CPSE ETF: a Perspective on the Follow-on Fund Offer (FFO)

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What is CPSE ETF?

The Central Public Sector Enterprises (CPSE) Exchange Traded Fund (ETF) is a route for divestment of part of Government’s stake in certain CPSEs. The ETF route was an innovation against the conventional method of sale of shares to investors i.e. either the IPO route or the Offer for Sale (OFS) route. CPSE ETF New Fund Offer (NFO) was launched in March 2014. Units were listed in April 2014 on NSE and BSE. Further Fund Offer (FFO) was launched in January 2017 and another one (FFO2) was launched in March 2017. Response to the NFO and FFOs have been good i.e. higher than the issue size. The combined AUM is Rs 11,500 crore. CPSE ETF is executed by Reliance AMC. 

Composition

There are 11 stocks across sectors. In terms of weightages, the top five companies are NTPC Ltd (19.59%), Coal India (19.17%), Indian Oil Corporation (18.98%), Oil & Natural Gas Corporation (18.92%) and Rural Electrification Corporation (6.19%). The 11 stocks are across sectors e.g. oil, power, mining, petroleum products, finance, etc. The composition has been changed recently; they have dropped Gail India, Container Corporation of India and Engineers India. The ones added are NTPC, NLC Ltd and SJVN Ltd. 

Sectors:

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6 out of 11 companies in CPSE being sector leaders or near monopolies:

  • ONGC & Oil India – Leadership in Oil production

  • Coal India – Monopoly in coal supply

  • Indian Oil Corp. – Leader in fuel distribution & Petrochem

  • Bharat Electronics – Leader in Defence

  • NTPC – Leader in coal-based power generation


Energy Companies: Attractive Valuations

 

  • Total installed capacity of power stations in India stood at 344.69 GW as of August 2018. Coal-based power generation capacity in India, which currently stands at 196 GW is expected to reach 330-441 GW by 2040. 

  • India’s per capita power consumption is 1/4th of the world average and thus there is a lot of scope for growth

 

Oil PSUs: Consumption at Attractive Valuations

Petroleum products (Petrol & Diesel) consumption demand remains strong and is structural. And given the limited capacity additions on the global refining capacity, GRMs environment is expected to remain healthy. 

 

Infra & Engineering: Leadership with MOAT

  • Big opportunity in Government Capex, Logistics & Defence 

  • Market leaders in respective sectors 

  • Excellent balance sheet with net cash, with ability to grow significantly

  • All of the above points towards a good growth opportunity going forward


Concept of CPSE Index

For ease of tracking the composition and performance of the ETF, there is a Nifty CPSE Index, specifically for this purpose. The Index comprises 11 stocks with weightages as discussed earlier. The weightages are a function of the free-float market capitalisation of the constituents.  

 

Attractive Valuation and Superior Dividend Yield – Compared to Other Broader Indices 

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Performance

Market sentiments about PSUs have been negative for some time. Performance of CPSEs in general and the CPSE Index in particular, has been poor. Over the last 3 years till 31 October ’18, CPSE ETF has yielded a return of 5.97% annualized against Nifty total returns index (TRI) of 10.22% annualized. Since inception, CPSE ETF return has been 8.17% annualized against Nifty TRI of 11.47% annualized. 

 

Valuations

The poor performance by itself is a positive. Valuations are that much more attractive now, and makes a case for investment with a long term horizon. As on 31 October ’18, the price-earning (PE) ratio Nifty, on the basis of FY18 earnings, is 25.4. As against this, the PE ratio of Nifty CPSE is only 9.5. This represents a 63% discount against Nifty PE level. Similarly, the price to book value (PB) ratio of CPSE at 1.3 times is at a 62% discount to Nifty PB ratio of 3.5 times. However, the Return of Equity (RoE) is at a similar level; 14.1% of CPSE against 14% of Nifty in FY18.   

 

Forthcoming FFO 

Context: Disinvestment target is between 6,000 – 12,000 crore even though current valuations are low.

 

After the earlier ones i.e. FFO and FFO2 of 2017, the next one i.e. FFO3 is scheduled for the last week of November ’18. As discussed earlier, performance of CPSEs so far has been poor but that makes the valuations (PE and PB ratio) that much attractive and that ROE is at a similar level as the broad index. On top of that, dividend yield of CPSE is superior, even after accounting for the relatively lower price level of CPSEs. Dividend yield of Nifty CPSE index is 5.25% against broad Nifty dividend yield of only 1.27%, as on 31 October ’18. While investors can purchase the ETF anytime, there is a discount available during the FFO period. 

  

Conclusion

For investors looking at the value proposition of CPSEs over the long term through passive management along with the cost saving, there is a case to look at CPSE FFO3. The recurring fund management charges of CPSE ETF are nominal against the actively managed funds, even after considering SEBI’s revised TER norms.   

  

Positives:

  • Attractive valuations

  • Dividends by the CPSE companies are yet to be announced. This is a great opportunity

  • Strong Business models of constituents

 

Watch out for:

The recent negative performance. 

However, as explained earlier, the low valuations make it an attractive investment option.