PSUs: Torchbearers of Indian economy

Our public sector remains a very vital cog in the economy’s wheel. PSUs offer a mixed bag: champions among them are setting benchmarks even for the private sector while laggards are a matter of extra concern. Our survey checks them all on a variety of financial parameters to find out if which of them will continue to lead the Indian economy

Jai Mrug & Nihar Dave | December 24, 2015

 “Are there only two options before us [for PSUs] – either disinvest or close down? There is a third way, corporatise it, change its culture, make it apolitical, bring in efficiency.” – Prime minister Narendra Modi at the Hindustan Times Leadership Summit in New Delhi on December 4, 2015. 

True, the public sector undertakings (PSUs) need to be rejuvenated to prevent a drain of national assets. And their role is much more significant given the government’s desire to reduce fiscal deficit to less than 3.9 percent of GDP in 2015-16. 

According to reports, the government has already reached 67 percent target of its fiscal for this year within the first five months of FY 2014-15. This means that they might go more aggressive than the 3.9 percent target in the coming years. One of the ways of meeting the deficit target is to be able to generate enough revenue through the dividend that the PSUs pay to the government. In recent years India has relied more on the dividend from these companies to plug budget deficit goals.

READ: The PSU story unfolds

To put the numbers in perspective, it will be worthwhile to mention that finance minister Arun Jaitley had taken into account a record '362 crore dividend from state-owned companies in the current financial year, up 27 percent from last year and double the amount a decade ago. He also made an appeal for higher dividends in the last financial year, following the footsteps of a previous finance minister. 
Are we talking about state capitalism? Let us take a look.

Just five companies – Indian Oil Corporation (IOCL), Oil and Natural Gas Corporation (ONGC), Coal India, Bharat Petroleum Corporation (BPCL) and National Mineral Development Corporation (NMDC) – can provide 90 percent of the target if their net profit meets analysts’ estimates and they pay the same dividend rate as in 2014-15. Together they had free cash of $13 billion in the previous financial year.

READ: How we selected PSU outliers

This is where the analysis of not just the current performance of PSUs but also their role in the future becomes extremely important. It’s not just their current performance but also their ability to adapt and ensure consistent growth that is critical. Also crucial is their vision for tomorrow, reflected in softer aspects such as green initiatives, HR policies and investment in technology – both information and communication technologies and core technologies relevant to their line of operation. This needs to be captured separately.

The Governance Now-M76 Analytics research, the PSU 100 report, and the Governance Now PSU Awards thus set out on a journey that would help in identifying what the PSUs bring in as strength and whether they are investing in a meaningful tomorrow. The research into the PSU data also helped Governance Now measure the performance of the central public sector enterprises (CPSEs) across multiple financial parameters such as profitability, asset utilisation, long term strategic investments, etc. 


The research team also evaluated the overall financial performance, based on aggregation of performance on these individual parameters. In order to gain a macro view of the performance of PSUs, we evaluated the percentage of total PSUs performing better than the industry across all the parameters. The results were as varied as the nature of the PSUs itself – across different parameters, ranging from 25 percent of PSUs outperforming their peers on five-year income and asset CAGR, to an interesting insight that 53 percent of PSUs were performing better than their peers on one year profitability (See graph: Performance Average: PSU vs. Industry). However, on the whole, the PSUs lagged behind their peers in the industry in 4 out of the 5 parameters. 

However, this is where the Indian public sector companies have a stunner to show. Unlike what one would expect as a natural corollary to the parameter-wise comparison of PSUs vs. the industry performance, where one would assume the overall picture to not be very pretty, 51 percent of PSUs surpass their industry peers when it comes to overall financial performance, which is a cumulative measure of performance on all parameters. 

To find an explanation to this anomaly, we looked into the past. 
Legacy strengthens the incumbent 

Till the 1991 reforms, India was a highly regulated market. The public sector and a handful of private firms ruled the roost. Today, with decrease in regulations, new behemoths have emerged in the private sector, the share of public sector in GDP has dipped from approximately 35 percent to 22 percent and the landscape is changing rapidly. 

However, legacy still holds immense leverage; the proof of the pudding being the fact that five of the seven Indian firms featuring in the Fortune 500 list 2015 are PSEs: IOCL, BPCL, HPCL, ONGC and SBI. Restrictions and capital infusion from the government ensured monopolistic or at least oligarchic structures in most industries for a long time after independence. For example, IOCL commissioned its first refinery in the 1960s, while Reliance did so at jamnagar only in 2008.

The principal advantages of legacy are very clear and there to see in terms of market access and asset creation, which has allowed the PSUs to keep their heads above water. This is evident from the fact that 53 percent of the PSUs have registered better profitability as compared to the industry. A long experience in the industry has also ensured good asset utilisation, with over 40 percent of PSUs performing better than the industry standards. 

PSU 2015 Winner List  

But a good profitability performance and asset based performance does not necessarily mean that the PSUs are investing in their future and they might just be losing out on the long march. An excellent case in point is the highly contested civil aviation space. Air India, owing to its full service legacy, lacks in operational efficiency (EBIDTA margin 5 percent points below industry average) and below par employee productivity (6 percent points below industry average) has been making losses for a while now. A closer look at the PSU numbers also reveals how these companies, while being closer to the industry average on some of the parameters, are steadily sliding on other parameters of performance measure.

On investment per unit, depreciation is measured over the past five years, 36 percent PSUs have fared better than their industry peers. If employee productivity is to be measured as revenue per employee, then employee productivity of only 28 percent of PSUs is better than the industry. According to the 2009 edition of OECD Journal, private firms in India are 32 percent more productive than public firms in terms of units of value added. 

The reason: high concentration within industry leads to a pseudo-oligarchy, which in turn leads to complacency. Other reasons such as rapid change of technology and legacy coming in way of nimbleness are leading to a fall in productivity. As a result, only 25 percent of the PSUs have been able to keep up with the profitability growth of the industry over the past five years. This relative lag in the rate of growth of PSUs has far-reaching impact not just on their own sustainability, but also on the value addition they bring to the society as well as the employees both in the short and the long term. 

Our analysis of performance of PSUs on softer aspects such as employee initiatives and CSR initiatives revealed that the effectiveness of such performance is a function of the profitability of the PSUs. This in turn means how the PSUs grow in the future will be a major factor in determining the extent of their contribution to the society in the long term.

With the importance of growth in the long-term profits being highlighted and the area being identified as a major concern for the PSUs, the next logical step was to identify causal relationships, if any, between the profits of the firm and other performance parameters. So we identified factors that correlated well with the profits. Interestingly enough, with parameters like investments/unit depreciation, employee productivity and growth in profit margins across past five years exhibiting a positive impact on the current profitability, this impact is rather small in magnitude.

One particular parameter, asset utilisation holds the strongest correlation among the analysed parameters with the current profitability of the PSUs. This correlation is four times as strong as the relationship between five-year growths in margins and profitability and 19 times as strong as the relationship between investments and expected profitability.  

While asset utilisation cannot be used to predict the extent of absolute increase and/or decrease in the profitability of the respective PSU, it surely holds a decisive impact on the direction the profits of the firm are expected to move in comparison to the industry average. In simpler words, if the asset utilisation performance of a PSU is better than the industry average, chances are, the profitability too, will be better than the industry. This makes asset utilisation an extremely important cog in the wheel of PSU corporate machinery.

There are specific examples of private players whose performance on asset utilisation in combination with parameters like operational efficiency, employee productivity and strategic investments has propelled them far ahead of the industry. Take for example IndiGo airlines that reported a record profit of '1,304 crore in year ending March 2015 or the case of Airtel that has taken over as India’s largest telecom service provider and has now become the world’s third largest. Such players are typically from industries where the pace of change is rapid and the PSUs have not been able to catch up due to myopic focus. The overall poor performance on long term investments and the declining asset utilisation are the identified pain points where most PSUs are suffering the most. 

Having considered the impact of the distant past on their present condition, let us analyse the actual performance of PSUs in the current scenario. 
Excellent sprinters, not marathon runners

The financial year 2015 has been a particularly good year for the PSUs in terms of profitability. A total of 125 out of 235 PSUs that we analysed have shown better profit margins than that of their respective industry average profits. 

However, raw numbers may not convey the complete story. One must account for the fact that a large percentage of the PSUs have been in operation since long in their industries and as it happens with mature companies, the growth tends to flatten out over a long period of time.

Besides, maintaining growth involves cutting down the belly fat or in other words, disinvestment. So, we analysed the impact of age on the growth of assets of PSUs. Considering the strong correlation between the age of the PSUs and their status, we looked at the numbers within the various ‘Ratnas’ categories.

It turns out that the ageing argument is strong. None of the age-old Maharatnas or for that matter even the Navratnas have been able to even match the industry average in asset growth. 

One might expect the situation to change when one looks at the relatively younger and therefore smaller PSUs. But even here the impact of disinvestment is evident and the percentage of PSUs in the Miniratna categories with assets growing at a rate faster than the industry is only 33 percent. Smaller entities are expected to grow faster than the larger ones and one expects the number in this category to be higher.

In the present scenario, there is no refuting that the PSUs are generating profits. However, these profits are obtained by partially compromising on tomorrow. Disinvestment dilutes the quality of cash flows since these are not out of normal operations of the company. While disinvestments help obtain cash blocked in non-performing assets, they might also create a false sense of security and an outlook towards disinvestment rather than looking out for possible ways of overhauls or for opportunities of investment. 

Does that mean that we see no exceptions to the trend?
Getting ready for the long haul

The excellent performance of PSUs in past one year and aggressive initiatives raise new speculations. BSNL recorded a profit for year ending 2015 based on excellent administration. Pawan Hans consummated its turnaround through improvement in operational performance. NTPC is in an endeavour to be at the forefront of technological change with its enhanced focus on renewable energy sources such as solar energy. The fact that it has its eyes on the long-term growth reflects in the consultation it has sought through KPMG. Through this partnership it aims to build a roadmap till 2032. 

Organisations such as NMDC are still very positive about their growth with plans to invest '40,000 crore in the coming eight years to reach a whopping 100 million tonnes per annum iron ore production (3.3 times the existing production capacity of NMDC). Consider the special case of NEPA, which has undergone a complete turnaround, thanks to the efforts put in by Brigadier Mutreja who took over the reins of the sick unit in 2005 and retired after an illustrious performance as its CMD only in November. This turnaround has had a huge impact on the town of Nepanagar as well, which has seen revitalisation ever since. 

NEPA’s efforts secured a sanctioned amount of '103 crore from the government in 2014-15, which has been augmented to the income. It was a special consideration awarded keeping in mind the wonderful turnaround of NEPA Ltd since 2005. Addition of the sanctioned amount to the income has improved the income to nearly twice its current level and hence improved the profitability and asset turnover ratios which propelled NEPA to the top of financial performance chart within its own category.

Have the PSUs been able to bring a turnaround in the growth and reverse the downward trajectory in the past one year? Are PSUs similar to the high beta stocks (performing better than the industry in conducive conditions and worse in difficult conditions)? Or has 2015 been just a lucky year? Only time can answer. 
Mrug, an IIT Bombay alumnus, is the founder of M76 Analytics. Dave, a student of IIT Bombay, is an analyst at M76 Analytics.

(The article appears in the December 16-31, 2015 issue)




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