What is your broad hypothesis for the PSU space in India which was never regarded as investment grade in the first place till some time back?
Basically when we are talking about the PSU space, there are three key drivers that we see at this point of time. The first driver is the valuation itself. Most of the PSUs are trading at single digit PE on FY22 basis and even when we look at our in-house model, a lot are actually factoring in negative value from a longer term perspective which basically means that the market is expecting that earnings will decline for most of these companies going forward beyond the foreseeable future. There is a huge amount of margin of safety in terms of valuations for PSUs.
The second driver is natural resources prices. We know that most of the natural resource prices — be it hard commodities or soft commodities — have been on an uptick and they have been surprising everybody for the last 12 months because of several reasons. The recovery in the developed market is higher than what one would have expected as well as the supply constraints and we know that one of the big parts of the PSU space is dominated by natural resources companies — be it the ONGC or GAIL or SAIL or Nalco. Clearly from an earnings tailwind perspective, these companies benefit from high natural resources prices.
The third important driver is disinvestment by the government. Clearly this is something which has been there for a long period of time but the recent disinvestment of Air India has certainly given one more leg up and higher confidence in terms of the capability of the government to execute and go ahead in terms of the disinvestment.
So margin of safety in valuations, high natural resources prices and potential disinvestments are the key drivers for the re-rating in the PSU space.
When you speak to institutional clients, where do you find maximum curiosity because if the PSU basket is broken into different categories, one is PSU banks which is considered investment trade. The lower ones are trading only. Then there are defence PSUs where there is huge interest. Then there are the structural divestment candidate PSUs. What kind of conversations are your clients having regarding PSUs?
It will be a little wrong on my part to paint the entire space with the same brush. Different clients have different appetites and different investment mandates. A few people will be more interested in structural stories like defence which has nothing to do with disinvestment but is a longer term structural story.
Then there are investors who are looking for value and those people will be interested in PSU banks given the fact that most of their pain in terms of the bad loans is behind them. Then there are investors who are looking at unlocking value through the disinvestment route. So investors are taking their own picks and their own way of looking at things depending on what their investment philosophy and investment mandate is.
What are the other revaluation triggers you see in some of them?
It will be difficult for me to talk on a stock specific basis. We know that at the end of the day the market always respects earnings so as soon as the earnings tailwind comes through, investors will start to get interested in the stocks. High natural resources prices clearly are one of the big drivers of earnings and hence the interest in the PSUs.
Also, the potential unlocking of value from the disinvestment perspective will be another driver. In the past, when PSUs got disinvested, value accretion took place for the company as well as for the investors.
Have institutions started coming in this pocket or is it more of retail HNI right now?
We are seeing interest from institutional investors as well in the PSU space. For example, there will be some clients who were not willing to look at this space at all six months ago. At this point of time, they are willing to reconsider and have a look at it. So the interest levels are clearly going up.
What about the PSUs which are trying to improve their technological advantage, some of the defence oriented ones?
There is an initial interest in that space as well but more interest will come through as and when people start to see proof of concept. So, yes people are warming up to that possibility. There is a huge opportunity in the defence sector in terms of indigenisation of a lot of equipment in India. Clearly, that is going to throw up a significant amount of opportunity.
So you are saying that there is a big case for re-rating over here and one should be hunting for good quality ideas and this time this re-rating could be durable?
This can be durable like what we talked about if the earnings are supportive and some of these companies are able to get to the next level in terms of operations and capitalise on the opportunities that are going to be thrown up from an indigenisation perspective.