PSU Stocks: Buying At The Right Price Will Make A Difference In Returns

Investors have been told for years that terrific companies with high growth rates, quality management and businesses with a competitive advantage will lead to wealth creation. However, historically it has been observed that great companies do not always make great investments if they are not bought at a margin of safety. For example, Hindustan Unilever was the darling of the stock markets in the early 2000s. 

The stock was trading at Rs 248 in March 2000. In August 2010, the stock was still trading around the same levels. The moral of the story is that there always needs to be a margin of safety in the purchase price of any stock. Public sector stocks have not found favour with the markets for a long time. These companies have traditionally destroyed a lot of investor wealth. However, as they say, “With crisis, there comes an opportunity.” The price damage has pushed public sector companies to very cheap valuations. However, the green shoots are now visible in some of these companies. 

Over the past few years public sector banks have been plagued with the problem of non-performing loans. As RBI forced the banks to recognize bad assets and make the necessary provisions, the banks took a substantial hit on profitability. The government has taken several initiatives to revive the struggling banks, including programmes like Indradhanush for bank recapitalisation.

The government also came out with the Bankruptcy Code which enabled the lenders of NPA accounts to recover at least part of the assets through the NCLT process. There was also a consolidation among some public sector banks in order to revive them. Experts believe the provisions for a lot of these banks have now peaked and profitability is expected to resurface over the next few years, which will shoot up ROEs.

Public sector stocks have also been under pressure due to selling related worries. The government’s strategy of using the exchange-traded fund (ETF) route to divest its stake in them had also caused some selling pressure. However, just like other segments, the PSU segment also offers some good investment opportunities during certain periods. There are some fundamentally strong companies that offer good value given the recent price correction. Some of these companies are also offering attractive dividend yields. Investors should note that the current high dividend yields on PSU stocks is also because the government will continue to divest stake in these companies in order to maintain fiscal prudence. The government's interference in the running of public sector companies has been a longstanding complaint of retail investors against PSUs. However, the public sector companies also have some inherent advantages. Following table shows the top 30 companies by YTD returns:

From the construction sector, NBCC for example, enjoys a strong edge over its competitors. The company is the preferred choice for all the government’s redevelopment projects as it has the Public Works Organisation (PWO) status. The company enjoys a strong order book of approximately Rs 80,000 crore, of which Rs 50,000 crore are from the Government of India, which gives the company a clear revenue visibility for the next 4-5 years. The company has an asset-light business model. The company makes detailed project reports and then executes the orders via private sector players. The reduction in non-performing assets combined with positive changes in the economy have put quality public sector banks in an advantageous position to benefit from improvement in asset quality. This was visible in the financials of India’s largest public sector bank, State Bank of India (SBI). After a series of loss-making quarters, the net profit for the bank stood at Rs 3955 crore during the third quarter of 2018-19. SBI’s gross and net NPAs at the end of December fell to 8.7 per cent and 4 per cent, respectively, from 9.9 per cent and 4.8 per cent in September. This trend could continue due to recoveries happening from the cases that are under the NCLT. The bank also reported a healthy domestic loan growth in excess of 15 per cent. 

In the power sector, NTPC, for example, has a strong pipeline of projects. The company is expected to add capacities via brownfield projects. The company’s old plants have large tracts of land and due to its balance sheet strength, developing brownfield capacity will be easier. NTPC, it is expected, could bid for select assets of other power players that may come up for bidding via the NCLT route. The company will look for plants that are close to mines, have a low landed cost of fuel and have not signed any power purchase agreements.

India is presently in the midst of the general elections. Contrary to popular belief, historical data shows that four of the last six elections did not see any meaningful rise in volatility. Volatility has historically increased after the elections. According to Credit Suisse, in the case of 11 Nifty stocks, volatility more than doubled in the month after election results in 2014 than it was in the previous month and most of these stocks were public sector stocks. Thus, it is quite possible that some movement in the public sector stocks could be seen post the election.

Conclusion

Thus, it can be concluded that all good companies are not good investments and some companies perceived to be bad can be good investments if bought at the right price. The outlook for some of the PSU companies appears positive despite these trading at low valuations in the market.