From white elephants to powerhouses: How PSUs are thriving amid government reforms

Reflecting these changed dynamics, PSU stocks, too, have displayed robust profitability growth and strong market performance in the past couple of years. In the past 12 months, the BSE PSU index has outperformed the large-cap and broader equity benchmarks. The BSE PSU index has rallied 96% in the past year (as of July 31, 2024), while the benchmark BSE Sensex and BSE 500 have surged 23% and 37%, respectively. In fact, select PSU stocks have surged by up to 660% in this period.

Aamar Deo Singh, Senior Vice President of Research at brokerage Angel One, says the government’s focus on infrastructure and manufacturing sectors has helped PSUs. “Special stress on railways and defence also helped many of the PSUs deliver solid performance and further, the priority given to ‘Make in India’ also aided in this stellar growth. Also, the thrust on infrastructure in terms of building highways, power [assets], ports, and airports have also helped the PSU pack,” he says.

Investors, however, are concerned about the comparatively high valuations and future growth prospects because of factors such as volatile commodity prices, execution-related issues, global and domestic macro challenges, and doubts on the continuity of the government’s focus amid a change in structure from single-party majority to a coalition at the centre. For instance, Himanshu Kohli, Co-founder of wealth management firm Client Associates, says the momentum in the PSU stocks will not continue as the focus now will be more on quality stocks that offer growth at a reasonable value.

Breaking the Shackles

Why were PSUs called white elephants? While such firms are major players in key sectors such as banking, energy, and defence, their performance was hit by macroeconomic and microeconomic conditions. As a result, many were considered a burden on the exchequer because of their piling losses and heavy dependence on government funding to remain operational.

Dhimant Kothari, Fund Manager at Invesco Mutual Fund, points out that between FY15 and FY20, India faced high fiscal deficit and challenges like demonetisation, a brief disruption and reset in the momentum of economic activities during the implementation of GST, the IL&FS crisis, and the pandemic. The financial space saw slow credit growth and rising credit costs, with a few public sector banks (PSBs) facing restrictions on growth due to the Reserve Bank of India (RBI) imposing prompt corrective action (PCA). RBI imposes PCA on banks showing signs of financial stress. As a result, PSBs witnessed a 14% compounded annual fall in earnings between FY15 and FY20, with a few of them reporting net losses.

Then, systemic reforms introduced by the government, its focus on domestic manufacturing, and high capex spending were aligned with the objective to increase the public sector’s efficiency and productivity. Besides, the mitigation of several sector-specific bottlenecks and deadlocks also helped PSUs recover from losses. “In the case of PSBs, their balance sheets got cleaned up by FY21 and the banks improved their capital adequacy with the government infusing capital,” says Invesco’s Kothari. A pick-up in economic activity after Covid-19 helped “them to improve credit growth and recoveries of past bad assets helped strong growth in profitability as well”, he adds.

Senior government officials and industry experts, however, note that this journey to profitability has been through a carefully planned strategy, and that the focus on ensuring that PSUs remain a major contributor to the economy will continue. “PSUs are amongst the profitable corporates in the country as of the 254 operating PSUs, 74% are profitable,” says Atul Sobti, Director General of Standing Conference of Public Enterprises (SCOPE), which is the apex body of the country’s public sector enterprises. He points out that PSUs registered gross revenue of Rs 38 lakh crore for FY23, which is equivalent to the GDP of a country like Singapore. “They are wealth creators, which is reflected in the present market capitalisation of PSUs, wherein only 57 listed PSUs (which is only 1% of the total listed companies on the BSE) form more than 10% of the market cap on the BSE,” he says.

According to him, PSUs have managed to reach this position because of efforts to adapt to the changing dynamics and meeting global benchmarks. “Their commercial success can be attributed to COT—capacity expansion, outreach, and technology advancement,” he says.

Finance ministry officials point out that now the focus is on value creation, rather than lining PSUs up for stake sales and seeking high dividends. “The main aim was to professionalise them and their operations so that they can compete with the private sector,” says an official source, adding that efforts were also made to listen to and address their problems. “There is also a continuous review of their position in terms of Miniratna, Navratna and Maharatna, as well as future planning of their performance,” the source explains.

In fact, on August 30, the government approved the upgradation of four more central public sector enterprises (CPSEs)—RailTel Corporation, Solar Energy Corporation of India, SJVN, and National Hydroelectric Power Corporation—to Navratna status, taking the number of such PSUs to 25. Navratna status is bestowed on top-performing PSUs, and they are permitted to undertake investments of up to Rs 1,000 crore without the approval of the central government.

Finance Secretary Tuhin Kanta Pandey, also Secretary at the Department of Investment and Asset Monetisation (DIPAM) who holds charge of the Department of Public Enterprises as well, explained the government’s strategy at an earlier interaction, adding that it looked at PSUs’ performance standards and added new criteria to it. “Also, we looked at how the management perceives its role and we said that only revenue generation is not adequate; other criteria such as profitable growth, bottom line, top line, Ebitda margin rate, return on capital employed, return on equity (RoE), [and] asset turnover ratio are also important as these are very relevant from the point of view of shareholders,” he had said.

Pandey said PSUs must strive for a consistent dividend policy, which is not aimed just at maximising dividends but also ensures that there is sufficient capital to plough back into the business. “These are the brass tacks or fundamentals. But performance and communication of that performance to the market are also critical factors,” he underlined. “If we do not value their (PSUs’) contribution as majority shareholders, how do we expect minority shareholders to value them?”

In a reflection of their robust performance, PSUs have already paid Rs 16,099.85 crore as dividend to the central government this fiscal.

The domestic economic momentum and the focus on capital expenditure are also seen as growth drivers for several CPSEs. K. Sadashiv Murthy, Chairman & MD of Bharat Heavy Electricals Ltd (BHEL), in the company’s annual report for 2023-24, highlighted domestic economic momentum as one of the growth boosters for BHEL. “The Indian economy, supported by domestic demand, consistent policy measures, and infrastructure development, is growing steadily, creating business opportunities. Your company has seized these opportunities, achieving its highest ever order book in FY24, with significant growth in both power and industry segments,” he wrote in a letter to shareholders.

Shantanu Roy, CMD of BEML Ltd, also mentioned the role of the domestic economy in the company’s performance. “Despite global uncertainties, the Indian economy has demonstrated remarkable resilience, achieving robust growth rates driven by strong performance across manufacturing, services, information technology, and agriculture,” he wrote in BEML’s annual report for FY24, noting that as the fifth-largest economy with a projected growth rate of around 7%, India offers a wealth of opportunities.

Meanwhile, Union Minister of Heavy Industries H.D. Kumaraswamy recently said that CPSEs will have a big role to play as India aims to be among the Top 3 economies in the next few years. “CPSEs will have to move forward rapidly and increase their role in the development of the country. This development should be sustainable and environmentally friendly,” he said at a recent conference on the annual performance review of CPSEs.

The Banking Story

Sector-specific policy reforms and investments have also boosted PSUs. Bad loans or non-performing assets (NPA) of PSBs had been a major concern in the past decade. According to CMIE Industry Outlook data, when the BJP-led NDA government took charge in FY14, the Gross NPA (GNPA) for PSBs was at Rs 2.17 lakh crore, and GNPA as a percentage of gross advances was at 4.7%. When RBI initiated an asset quality review to clean up bank balance sheets in 2015, PSBs’ GNPAs spiked from Rs 2.79 lakh crore in March 2015 to Rs 5.4 lakh crore in March 2016 and peaked at Rs 8.96 lakh crore in March 2018.

Then, RBI’s clean-up measures started showing results. In FY23, GNPAs had dropped to Rs 4.28 lakh crore or 5% of gross advances. The clean-up of balance sheets led to rapid growth in the profitability of PSBs. Robust credit growth also helped. CMIE Industry Outlook data shows that in the past 10 years, PSBs’ total outstanding credit has surged over 90% to Rs 87.55 lakh crore in FY24. Credit growth also picked up in the past three years, with a 40% increase recorded since FY21.

Invesco’s Kothari explains that PSBs as a set witnessed solid earnings rebound, with 43% CAGR between FY21 and FY24. The non-financial segment also recorded 22% earnings CAGR in that period. PSU companies now report a healthy RoE of 17%, which is likely to sustain for the next couple of years .

Defence Driving Growth

The Indian defence sector is known to be saddled with red tape, project delays, and cost overruns, but in recent times, it is emerging as a world-class hub with a robust local manufacturing ecosystem. With over 100 firms exporting defence equipment, the government expects the figure to cross Rs 50,000 crore by FY29.

The government’s focus on self-reliance and growing a manufacturing ecosystem has boosted India’s defence production and exports. CMIE Economic Outlook data shows that in the Union Budget 2024-25, the government allocated Rs 6.22 lakh crore to the defence sector compared to Rs 2.54 lakh crore in FY14. Similarly, the government has spent Rs 12.73 lakh crore on capital outlay for defence services (including BE of Rs 1.72 lakh crore for FY25) over the past 11 years.

To better understand the transformation of defence manufacturing in India, let us take the example of two tanks. Arjun Mk I is India’s main battle tank. Its design began in 1986 and was completed in 1996, and the tank entered service in 2004. But even after investing decades on the Arjun Mk I, the army is heavily dependent on Russian-origin tanks. On the other hand, India’s indigenous light tank ‘Zorawar’—jointly developed by the DRDO and Larsen and Toubro (L&T)—recently went through test trials. It took just two years from design to trials and the tank is likely to be inducted into service by 2027.

Per government data, India’s annual defence production hit a record high of Rs 1.27 lakh crore in FY24 with a growth of 16.7% year-on-year; it was a 60% increase since FY20. Of the total value of production in 2023-24, about 79.2% has been contributed by defence PSUs/other PSUs and 20.8% by the private sector. Meanwhile, defence exports grew 31-fold to Rs 21,083 crore in FY24 from Rs 686 crore in FY14, reflecting India’s growing clout in the global defence manufacturing market.

Defence Minister Rajnath Singh has announced that the government’s objective will be to focus on domestic production and increase defence exports in the times to come. “Our target will be to export over Rs 50,000 crore worth of defence equipment by 2028-29,” he said recently.

The Path to Profits

As a result of these efforts, the profitability of PSUs has rebounded in the past couple of years. According to ACE Equity data, between FY14 and FY20, the combined annual profit after tax (PAT) of the 58 listed PSU stocks on the BSE PSU index had hovered in the range of Rs 1-1.5 lakh crore. But profitability has gained momentum since, and in FY24, the combined PAT was Rs 5.15 lakh crore, registering 367% growth in the past four years. Profit levels at several PSUs, too, have surged in the past 10 years. The top performers are Life Insurance Corporation of India (profit surged 24x), Bharat Petroleum Corporation (6x), and Indian Oil Corporation (6x).

PSUs have also become wealth generators for the government by providing record taxes and dividend, along with a high market valuation—should the government choose to disinvest. ACE Equity data shows that since FY20, 54 PSUs have registered a 259% increase in taxes paid, at Rs 1.61 lakh crore in FY24. Additionally, in FY23, PSUs contributed Rs 77,000 crore to the government’s coffers, registering an increase of 72% since FY20. According to Budget documents, in FY22, there were 201 PSUs among the 1.03 million companies that filed electronic tax returns. Their share in total profits was 17.46% and their share in the total tax liability was 13.07%.

The Road Ahead

What does the future hold for PSUs? Sobti of SCOPE says PSUs have emerged as world-class institutions. Some other factors will enable them to maintain momentum on the productivity and efficiency fronts. These include effective productivity because of economies of scale, exploring newer export markets, investments in skilling of employees, and any move towards energy transition to meet net zero goals. “Recognising the power of innovation, PSUs are making investments in R&D as well, which can be seen from the fact that while the nation spends less than 1% of its GDP on R&D, some PSUs like HAL, Bharat Dynamics, BHEL, Coal India etc. are spending 2-9% of their revenue on R&D,” he says.

Singh of Angel One is also optimistic. “Stronger balance sheets and sizeable order books for the foreseeable future bode well for these companies but ultimately, going forward, execution will hold the key for future performance,” he says. The Budget holds promise for many of these companies, so the way forward looks exciting, he adds.

Deepak Jasani, Head of Retail Research at HDFC Securities, however says no specific sops to PSUs for manufacturing have been provided in Budget 2024-25. The bullish commodity cycle, increased orders from the government, Make in India initiative, greater freedom to PSUs, and stiff targets for revenue and profits from them are some key reasons for the improvement in their performance. PSUs are riding the momentum of revenue and profit growth, he says. Unless the reasons stated above abate or reverse, there is no reason for the growth momentum to stall or reverse, though there may be a change in the pace, he adds.

While a majority of experts are positive on the profit outlook for PSUs, some are concerned about the higher stock valuation, which might hinder their market performance in the short term. Overall, those tracking PSUs can look forward to an exciting journey.

@PrinceInMedia, @surabhi_prasad