Should you ever buy a PSU stock?

Feb 10, 2014

In this issue:
» Why high interest rate is not a deterrent for slowing capex cycle...
» Weak banks should be allowed to perish: Eurozone regulator
» SEBI to finalize new code on insider trading
» How to curb food inflation?
» ...and more!

Incompetent governance and political interference has seen PSU stocks destroy investor wealth in the past. Collectively, these stocks have eroded investor wealth to the tune of Rs 6800 bn over the last 3 years! Thus, it would not be wrong to term the entire PSU pack as a value destructive basket. Or perhaps uncontested crown jewels of wealth erosion.

This leads to a fundamental question - whether one should ever buy a PSU stock? Before answering that question, let us have a look at the reasons behind under-performance.

For one, PSU stocks are at the mercy of the government (read politicians). They are arm twisted to serve societal & social interest rather than those of their minority shareholders. Take the case of oil PSU's for example. The need to meet a social obligation of providing citizens with cheaper fuel and filling Government tax coffers are the reasons why they are forced to absorb the subsidy burden.

In short, not all PSU business decisions are taken with profitability and a reasonable return on capital in mind. This hurts growth and share price. Apart from being used as subsidy absorbers, they are also manoeuvred to meet government's fiscal aspirations. Most PSUs are milked by the government to fund the exchequer's fiscal deficit. Coal India's jumbo dividend was a prime example of that.

Robbing any PSU of cash would mean it will have to forego a lucrative investment opportunity in future if it arises or take debt to fund it. This is another situation where government's sub optimal business decision can hurt minority shareholders in general.

Apart from milking PSUs for personal agenda, the biggest concern is lack of competence and professionalism which government shows while managing them. No proper governance system is in place and the management at most PSUs is basically a puppet in the hands of the government.

However, in the past, these very PSUs were darlings of investors. But there is a basic reason why they prospered in the past and will not do so in the future. Prior to liberalization, most PSUs were virtual monopolies or market leaders. Take the case of Bharat Heavy Electricals (BHEL) or BSNL for example. Being monopoly created entry barriers. As a result, their performance shined and investors created wealth out of them.

However, after liberalization competition has increased, erasing their monopoly status. With poor governance they are unable to compete with private sector enterprises. As a result, they have fared poorly. Even the future performance is under shadow as there has been further liberalization and integration of the global economy. Hence, their future looks bleak except for the ones that are able to create competitive advantage for themselves.

We believe that the job of any government is to run the country. Hence, it should focus on running the country and appraise the profitability and operating efficiency of PSUs (that should be run by independent professionals) from time to time.

Have you made money in any PSU stock over the last 3-5 years? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
The state of Maharashtra seems to be setting a record for bad reasons. Maharashtra has surpassed even mineral rich states by wide margin in cases of illegal mining. As per an article in Business Standard and data shared by Department of Mines, total illegal mining cases in Maharashtra stand at 7,248. This is followed by Karnataka with 1,827 cases (Data up to June 13). It is believed that the surge in such activities in Maharashtra could be on account of illegal sand mining as getting statutory permission for the same is a cumbersome process.

What is even more surprising is that there is not a single First Information Report (FIR) or court case regarding the issue. The blatant misuse of resource of national importance has caused loss of revenues. As such, the Centre has tightened noose on the state Government so that such cases get detected in time.

The Centre has suggested increasing the manpower at the field and directorate levels. The move is expected to ensure enough vigilance to deter such activities. Further, the Union ministry has suggested following the model of Gujarat State where staff was employed on contractual basis to curb illegal mining. We hope that the State Government will be serious about the issue and take steps to restrain such activities.

States with highest number of illegal mining cases
Figures up to June 2013

Is there any one quality you can name that Indian policymakers lack the most? We believe there's a strong chance that quality could be the inability to introspect. For it is this very shortcoming that has led to the current state of affairs on the economic front. If further justification is needed, look no further than the recently released advance estimates of GDP growth for FY14. Clearly, the industrial slowdown is getting worse by the day with investments slowing to a crawl. As an article in highlights, gross fixed capital formation has slid from nearly 34% in FY13 to 32.5% in FY14. And there seems to be no respite in sight as Government is cutting capex further in order to bring down the deficit.

When prodded, the Government is likely to employ its usual trick. They will pass the entire blame onto the global crisis and more importantly the RBI. They will argue that it is the stubbornness of the central bank of not lowering rates that is costing the economy dear. We simply don't buy this argument. Interest rates are indeed important but are they the sole reason businesses don't invest? Certainly not. We invest because we hope to profit from it in the future. And if there is a big question mark over this hope by way of uncertain environment and ease of doing businesses, then even lower interest rates may not help. Therefore, the Government should introspect and understand that it is their ineffectiveness and incompetence in fostering a positive business environment that's taking a huge toll on the economy. And the sooner they address this problem the better off we will be.

The concept of 'too big to fail' that rocked the global economy in 2008 seems on its way out. The economy of Iceland was the only one to allow its banks to fail in the aftermath of subprime crisis. However, over the last 5 years the economy demonstrated how the decision helped it emerge stronger. The Eurozone, on the contrary, is saddled with debt for having ventured into the viscous cycle of bailing out its large banks. However, as per Financial Times, the Eurozone's new banking regulator is in disapproval of the past approach. In fact, she has warned weak banks of the proposition of winding up. That however is easier said than done! The European lenders have been buying sovereign debt in increasing amounts. And hence there is a nexus between the governments and banking systems. Whether the banking regulator will be able to weaken the link and allow the banks to fail is anybody's guess. However, without such painful steps it is unlikely that the global economy will witness Iceland-like revival.

The past few years have seen several lapses in corporate governance standards as far as India Inc is concerned. The biggest of these undoubtedly has been the Satyam scandal. Not just that, insider trading has also been rampant in India due to overall haziness and lack of proper laws. This is in sharp contrast to the developed countries such as the US, where such laws are quite strict. The conviction of Rajat Gupta in the US for insider trading is a case in point. But the Indian regulator SEBI has now finalized laws that will address these problems. Indeed, SEBI is expected to soon announce a new corporate governance code and also revamp insider trading regulations. As far as corporate governance is concerned, SEBI intends to lay down various norms. This means that companies will now have to justify higher salaries paid to executives. The management will have to put in place an orderly succession plan. Other norms include adopting a whistle blower policy for employees and limiting the number of directorships that a person can hold on company boards. Many other measures are also expected to be put in place.

The other aspect is insider trading laws. These have now been two decades old and the regulator intends to overhaul them. Those violating these norms will be severely punished. Moreover, more categories of people will be brought in its ambit. These include public servants, regulatory officials, judiciary and government officials among others. Basically, anyone who has access to very sensitive information. We believe that these laws are a step in the right direction when it comes to protecting the interest of minority shareholders.

Any classical economics textbook will tell you that if there is a rise in production, it will lead to a corresponding increase in supply. And this, in turn, will bring prices lower. Price is nothing but a function of demand and supply. But real life economics is often too complex and sometimes, ironical.

Take India's current food situation. On the production side, India has growing stocks of food grains so much so that the country is in a position to even export them. But is this benefitting the end consumers in the form of lower prices? Not at all!

India's real problem lies in the supply chain. Severe supply chain bottlenecks such as poor storage systems, excessive wastage and lack of easy access to markets translate into a huge burden on the Indian consumer. Hence, it is critical that the appropriate investments are made to remedy India's supply chain problems. Otherwise, Indian consumers will continue to bear the burden of persistently high food inflation.

In the meanwhile, the Indian stock markets continued to be marred by volatility and traded close to the dotted line. At the time of writing, the benchmark BSE-Sensex was down by about 15 points (-0.1%). Stocks from consumer durables and realty were witnessing maximum buying interest whereas IT and FMCG stocks were the biggest losers. Majority of the Asian indices were trading strong with markets in China and Japan being the biggest gainers.

 Today's investing mantra
"Avoiding the dumb things is the most important. Learn more, know limitations, avoid the dumb thing "- Warren Buffett

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14 Responses to "Should you ever buy a PSU stock?"

g m kandoi

Feb 13, 2014

very good article,i feel PSU stocks should be bought only on merit and not because it is PSU



Feb 13, 2014

Shrikant Pavanaskar perhaps you did not notice a drop of 50% in the share price of SBI, PNB and 40% in BOB since their peak values a few years ago ! The PSUs have by and large lost value ever since the disinvestment of national heirlooms was announced. A PSU used to be rated high as it was considered to be a Govt Backed, secure investment and had the advantage of monopoly. Failure of Scooters India, HMT, BSNL, MTNL and reduced profitability of Oil Marketing Companies has changed that rating.



Feb 13, 2014

Mr Sanjay Tiwari is right to point out the loss of capital in PSUs but is it fair to blame the Equity Master for the policy paralysis of the government? PSUs have lost value due to govt interference, poor governance and incorrect policies and not because Equity master gave the wrong advice. Everyone expected PSUs to perform well - many were doing well at that time - no one expected the scams to roll out and inept Manmohan Singh to sit twiddling his thumbs. He could not react to all that his cabinet colleagues did to undermine pubic confidence. If Balmer Lawrie could be turned around then most of the current slow performing PSUs will also turn around some day.


Ajay Kumar Gupta

Feb 11, 2014

In third para you have mentioned "filling Govt Tax coffers" I tend to rephrase it filling personal coffers, I am unable to understand why there is race to become politicians all the older ones are trying to bring their offsprings in the arena. Where they get so much funds to spend in Elections. Actually public itself is foollish they do not think that no one is going to give free lunch.


Shrikant Pavanaskar

Feb 11, 2014

Your views about PSU are no doubt correct,but with exception of Nationalised Banks especially SBI, BOB,PNB who are giving not only good dividend but also value appreciation.


G Balakrishnan

Feb 11, 2014

I agree with the comments provided by you 100%
PSU units are not managed well professionally. Had been these monopolized units were in private sector, the shareholders would have got very good returns for their investment.



Feb 11, 2014

Thanks for warning on PSUs. Interference by govt in commercial ventures will lead to their downfall. Public interest in PSUs and Govt owned banks is waning as there is loss of faith in their ability to survive. MTNL broadband connection on landline in Delhi is one of the best, fast and reliable network yet the company is in dire straits financially. Union Bank, Corporation Bank, SBI, PNB, BHEL, BEL etc are all sinking slowly but steadily. They were all recommended to investors by financial experts during last couple of years as they could not foresee this slow march to destruction of wealth.


Dr. Arun Draviam

Feb 10, 2014

Government should not be in the business of running commercial business activities. In the socialistic pattern of society with the public sector at the commanding heights of the economy, running business by the Government was acceptable. After the liberalisation and globalisation, government continuing to run commercial business is not justified. It is not only Coal India’s jumbo dividend that hurt the company but the artificial fixing of the strike prices of the futures and options gave the big operators to manipulate the prices in the F&O segment to the disadvantage of small investors.


Avinash Bhome.

Feb 10, 2014

I had purchased some of PSUs stocks - mostly of the " Nav Ratnas " like ONGC, HPCL, BPCL, PETRONET-Lng.....etc.....but mostly lost my money....Instead of getting good dividends, my investsments eroded. I observed that PSU are not independent to take decisions. They can not issue Bonus shares although their Reserves might be in billions or crores and arabs. They have no freedom in decision making. It is mostly dominated by govt.which hardly cares for its efficient management and running. SO IA HAVE STOPPED INVESTING IN PSUs.....Instead I have been for last 3-4 years investing in well managed Cos. of well known Business Houses, who are sincerely managing their business ( and not the likes of Reliance group, which is famous for jugglery instead of performances oriented approach.).....I have been advising others also...." not to invest in all."



Feb 10, 2014

yes I hold many PSU stocks like SBI,GAIL,ONGC,Syndicate Bank,HPCL,CHENNAI PETRO,GSFC,NTPC,NHPC,PFC,REC

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