Why PSUs like NBCC and BPCL are becoming hot stock market bet

State-owned companies, from builders such as NBCC to oil firms such as Bharat Petroleum Corp Ltd, are attracting top investors as cheap valuations, improving earnings, and share buybacks make them stand out in an otherwise expensive market.

A government move to increase taxes on dividends has spurred these cash-rich companies towards buying back shares for the first time to reward investors, but supporters say the allure extends beyond that.

Many of the biggest state-owned companies are in the oil and gas sector, which is benefiting handsomely from a government decision allowing them to set prices – effectively turning them into regular profit-seeking businesses.

Valuations are also cheap. As a result the Nifty Public Sector Enterprises (PSE) Index has surged nearly 17 percent since the start of June, handily beating the 6 percent gain in the broader Nifty 50 index, or NSE index, over the same period.

“They are good strong companies, good balance sheets – no issues there,” said Mahesh Patil, co-chief investment officer, Birla Sun Life Asset Management, which has $22 billion under management.

“They had seen some pain due to the cyclical downturn. (But) I think public sector undertakings (PSUs) as a theme have the potential to re-rate.”

This new-found investor appeal marks a turnaround for a category that had typically underperformed private sector peers and was seen as composed of poorly-run and bloated mammoths.

To be sure, not all state companies are doing well, with banks continuing to struggle with bad loans while other companies such as power equipment maker Bharat Heavy Electricals have suffered from strong private sector competition.

Buybacks, however, remain attractive: Four state companies, including Coal India announced nearly 150 billion rupees ($2.24 billion) in buybacks between May and July, and analysts expect more to follow suit in the year ahead.

The share buybacks follow the introduction in February of an additional tax on dividend income of more than 10 million rupees as a way to generate more state revenue.

But strong earnings potential is now an attractive element as well, reflecting the number of state companies concentrated in sectors with fast-improving prospects.

After two consecutive years of declining profits, companies in the Nifty PSE Index are on average expected to show a rise of nearly 10 percent in full-year profit for the year ending in March 2017, according to Thomson Reuters data.

Builder NBCC Ltd has surged nearly 22 percent so far this year on expectations that earnings will grow 30 percent in the year ending March 2017.

BPCL, set to report quarterly results early next month, is up 29 percent so far this year and hit a record high this month.

Despite the expected recovery in earnings, state companies in the Nifty PSE index are trading at a one-year forward price-to-earnings ratio of about 14 times – well below the NSE’s price-to-earnings ratio of 18-19 times or the NSE’s historic 10-year average of about 15 times.

“The Government’s initiative to revitalise PSUs through policy and monetary measures, seems to have begun to bear fruit, especially within the energy and power segments,” said Paras Adenwala, an investment manager for Capital Portfolio Advisors.