PNB Gilts an opportunity in queue..?

PNB Gilts - a table-thumping, deep value Buy with high dividend yield

  1. PNB Gilts Ltd is India’s only listed, pure-play primary dealer (licensed activity by RBI) whose principal business is to hold and trade in Indian Govt securities
  2. It earns money through interest on g-secs and bonds and through profits made on trading in g-secs / bonds held by it
  3. It owns g-secs of roughly INR 10,000-11,000 cr out of its total investments of roughly 14,000 cr
  4. It has borrowings of roughly 12,000 cr (largely from RBI - LAF and REPO borrowings and some from banks including PNB)
  5. The current net worth of the co is roughly 1,500 cr and its m-cap is roughly 750 cr (0.50x Trailing Net Worth)
  6. The business is in a sweet spot and is benefiting on 2 accounts - reduction in interest rates (ie Repo rate - currently 4%) resulting in substantial and material reduction in borrowing costs and increase in g-sec prices resulting in substantial trading profit
  7. Management is professional and independent from PNB
  8. Borrowing franchise is solid; the co recently raised unsecured CPs at 3.45%
  9. Going forward, even if interest rates were to start rising again, PNB Gilts would be able to offset increase in borrowing cost (at Repo Rate) by increased interest income on g-secs (Bond yields are usually higher than the prevailing repo rate)
  10. In Q1FY21, the co earned 210 cr interest income and had borrowing costs of 103 cr. Over and above the co earned 280 cr trading profit (realised and unrealised), thus giving it a PAT of 285 cr for the quarter; to put this into perspective, for full year FY20 PAT was 186 cr
  11. Even assuming zero trading profit and rising interest rates (both highly unlikely), the co can easily return PAT of 70 cr per quarter only through net interest income after accounting for operating costs of 30-40 cr; Thus even at 280 cr PAT for the year, the co currently trades at a P/E of 2.5-3.0x
  12. Why buy now? From 2017-2019 the co’s net worth was stuck between 850 cr - 900 cr, which prevented it from borrowing more and hence investing in more g-secs; now that its net worth is 1,500 cr (and growing) a virtuous cycle of compounding and growth has begun - the co will be able to borrow more from RBI (at the Repo Rate) and from others and hence invest in more g-secs and other bonds and hence earn more interest (at at least the G-sec rate)
  13. The net worth (and hence cash flows) will therefore compound rapidly and sustainably and given the low risk nature of the business, the price would have to catch up with the net worth at some point
  14. The co is now also handsomely rewarding shareholders with higher dividend - Rs 3 dividend for FY20 which translated to a yield of 7.5% at CMP (9% yield on date of announcement)
  15. With the brilliant Q1 performance and therefore FY21, shareholders can hope for even more handsome rewards in years to come
  16. Risk - sudden and materially adverse movement in interest rates. Would like to stress on the words sudden and material because even in times of adversity, management has time and again demonstrated risk management, capital preservation and earnings capability
  17. Disclosure - invested. However, still buying
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