This is a reply to an imaginary letter received from the management of Public Sector Undertaking (PSU) companies.
Thank you for your letter.
I appreciate your concerns. You are upset with me.
I don't blame you.
In this letter, I will try to express my side of the argument. Hear me out.
You said in your letter that despite starting Smart Money Secrets 16 months back, we have not recommended a single PSU stock.
'Why such hate?', you asked.
You further said, 'despite coming in the screener list, still, there is no consideration for PSU companies.'
'Look at PSU space, we trade at reasonable valuations, we pay a good dividend and, in some cases, we have good ROE, ROCE', you said proudly.
I hear you PSU.
I know you're in a lot of pain right now. The market hates you.
But we, at Smart Money Secrets just can't afford to recommend your stocks at this stage.
Let me give you some recent examples which are still fresh in our memories.
Last month, the government (i.e. the promoter) proposed the merger of Bank of Baroda, Dena Bank, and Vijaya Bank to create India's third-largest lender.
The rationale was two strong banks will absorb a weak bank to create a mega bank.
This is a good move from the government's point of view. But think about it from the minority shareholder's point of view. In this case, from the point of view of the minority shareholders of Bank of Baroda and Vijaya Bank.
From their perspective, this merger is nothing but a bailout of the weak bank i.e. Dena Bank. As you know, Dena Bank reported a loss of Rs 19.2 billion in FY18.
Now such a big merger will have its own challenges and difficulties. This includes process integration, bank rationalisation, work culture and HR etc.
Besides, there are concerns of the NPA burden and the decline in the capital adequacy ratio. We still don't know what's the government's plan for infusing further capital into the bank.
In short, there's a lot of uncertainty. And minority shareholders don't like such things.
That was about banking.
Let's look at another example. That of oil marketing companies (OMCs).
What just happened last week?
The government directed the OMCs to absorb a cut of Rs 1 per litre of petrol and diesel. It is expected that this will lead to around Rs 45 billion hit in net profits.
I don't know about you but to the aam investor Rs 45 billion in profits is a lot of money. We get dividends from that profit. And the government made it disappear overnight.
Normally, such sudden decisions are considered as unforeseen regulatory risk. But in your case, it was already known!
All this while, the government maintained that they will not interfere with fuel pricing regardless of crude oil prices.
But look at what happened!
Since this decision, the market cap of OMCs has declined by more than Rs 750 billion.
It is important to note that OMCs were indeed on our screening list.
As you mentioned in your letter, they generate ROE and ROCE upwards 25%. The dividend payout was decent.
But this kind of risk was looming large over these companies. Since the valuation wasn't dirt cheap, we decided to stay away.
Now I come to my last example: Steel Authority of India (SAIL).
In August, the promoter (i.e. the government) demanded a dividend payment.
But SAIL, didn't have enough cash. For the dividend payment, SAIL would have had to borrow from the market.
Not to mention, SAIL has Rs 32.2 billion of debt repayment due this year.
Normally, shareholders love dividends. But just because SAIL turned profitable in the last three quarters, it doesn't make any sense to demand such an unreasonable dividend payment.
Thankfully, SAIL declined the government's request for the dividend.
I hope you are getting my point, dear PSU.
These are not isolated cases. There are plenty of such examples of government intervention in your business activities.
Dear PSU, I urge you to think from the minority shareholder's perspective. Then you will understand our pain.
'What do you want then?', you'd ask.
Well, you see, at Smart Money Secrets, we love businesses that show excellent capital allocation skills. These are companies with strong business models, a long runway of growth, the minimum impact of any regulatory intervention, strong promoter track record and many other things.
These are some elements of our Smart Money Score, a proprietary tool that helps us weed out companies that score poorly on fundamental factors.
Now you might ask a follow-up question to this... 'Does that mean there is no chance of you recommending a PSU stock?
If the valuations are dirt cheap, factoring in every negative aspect, then we might take a look you. But I am not promising anything.
| --- Advertisement ---
IMPORTANT: Do Not Buy This from Amazon…
Equitymaster's Secrets is our most popular book ever – with over 20,000 copies in circulation.
It is a book we believe every serious investor should have a copy of.
And even though this book is available on Amazon for Rs 1,450…as an Equitymaster reader, we don't want you to have to pay for the book.
Instead, we'll send you the latest edition – virtually free – wherever you want (within India).
Just cover postage and handling charges – a minimal Rs 199, and your hardbound, limited-edition book will be in the mail the very next day!
Click here to claim this book.
Because you see, at the end of the day, my comfort level is not that great with you.
Now, you know my reasons.
Hope you understand why I'm not recommending you now.
I know, this letter might hurt you. But that's the bitter truth.
Take care and all the best for the future. May it be better than your past.
My best wishes,
Chart of the Day
Since we are talking about PSUs, I thought, it would be an interesting to compare how these stocks performed compared to the frontline index - BSE Sensex.
The BSE-PSU index, which includes many companies from the PSU space, considerably underperformed the BSE Sensex.
Underperformance of BSE PSU Index
For three out of five years, the BSE-PSU index considerably underperformed the BSE Sensex. From 2014 till date, the BSE-PSU index gave a meagre annualised return of 3%. Whereas, the BSE Sensex delivered 14%.
This underperformance can be attributed to sector specific events such as non-performing assets (NPAs) in the banking space and rising oil prices that impacted OMCs, among others.
In Smart Money Secrets, we are not yet comfortable with the PSU space. We prefer owner-operator driven companies run by excellent management.
This month's upcoming recommendation is one such example. It fares very well on our proprietary tool - Smart Money Score.
A long runway for growth, strong sectoral tailwinds, negative working capital, strong brand recall, undervaluation of two of its business segments, and corporate restructuring of one of its business units to unlock shareholder value are some the key triggers for this company.
Watch this space!
Research Analyst, Smart Money Secrets
PS: You can now track the moves of 40+ super investors of India and receive cherry-picked recommendations of the most lucrative stocks bought by these market gurus. Smart Money Secrets is a premium stock recommendation service based on following the smart money, the market activities of the very best investors in India. Get access to this exclusive stock recommendation service here.
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringementDisclosure & Disclaimer:
Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. The Author does not hold any shares in the company/ies discussed in this document. Equitymaster may hold shares in the company/ies discussed in this document under any of its other services.
This document is confidential and is supplied to you for information purposes only. It should not (directly or indirectly) be reproduced, further distributed to any person or published, in whole or in part, for any purpose whatsoever, without the consent of Equitymaster.
This document is not directed to, or intended for display, downloading, printing, reproducing or for distribution to or use by, any person or entity, who is a citizen or resident or located in any locality, state, country or other jurisdiction, where such distribution, publication, reproduction, availability or use would be contrary to law or regulation or what would subject Equitymaster or its affiliates to any registration or licensing requirement within such jurisdiction. If this document is sent or has reached any individual in such country, especially, USA, Canada or the European Union countries, the same may be ignored.
This document does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Our research recommendations are general in nature and available electronically to all kind of subscribers irrespective of subscribers' investment objectives and financial situation/risk profile. Before acting on any recommendation in this document, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. The price and value of the securities referred to in this material and the income from them may go down as well as up, and subscribers may realize losses on any investments. Past performance is not a guide for future performance, future returns are not guaranteed and a loss of original capital may occur. Information herein is believed to be reliable but Equitymaster and its affiliates do not warrant its completeness or accuracy. The views/opinions expressed are our current opinions as of the date appearing in the material and may be subject to change from time to time without notice. This document should not be construed as an offer to sell or solicitation of an offer to buy any security or asset in any jurisdiction. Equitymaster and its affiliates, its directors, analyst and employees will not be responsible for any loss or liability incurred to any person as a consequence of his or any other person on his behalf taking any decisions based on this document.
As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use
, available here. The performance data quoted represents past performance and does not guarantee future results.SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited (Research Analyst) 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: firstname.lastname@example.org. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407