Everything Good is Bad, Everything Bad is Good !

This line is from the not so famous album 'Orange Blossoms' and I am not sure what JJ Grey & Mofro had in mind when penning this down however it holds a valuable lesson for investors.

Text books & statistics attempt to objectify our decision making. They indicate a range for various ratios & these tend to get ingrained deep in our minds thus influencing our stock selection. For example a tilt towards low PE ratios, low Debt/equity, high Dividend Yield, more tangible assets, low NPA's etc. Here is a table of a bunch of stocks that theoretically were great investments :-

=> They offered valuation comfort versus peers& were growing at a fast pace.

=> They enjoyed the trust of depositors thus raised funds at a much lower cost than their private sector peers. Thus they were able to lend at a lower cost, theoretically attracting the least risky borrowers.

Alas, Everything that looked good turned bad. We know the present state of these institutions but still a tabular representation is quite informative.

Many 'value investors' have lost a large chunk in this trade. Infact during this period the victims of PSU Banks include 'investors betting on turnarounds' , 'bottom fishers' & 'contrarians'. The market has been right in attributing lower valuations to these stocks. Lets quantify the destruction:-

=> The absolute correction for a value investor is ~48%. If one were to consider opportunity cost at the repo then the portfolio lost ~65%. I wish it ended here, this is not difficult to recover from in equity markets. IOC, HPCL, BPCL have recovered from similar corrections.

=> The market cap of these firms is higher by 10% in absolute terms. This is the big loss, the firms have issued more shares than what was outstanding in 2011 to stay afloat. Being Govt & LIC backed capital raising has not been a problem but to put it simply over the last 6 years the govt has re-created the entire PSU banking and the exercise is not over. 

=> In individual cases, a bank like IOB has been created 4 times in the last 6 years ! This also gives a picture of the challenges that we as a nation have faced & survived with a growth rate of 7% !

The picture looks grim for PSU Banks. Their own management is a tense lot on the day they have to announce their results. There is deep rooted fear & every analyst recommends staying away. They have been right for the last 6 years. However,

=> This is  the 1st quarter when NPA's have stabilized & provisioning is at ~60% plus.
=> Historically 25-30% of NPA's are recovered thus we are probably at the end of aggressive provisioning which has depleted the books of the banks.
=> They still retain the trust of depositors thus raise money at much lower costs than peers & even during demonetisation their CASA increased far more aggressively than private peers despite their rates being lower by 200 basis points.

Who knows, Everything that looks bad, could turn good !