Coronavirus isn’t just causing a slowdown in the economy and mayhem in markets but it’s also spoiling the government’s revenue math really badly. In the wake of falling markets and probable loss of revenue on account of lockdowns, the government is likely to face a challenging situation.
The government has set the fiscal deficit target of 3.5% for FY21 and has pegged the disinvestment target at a massive Rs 2.1 lakh crore. Achieving such a humongous disinvestment target may require some sort of a miracle. After all, some of India’s most efficiently run non-cyclical private sector companies have been in a firm bear grip, let alone Sarkari companies.
But what one thinks is an area of trouble might be an opportunity for someone else.
On how many occasions have you heard somebody saying lately, there’s a very big opportunity in Public Sector Undertakings (PSU) stocks?
What makes ‘big bulls’ of Dalal street say so?
Do PSU stocks really offer a great value at this juncture? Or is there a value trap?
For those who don’t know what value investing is; it’s a school of investing in which proponents buy a stock at a discount to its intrinsic value. Intrinsic value, in simple words, is the true worth of a company, as against the market value denoted by price (which is a perceived worth of the company).
Between March 2010 and March 2020; BSE PSU has lost 50%, at a time when BSE Sensex has gained 70%. This indicates PSU stocks have been knocked off severely—many of them being NPA-laden PSU banks. A few others that have witnessed massive market cap erosion are utility companies, mining companies or engineering companies—in short, most of them are directly linked to the performance of the economy. And as you know, the Indian economy has been passing through hot waters. The growth rate has reduced to half of the peak growth rate experienced about a decade ago.
Needless to say, most of the PSU companies play a pivotal role in nation building and can’t be easily replaced.
But still, out of 57 BSE PSU stocks, 26 have lost more than 80% from their all-time high—too much?
And that’s why it’s so crucial to see if the fall is justified or markets are overreacting, as they do on many occasions.
Yes they are. Going by the simplest conventional measure of valuation, Price-to-Earnings Ratio (P/E) ratio, PSUs have become cheap. On an average, their Trailing Twelve Month (TTM) P/E quote at a 50% discount to their 5-year average PE. Out of 57 BSE PSU constituents, 21 offer a dividend yield of over 6% and 40 trade below their book value.
Their median 4 quarter revenue growth is just 4% and profit growth is -12%. The median Return on Equity (RoE) is a moderate 8%. In other words, PSU companies have been feeling the heat of the slowdown. Most of them are low-growth companies generating poor returns on shareholders’ funds.
No! Many of them have a wider economic moat—meaning higher competitive advantage.
For example, India is still a capital starved country and PSU banks still hold a market share of 63% in deposits and 59% share in loans. Given the recent fiascos that some cooperative and private sector banks experienced, it’s safe to assume that, PSU banks are going to be pretty much relevant for a considerable period of time. That said, many of them face complicated issues such as recapitalisation and profitability. Some of them were (and some still are) under the Prompt Corrective Action (PCA) framework of RBI which imposes restriction on expansion, fresh lending (mostly on big ticket corporate lending) and pay hikes amongst others.
Unless these banks come out of PCA and overcome governance issues, cheap valuations are unlikely to attract investors. Moreover, it remains to be seen how many of them would see a spike in NPAs owing to the Corona related slowdown.
On the other hand, some utility and mining companies don’t have solvency issues but they are struggling to grow. For example, average PAT (Profit After Tax) growth of the last four quarters of ONGC and Oil India has been -27% and -63% respectively. They earned RoE of 10% and 3% respectively on TTM earnings basis—high barrier, poorly managed commodity business?
In contrast, companies that are either growing at a blistering pace or earning high RoE aren’t cheap on valuations—for instance, Gujarat Gas and Coal India.
Some companies have been up for privatisation but the government hasn’t been successful so far in setting a milestone high and unlocking value—case in point BPCL.
As remains the questions of some unlisted PSUs going public, they shall also be analysed on the same parameters of value investing.
Steep price erosion in case of many PSU companies is justified by the variety and magnitude of challenges they have been facing. Nonetheless, their economic moat still remains wide and valuations attractive. A right government policy response remains a crucial aspect for their future.
If PSUs can ride out a phase of difficulty and resume growth path, they might see a massive re-rating, assuming government would take nimble steps on the policy front— looks like a distant dream for now.
To sum up, not dumb ducklings but not great bargains either.
Always remember what the father of value investing, Warren Buffet, famously advised—It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.
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We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.