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The curious case of Public sector enterprises in India

Updated: Apr 1, 2019

On 14th Feb 2018, one of the biggest Public Sector Banks in India (Punjab National Bank) disclosed a fraud involving approximately Rs. 11000 Crores. The magnitude of the scam was big enough to shake investor confidence in the PSBs and PSEs at large. The total reserves reported by PNB for the FY ending 31st mar 2017 stood at approximately Rs. 42000 Crores. A savvy investor should have quickly done the math and realised that close to 26 percent of reserves were being reported as scam /fraud by India's leading PSB.

There was indiscriminate selling in all PSEs irrespective of the quality of earnings and balance sheet. Such heavy selling left many bottom-fishers in a trap.

In this article we try to analyse the underperformance of Nifty PSE index compared to three other major indices: Nifty 50, Nifty Midcap 50 and Nifty Next 50.

1. Price: Book Value ratio chart

In the figure above, we compare the PB ratio of above mentioned 4 indices from 14th Feb 2018 to 14th Feb 2019. The period signifies exactly one year after the PNB fallout. It is evident from the figure above how the PB ratio of Nifty PSE index has been constantly falling after Feb 2018.

The fall looks systematic and planned by big investors and it wouldn't take a genius to figure out that there was a destination to this fall. In the last part of this article, we try to explain our logic for identifying this destination.

2. Price: Earnings ratio chart

Just like the PBV ratio chart, it is clearly evident from the PE ratio chart how investors have paid little premium to the PSEs over other major indices. In the remaining part of this article, we will try to see the reason for this underperformance and to find an investment opportunity in the sector.

Why the sharp fall?

The PNB event clearly rose doubts in the minds of investors as far as the asset quality of PSBs is concerned. There was steep correction in almost all the PSBs and the spillover was quick on the larger PSE space. The investor fraternity probably started doubting the asset quality of PSEs without having any regard for the quality of earnings reported.

Another reason we see that intensified the fall is the Government's ambitious disinvestment target. The investment community was well aware of the Modi Government's focus on sticking to the fiscal deficit target and thereby the importance of achieving the disinvestment numbers. This coupled with the PNB event gave an opportunity to the market participants to get better bargain deals on PSE scrips. This can also be seen as a fight between the opportunist private sector investors and the Government of India for a bigger share in good quality PSEs.

When does this stop?

We at Tequity Investing have interacted with many clients who are interested in investing in good PSE scrips. We know how retail investors lost their money during this fall. As observed from the PBV chart, the sector has taken a bound back from a PBV ratio of 1.3. This number close to 1 is significant, however investors waiting for a PBV below 1 would probably just keep waiting and never get the stock in their hands. A PBV ratio for the sector below 1 means the assets owned by the Government are trading at a discount to their value. What does this speak about the world's largest democracy who is aiming for consistently retaining the fastest growing economy tag? Will an ambitious Modi Government allow this vital ratio to fall below the critical mark or will they take timely steps to restore investor confidence?

We try to figure out a probable bottom for the Nifty PSE sector as a whole.

a. The case of divergence (the price top)

We have taken 1st Jan 2014 as a base for calculating the convergence and divergence. This date is vital as the new Government was about to take charge in next few months. As can be seen from the above table, on 26th Oct 2017, the Nifty PSE index made a top and after that it has been consolidating. The divergence in important ratios is worth observing where the EPS has been a laggard significantly.

b. The case of convergence (a probable bottom?)

On 22nd Feb 2019, the index has made a bottom (atleast as on date). We may not see this number on the index in the near future. As can be observed from the table above, the important parameters have shown the most convergence after Jan 2014. In our experience, such convergences are well indicative of a bottom in a sector.

Supportive facts

The Convergence in ratios well coincides with following important factors which make the case of a bottom stronger:

  • Good numbers being reported by heavy weight like Coal India and ONGC

  • Upcoming elections which will most likely lead to a pre-election rally

  • The bounce from a PBV close to 1

  • Confirmation on various technical indicators on price charts.

What we advice our clients?

Tequity believes in spotting value in sectors/individual stocks. However, we do not keep holding stocks indiscriminately in our Techno-fundamental portfolio. We are quick in acknowledging losses. As usual, we advice to invest in good quality stocks with suitable stoploss. We standby our belief of keeping a balance between pragmatism and idealism.

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