PSUs do not get optimal returns on funds

A cursory examination of the 27 largest listed central public sector undertakings (PSUs) by market capitalisation reveals that the financial profiles of these companies are stable with profits after tax (PAT) and cash flow from operations (CFO) increasing by 8 per cent and 14 per cent, respectively, during the five-year period April 1, 2013 to March 31, 2018. Net indebtedness, as indicated by the ratio of reported debt less cash to CFO, continues to be moderate despite increasing to 2.39x as of March 31, 2018, from 1.74x as of March 31, 2014.

The 27 PSUs covered in this article are Balmer Lawrie & Co., BEML, Bharat Electronics, BHEL, BPCL, Coal India, Container Corporation of India, Engineers India, GAIL, Hindustan Copper, HPCL (till ONGC acquired a majority stake in HPCL), IOC, MMTC, MOIL, NALCO, NBCC (formerly National Buildings Construction Corporation), NHPC, NLC, NMDC, NTPC, ONGC, Oil India, Power Grid Corporation of India, Rashtriya Chemicals & Fertilizers, Shipping Corporation of India, SJVN and SAIL. Notwithstanding the increase in PAT and CFO, corporate income taxes paid in cash declined by 41 per cent while the increase in dividends paid was lower than the PAT and CFO growth at 5 per cent. These PSUs have been paying the government lower taxes and dividends than what they potentially could have in the last five years.

Unlocked value

The PSUs have deployed their funds in four asset categories — bank deposits, loans, investments and surplus landholdings — that depress their return on consolidated assets and inhibit their dividend-paying ability. The pre-tax return the 27 PSUs earn on their cash, bank deposits, loans and investments in FY18 was 7.8 per cent; 250 basis points lower than the 10.3 per cent pre-tax return on their core business. Banks charge a higher interest rate on their loans than the interest they pay on their deposits. Hence, it is not financially prudent to invest ₹72,817 crore in bank deposits when these PSUs have ₹5,67,439 crore of outstanding debt. The ₹16,315 crore loans these PSUs have extended to their employees, suppliers and vendors ought to be immediately refinanced by banks. The PSUs should bear the interest differential on subsidised employee loans and guarantee the loans that they have extended to counter-parties that do not meet the banks’ lending norms.

The ₹1,17,705 crore investment portfolio dispersed across the 27 PSUs is the largest black hole that depresses their return on assets. All PSUs must transfer their investment portfolios to a panel of authorised mutual funds to manage these investments on their behalf. The mutual funds may streamline these investments and pay the PSUs the sum of returns earned from these investments and opportunistic divestments net of a pre-agreed management fee.

Back-of-the-envelop calculations indicate that debt reduction achieved through the ₹2,06,837-crore disposal of bank deposits, loans, and investments would result in approximately ₹11,300 crore of savings in interest expenses and an additional ₹1,100 crore of tax payments. The CFO of 27 PSUs would have increased by around ₹10,000 crore in FY18, which may be used to pay additional dividends and to incur incremental capital expenditure that has been range-bound in the last five years.

The most complex piece in the PSU asset streamlining exercise is the divestment of their surplus landholdings. The book value of the landholdings of 26 (excluding NBCC) of the 27 PSUs was ₹38,589 crore as of March 31, 2018. NBCC reports the aggregate of the book value of its land and buildings. The 26 PSUs report the historical cost of their freehold land (58 per cent of book value) and the present value of future minimum lease payments of their leasehold land (42 per cent). The market values of PSU landholdings are likely to be exponentially higher than the book values.

PSUs do not report the extent of their surplus landholdings, that is, land not utilised for existing businesses and pipeline projects. The Central government has taken a step in the right direction by announcing its decision to sell the properties of nine PSUs — Air India, Pawan Hans, Hindustan Fluorocarbons, Hindustan Newsprint, Bharat Pumps & Compressors, Scooters India, Bridge & Roof Co., Hindustan Prefab, and Projects & Development India.

The government proposes to adopt three methods to sell PSU properties — open market bidding, transfer of assets to NBCC for development and subsequent sale/lease, and an exchange traded fund (ETF) for immovable assets. The nascent proposal for an immovable asset ETF involves handing over properties to an asset manager, who then sells units of the ETF to investors. Each unit comprises a predetermined share or stake in each of the properties, which are part of the bundle.

However, the government needs to effect two changes to its PSU asset disposal proposal. First, this initiative needs to be broadened to include all central PSUs. The government must make it mandatory for all PSUs to report properties in use and surplus properties. And, second, it must consider incorporating a property-holding company (PHC) to which all PSUs should transfer their surplus properties.

Put and call bonds

The PHC may issue lot-specific put and call bonds to the PSUs in lieu of the properties transferred. The PHC may call the bonds and pay the PSUs the sale proceeds less a pre-agreed management fee as and when specific properties are sold. The PSUs have the flexibility to put the bond and acquire the land they had previously transferred to the PHC should they have a requirement.

The PHC enjoys three advantages over an ETF. First, the PHC may dispose properties piecemeal. Second, whereas the ETF caters just to stock market investors, the PHC’s customer base is wider encompassing corporates, property developers, investors, and individuals. And, third, an ETF may struggle to attract adequate investor interest in the currently declining Indian stock market. The PHC’s performance is likely to be less correlated than the ETF to the stock market.

Requiring all PSUs to report and transfer their surplus properties to a PHC will allow PSUs to focus on their core businesses, moderate real estate prices and strengthen the pool of property valuers and other real estate professionals. PSUs must, however, improve their reporting to enhance their credibility and render their asset disposal exercise effective. PSUs must report their operating and financial lease commitments to ascertain the full extent of their off-balance-sheet liabilities. Restatements of accounts like ONGC’s FY17 results after its acquisition of HPCL in FY18 must be clearly explained.

The writer is an independent analyst.