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Should You Take SBI Chief's Advice and Load up on SBI Shares?

Jul 6, 2017

In this issue:
» Increasing Bond Issues by Indian Companies
» A Long and Painful Road Ahead for Public Sector Banks
» Market roundup
» And more!
Tanushree Banerjee, Co-Head of Research

Public sector bank stocks haven't been in favour since just after the NDA election in 2014. The problem of bad lending had just begun to surface. And banks were yet to reveal the scope of restructured loans in their books.

Investors hoped the government would bail out the PSU banks. With loads of capital infusion, the NPA problem would be behind them.

But the PSU hysteria only got worse. Markets soon realised the change of government could do nothing to the fundamentals of PSUs. Least of all, the public-sector banks.

Since then, bad loans, provisions, and the RBI's strict vigil have topics of enormous concern. Today, banks in India have more irrecoverable loans than ever.

Of course, private banks are much better off than their state-owned counterparts. For instance, in March 2017, public sector banks' gross bad loans were 11.4% - versus 4.2% at the private banks. The PSU's net bad loans at 6.7% was more than three times the net bad loans at private banks.

It's no wonder PSU stocks are finding no takers. Even as they languish close to historically low valuations, the upside in PSU bank stocks lacks conviction.

Top PSU Banks close to historic lows
Price to book value (x) Last 5 year low Current*
State Bank of India 0.8 1.2
Punjab National Bank 0.4 0.6
Bank of Baroda 0.8 0.9
Union Bank 0.5 0.4
Corporation Bank 0.4 0.4
Source:Equitymaster, Ace Equity

So you can imagine our surprise at the following comment from SBI chief Arundhati Bhattacharya...

  • But from FY19, we will be much better. So therefore, I urge you all to buy our shares now. You won't get it at such a price later.

The SBI chief's confidence in India's largest bank is understandable. But before urging investors to load up, she could do with a lesson or two on value versus price.

Price is what you pay. Value is what you get.

This singular distinction, clarified by Warren Buffett years ago, is even lost on many investors and promoters.

Remember this: Every 1% of incremental non-performing asset (NPA) can erode a bank's networth by as much as 10%. So when you see a bank's price-to-book value multiple going lower, you need to question if the denominator itself is stable.

If, as is the case with most PSU banks, including SBI, the networth itself is at risk of erosion, the fall in price-to-book may not offer real value. And in that case, even a lower 'price' may not offer an attractive buy proposition.

In a rising market like ours, it can be difficult to spot the line between cheap and value stocks. It's natural to look for falling prices. But if you are looking to buy stocks for the long term, we recommend looking for stocks that are not only cheap and hated but also have an uptrend in earnings and book value.

Editor's note: In the latest issue of ValuePro, Rohan and his team have uncovered a business that has positioned itself extremely well for earnings growth. With GST, the sector is becoming an organised, and this is a huge catalyst for the company. In addition to this strong tailwind and a focused management, the company ticks all of the team's boxes. Subscribe to ValuePro today to get access to the recommendation report.

02:30 Chart of the Day

Indian companies raised a record US$ 46.5 billion in debt and equity in 2017, the highest amount in the last decade. 64% of these funds are from the financial sector. What is interesting is that the energy and power sector was the second highest in raising funds. Also, amongst the financial sector companies, Power Finance Corp (PFC) which raised US$ 3.5 billion was one of the largest fundraisers.

Increasing Bond Issues by Indian Companies

This can be one of the indicators of a major transformation in India's energy market. India has been reliant on traditional fossil fuels like coal, oil and gas for its energy requirement. Recent numbers indicate a shift in trend towards renewable energy. Share of renewable energy has grown to 17.4% in FY17. In fact, the addition of renewable energy capacity was more than traditional energy in FY17.

While this shift is good for players in the renewable energy space, traditional power companies like Coal India are suffering due to a decrease in demand. Its sales fell marginally in FY17 even as wage revision pulled down profits by 35%. The future prospects of higher realizations remain clouded as Coal India will have to supply coal to power plants having Power Purchase Agreement thereby curtailing sale through e-auctions. Moreover, the management also expects subdued demand for washed coal due to reluctance of power generators to pay for expensive washed coal.


Continuing with Public sector banks' (PSB) bad loan plight, Canara Bank recently highlighted its Non- Performing Asset (NPA) issues. In an interview with Livemint, Rakesh Sharma, managing director (MD) and chief executive of Canara Bank mentioned that Canara Bank's exposure to the 12 major defaulters is Rs. 102 billion. This constitutes roughly 30% of its gross NPA of Rs 340 billion.

PSBs dominate the banking industry in India with more than 60% of the total outstanding loans. They chose the easy life of issuing big-ticket loans to large corporations over the hard work of reaching out to many small retail subscribers. Extending credit to small and medium enterprises (SME) was also limited - to the extent of meeting priority sector lending targets set by regulators.

Moreover, large-scale bureaucracy and a lack of autonomy ensure the sub-optimal profitability and asset quality of state-run banks.

While Canara Bank was positive since action has been taken on 30% of its stressed assets, recovery of these assets will not be an easy task. While the final solution would be liquidation of these 12 major defaulters, the value of assets owned by these companies will be a major issue. Since, these companies have been under huge amounts of debt since long, it's likely that they would have already sold their most productive assets to stay afloat. Since these companies are now saddled with unproductive assets, how much value will their lenders i.e. PSB's get from selling them will be the main question.

Thus, in spite of RBI showing urgency in tackling this rising NPA issue, resolution of the same will be a long and painful road ahead for the lenders involved.


The Indian stock markets were trading higher at the time of writing with stocks in the realty sector and FMCG sector witnessing maximum buying interest. At the time of writing, the BSE-Sensex was trading up by around 164 points and the NSE Nifty is trading up 41 points (up 0.4%). The BSE Mid Cap index is trading up by 0.6%, while the BSE Small Cap index is trading up by 0.8%.

04:56 Investment Mantra of the Day

"When you combine ignorance and leverage, you get some pretty interesting results." - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Tanushree Banerjee (Research Analyst).

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