PNB Gilts Ltd. : A 50 cent Dollar?

Stock Opportunities
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A little bit about the Company

• The Company is promoted by Punjab National Bank – which owns 74.07% of the Company.

• The business of the Company is as a “Primary Dealer” for Government Securities. There are not many of these around (one has to be licensed for this) and it is the only publically listed one.

• The Company is not your typical Non-Banking Financial Institution. It lends to nobody, borrows from nobody. If you check its balance sheet, it has zero long-term liabilities. So there is obviously no question of NPAs etc.

The numbers.

• The entire Business is available for a total consideration of Rs. 432 Crores in the Open Market as of this moment. That is at Rs. 24 per share of the Company.

• The “Liquidation Value” of the Company (that is Current Assets less ALL liabilities) is a little above Rs. 726 Crores – that is Rs. 40.34 per share. Out of this Rs. 23 per share is held is Cash and Rs. 17 per share in the form of Government Securities. Once again, this is after deducting ALL liabilities – that is, assuming that all of the short term borrowings are “settled”.

That is 68% above the Market Capitalization of the Company.

• The shareholder’s equity in the Company is Rs. 742.55 Crores. That is a Book Value of Rs. 41.25 per share.

So here is the play.

• The Company makes short term borrowings – way in excess of their Equity – to purchase Government Securities to “underwrite” (to sell as a wholesaler) and also trades them on their own account.

In any case, they have a Capital Adequacy Ratio of 65% - so they have tons of space to if need ever be.

• As per the Balance Sheet, the Company held about Rs. 3,508 Crores in these Government Securities on their “Current Investments”. This I am assuming is their Inventory for underwriting and trading.

• So the simple point that needs to be analyzed is whether there is a possibility (or analyze the subjective probability) of the company losing Rs. 306 Crores (that is Rs. 17 per share to get to the CMP) on their Inventory of Government Securites. That is a humungous 10% loss on their holdings of Long Term GOI Bonds. It is really not that simple to lose that kind of money on Government Debt.

Because that is the only way that the market price of their shares can be justified. We must begin with the presumption that Markets are “efficient”.

• Just for the record, the Company – in atleast the last 15 years – has only made a loss once. A net loss of Rs. 68 Crores.

• Everything else is ‘noise’.

Their earnings per share is usually between Rs. 2 and Rs. 4 over the last 10 years. I doubt if any projections can be made to this end – since a lot of it is “trading” (read, “speculative”) income. That is not what is important or even relevant in this particular investment. In any case, I am pretty confident that the Indian Debt Market will only get exponentially bigger in years to come. That should be good for business.

They do have a long track record of paying pretty healthy Dividend too. At Rs. 1.50 last year – that yields a fantastic 6.25% at this price. Even assuming an average dividend of Re. 1 per share (considering the income last year was mush higher thanaverage) gives a yield in excess of 4%. That never hurts while you wait.

Plus they have grown at about 8% per year over the last decade (CAGR) and have a decent ROE of 12.42%. It is a decent business.

• End of the day their income – though once again, that is not what is important in this case – is a proxy on the interest rates. And on the whole, there is a widespread expectation of interest rates being cut in the near future. That should augur very well for the Company.

Let me know if I am missing something. If there is a ‘hole’ in my thesis.

Mohit Kumra

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Thanks Mohit for the analysis…
This stock was in my watchlist from last six months. But not able to understand the last six month downplay in the stock.
Disc - Not invested

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is market pricing in bad mgmt who have messed up parent bank pnb
if interest rates rise (or stay flat a long time ) will it hurt this co ?

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Considering the long term ROE generated by the business is in single digits, shouldn’t the business be valued at a significant discount to its book value?

If the entire business was available to buy, you could as an owner liquidate the business and make a good profit. However, as a minority shareholder you are at the mercy of the majority shareholder who is destroying value by running a business at single digit ROEs which is below its cost of capital. In such a case, a significant discount to book value seems justified.

When valuing a business by assessing the liquidation value, it is essential that the existing managers are able to generate an ROE above their cost of capital. In situations when this is not the case, liquidation value is a poor indicator of value. For example: If a business is likely to generate an ROE of 8% in eternity while its cost of capital is 10%, as a majority owner the business’ value would be equal to the book value. However, as a minority shareholder the value of such a biz would be close to 0.8x of book value.

So in your thesis it is important to assess what the long term ROE of the business is. If it is significantly below cost of capital, a big discount to book value is essential.

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Hi Mohit
Thought of sharing few points, might be helpful in the overall scheme of things. The only background which I have regarding the company is that {a} I spent few weeks there understanding the nuisance of debt market in India (this was some years back, when I was on the beginners phase) {b} Now i have a very active interest in debt market… So here are they
• Primary dealership was an attractive idea in the era when the licenses were doled out but it has lost much of their charm due to many reasons (do some Googling R&D) and that is why you don’t see many of them around as on date
• These guys needs to take an active view on the multiple macro factors which might have an impact on interest rates & we all know how easy it is!
Remember they have to put there money where there mouth is.
• Regarding the point on possibility of company losing a substantial amount of money – I was told by their investment team that few bps movement, in an unanticipated direction, can create havoc worth Crores in their portfolio. (At that of point of time I though they must be kidding!).
But today, with some understanding, I can vouch that it is a real possibility and not a remote/Six-sigma event – So they have to be on their toes at each and every movement.
• The issue is that these people have to deal with long term securities which are most susceptible to interest rate volatility and that too with short funds (i.e. intention of not holding it till maturity). Now there can be serious MTM damage here, in a very short span of time. Given their networth and the amount of trade they do in a year (worth thousands of Crores) – it does not make the business very simple.
• In debt market, more the money you have the more you will need – so your idea of liquidation value might not stand, because they are never going to part with anything.
• Also, there core revenue model was a fees for there services – now in debt market, where there is a cut-throat competition for every single basis point – who would like to pay anything extravagant. So one can really not imagine that things will change in a tizzy
• I believe at that point that they were dealing with plain vanilla G-sec bonds but were excited about interest rate derivatives/structured products – which were about to gather pace. They had good understanding about the structured products but I have no idea about how they have fared in the last few years
• Lastly there investment team consisted of professionals (hired on merit) and were awesome in their understanding (though I didn’t like the CIO then– he said, giving me some time will lead to loss of work :grin:, but now I can appreciate his situation). But the top management was deputies of the parent bank, like we have in all PSU based set-ups/subsidiaries.
The above points are unstructured and are also based on old information, things might have changed now (except how to lose money in debt market in India/world) and I might be wrong. Your investment premise might be correct but definitely you have to dig. deeper.

Best

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@sko5prasad

I cannot comment on the stock prices or stock price movements since I am barely – if at all – bothered about it.

Eventually everything moves to “fair value”. It always does. We just have to make sure that our estimation of “fair value” is correct.

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@reacher :

Their executive management has nothing to do with that of Punjab National Bank and I doubt if that is the reason I would ascribe to its apparent undervaluation.

Of course, a rise in interest rates (or even flat interest rates for that matter) would hurt them at this point since there is a widespread expectation of lowering in interest rates and I assume that their portfolio is positioned accordingly. As a matter of fact you can clearly see the effect in this year’s result as compared to last years - when the yield on the 10 year benchmark fell about a percent. The EPS is down about 50%.

But that is not what I am looking at here since over the long term they have managed to generate a decent profit year after year.

More importantly, I am very clear about the fact that this is a Asset Price to Market Price mismatch I am trying to exploit. Earnings - as long as they continue to be average - is secondary.

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@Mantri

So let us get something on the table first. You are obviously a “left-wing” quality driven Value Investor and I am an admitted “right-wing” asset driven Value Investor. We will not agree with each other no matter how long this goes on - and I am sure that both of us do very well doing what we do, the way we do it.

In any case, I love to learn more and thank you for your insight.

So here are my 2 cents :

  1. The ROE is definitely an indicator of the “quality” of the business and by extension the management. Who doesn’t love a high ROE business. Unfortunately, they are seldom available at “great” of even “fair” prices.

  2. But ROE has its place. I think I was very clear when in my analysis of the Company that this was just a “decent” business. Nothing more. But, there is a point in valuation where other factors - and I know it is not as simple as this - such as the P/E you are purchasing it at, the P/BV (though I only give importance to the “Liquidation Value” when we are talking about the “assets” of the Company, in most cases) you are purchasing it at and the yields you receive cannot be ignored all of the time.

I have those high ROE, high Growth, long term investments in my portfolio. But all these “games” of 30% to 50% undervaluations have to be indulged in too. A man’s gotta eat after all.

  1. So that is what we are looking at here. Has the market gone too far in its disdain for the stock? With history as a guide - the Company generates a decent amount of cash every year. Is it fair for there to be a 70% differential between the Market Cap and the Govenment Securities the company is holding.
    That is the question that needs to be answered.
    In my opinion - and that is what I am trying to figure out here - the highest valuation this Company could ever be ascribed is, say, Book (which is almost its liquidation value). In a year of great earnings or if there is ever a momentum for any speculative reason - I don’t see this stock ever being traded above that. Even if we ascribe a average valuation of say 0.80x book - we still have 33% to go up from here.

  2. You will never, ever find the “liquidation value to market value” sort of deal in any Company that is anything more than “average”. So if that is the road you want to walk down, be prepared for “average”. It is a moot point to say that the Company is not the highest of quality.

  3. I always look at any purchase in the stock market as a private buyer of the entire company. As simple as that. Would I buy the entire Company at this price were it offered to me. The Market has a way to getting things to fair value. It just does.

Mohit

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This stock has gained a lot of attention lately with anticipation of interest rates going down sharply. Last 2-3 days this stock has been mentioned frequently on cnbc and others.

disc: tracking position at 45 levels.

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Saral Gyan recoed as hidden gem on 20th Nov at 42.45

Amit

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HDFC Sec issued a research report last week with a target price of 48. It has been up 50% since then. The report is attached. report(1).pdf (497.6 KB)

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Hi,
Any reason why this stock started moving South wards.
Was is due to RBI asking banks to transfer 100% of their cash under the central bank’s cash reserve ratio (CRR) from deposits generated between September 16 and November 11

Thanks

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Looks like consolidation in this price range. Chances of rate cut are high in upcoming RBI meet.

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Was looking at the India 10 Y G-Sec yield and seems like a very good correlation between the price of this stock and G-Sec yield. Both are inversely proportional

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Even this quarters results are excellent … EPS at 3.66 ( FY 16 was 0.52).

I was trying to understand little more regarding their business , can someone please shed some light on :

why their is no competition to them as they are the only listed player as underwriter for Govt Securities ?

Is their entire income just commission based or they earn significantly by trading Govt Securities from their inventory when interest rates fluctuate ?

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Read this article. Can anyone help explain what does this mean for pnb gilts

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As per my limited understanding this would mean an increase in cost for PNB Gilt and decrease in bond prices where this company deals in. Last quarter profits were good partially due to lower cost of funds at 6.38%. After RBI policy meeting the yield has already jumped to 6.857.

IMO slightly tough time ahead if the yields get past 7%.
Seniors can provide their inputs here.

Disclosure: invested

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As the original article writer and long time PNB Gilts follower, I would
urge you to keep the following in mind :

  1. The earnings that you saw this year are exceptional - they will only
    happen once in a while when there are aggressive interest rate down-cycles.
    So don’t expect anything close to this as an average in the long time.

  2. Interest rate cuts are definitely good for the company - but I would not
    try to predict their earnings based on that. Sometimes volatility in itself
    good for them, either which way.

  3. All in all, stop trying to predict their earnings. Good times or bad -
    they always make money with a 10 year average of about Rs. 2 / share. That
    is their “earning power”.

  4. This is the most important thing. PNB is now openly stating that they
    are looking to sell their stake in PNB Gilts to shore up their capital base
    (the Business Standard yesterday). PNB Gilts has their entire Equity (Book
    Value) in a Hold-To-Maturity (HTM) bond portfolio - that is the maximum RBI
    allows. By March, this should be around Rs. 50 / share. That means they
    have Rs. 50 per share in cash. That becomes the base value of any stake
    sale they might do. Add to that 10x their above mentioned earnings power
    which equals Rs. 20. If I were in their shoes, I would not even dream of
    selling my stake in the Company for less than Rs. 70 - that is the worst
    case value.

Take care.

Mohit Kumra

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@mokumra Thanks for your insight on this.

I got couple of queries

What’s ur view on stake selling by PNB, should it be taken positively that liquidity of stock would increase and that can attract more institutional investors or we should be lil cautious.

Is this good earning year due to lower costs or majorly due to Interest rate volatility?

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Hey.

There is nothing negative in the stake sale. It will actually be a great
thing because it will reflect the true value of the business in the market
quote. Plus there will have to be an open offer too.

As for the earnings - I don’t know. Maybe it a combination of both. I try
not to speculate. They obviously do not have a “steady” income model. So
it’s best to value the business using their average earnings over let’s say
10 years.

Mohit

1 Like