSUs) grabbed investor attention fuelled by the government's thrust on reforms. In the last one year, the S&P BSE PSU index zoomed by 94%, beating the benchmark index Nifty 50’s 22% returns. But the Bharatiya Janata Party (BJP) failed to secure a majority on its own in the 2024 general elections.
So, formation of a coalition government exposes PSU stocks to certain risks. Coalition members would have at least some say in politically sensitive sectors such as fuel and power that affect almost the entire population directly. Prominent PSUs operating in these sectors such as Hindustan Petroleum Corp. Ltd (HPCL), Bharat Petroleum Corp. Ltd (BPCL) Indian Oil Corp. Ltd (IOC), Oil and Natural Gas Corp. (ONGC) and National Thermal Power Corp. (NTPC) are susceptible to any populist policies that do not allow a fair return on capital with policy interference.
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Impact of fuel price on elections
Fuel prices especially petrol, diesel and liquefied petroleum gas (LPG) play a crucial role in politics. The BJP government was conscious of allowing the oil marketing companies (OMCs) to recover their past losses caused by absorption of the surging crude oil price. Hence, it did not ask OMCs to reduce fuel prices despite a decline in the average Brent crude oil prices in FY24 to $82 per barrel from $95 in FY23. As BJP had a majority of its own, it could do so. But going forward, there could be potential friction with alliance partners to keep the fuel prices low irrespective of the international crude oil price and financial health of the OMC.
Any negative for HPCL also impacts ONGC with the former being a subsidiary of the latter. As it is, the upstream companies like ONGC are already not being allowed to benefit from higher crude oil prices owing to the windfall tax. It may be asked to share some more burden of OMC if the need arises. The windfall tax was $10 per barrel for ONGC when gross realization was $82 per barrel in FY24.
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Subsidized rates for power
Janata Dal (United), a key coalition party headed by Nitish Kumar, faces state assembly elections in 2025. Kumar has been demanding electricity at subsidized rates from NTPC and other central producers. There could also be a demand for free agricultural power along the lines of Andhra Pradesh, under the control of Telugu Desam Party (TDP), the other coalition partner.
Even if NTPC is not going to directly offer the discounted power as the subsidy burden is generally borne by the respective state electricity boards (SEB) or distribution companies (Discom), the financial health of Discom might be affected resulting in overdue receivables for NTPC.
Before the Modi-led government came to power in 2014, SEB or Discom suffered from financial distress with accumulated losses of more than ₹3 trillion and debt burden of over ₹2 trillion. It was because of inefficiencies, high transmission and distribution losses, and financial mismanagement. The power sector reforms saw the introduction of several initiatives aimed at addressing the financial and operational inefficiencies in the power sector, including the Ujwal DISCOM Assurance Yojana (UDAY) scheme. The reforms could again get disarrayed.
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Meanwhile, the PSUs engaged in the defence sector are at a low risk of policy interference. Some of the companies like Hindustan Aeronautics Ltd (HAL), Bharat Electronics Ltd (BEL) are already sitting on high order books of ₹94,000 crore and ₹76,000 crore respectively. Based on FY24 topline, the book-to-bill ratio i.e. order book to annual sales ratio of these two companies is almost at 3x and 4x that gives revenue visibility for the foreseeable future. The risk in these companies is timely execution and rich valuation multiple. Further, metal PSUs like Steel Authority of India Ltd (SAIL) and National Aluminium Co. Ltd (Nalco) are generally immune from policy changes by the government as their product prices are not as politically sensitive as fuel and power prices.
To conclude, notwithstanding the high dividend yield and low valuation of some of the PSU stocks, especially OMCs, risk averse investors may steer clear of them, for now.
