Public sector banks have been in huge demand in recent months, thanks in part to their improving financial performance but Saurabh Mukherjea, the founder of Marcellus Investment Managers, is not a fan.
“For a typical public sector bank, the return on equity is consistently below the cost of equity, which means value generation is zero. And that’s reflected in the five-year and 10-year share price movement, which is zero,” Mukherjea told Moneycontrol.
The Nifty PSU Bank index, a representative measure of public sector bank shares, has advanced 55 percent so far in 2022, with most of the gains kicking in since September. However, it delivered only a 6 percent return over the past five years.
Many PSU Banks, especially State Bank of India (SBI), Bank of Baroda and Canara Bank, have delivered superlative quarterly numbers in the September quarter, riding on better credit growth and higher recoveries. A decline in bad loans also improved their outlook.
However, the trend hasn’t been consistent. Most lower-tier banks such as Punjab National Bank are still plagued with high levels of toxic debt. The market has disregarded this and has bought PSU banks indiscriminately.
Mukherjea said the returns look respectable in the short term because prices had plunged significantly during Covid-19. But public sector banks have not made money in the long run, he said.
Some value
However, he is not bearish on every public sector bank. He sees some value in SBI, which reported better-than-expected earnings in the September quarter. The lender has improved its performance consistently over several quarters and its stock has also appreciated.
Also read: PSU banks an attractive play, stick to the strong ones, says this wealth manager
“I think a lot of credit should go to Arundhati Bhattacharya (the former chairperson of the bank) for improving the efficiency and quality of the bank,” said Mukherjea. “Will SBI continue doing well, going forward? I think so because the worst excesses of crony capitalism seem to be behind us. Provided the kind of mass destruction of the SBI balance sheet, which happened a decade ago, doesn't happen again, I think SBI should be a decent compounder going forward.”
Mukherjea, who is heavily invested in HDFC Bank via the funds he runs, will not be buying PSU banks, including SBI, because he does not see them compounding at a rate of 20 percent, which is his threshold.
Other PSUs ‘fragile’
Mukherjea refuted the notion that the quality pack, which refers to companies that rely on traditional business models to consistently generate high cash and return ratios, may see some kind of moderation compared to cyclical or public sector companies.
In the past 12 months, such quality plays have not performed well when compared to public sector institutions, whether they make defence equipment or give loans, which have had a great run.
“I can't deny that,” said Mukherjea, adding that he still stays away from such companies because there is “no business engine” there. While they might be having their moment in the sun, it will not be long term, according to him.
“If you take a typical public sector institution, the return on capital (RoC) will be significantly below cost of capital. If your RoC is below cost of capital, whether you are a metal and mining company or a public sector company, you're not generating a surplus. If you can’t generate a surplus, you cannot grow your business,” he said.
The star fund manager said he continues to focus on companies that generate cashflows.
“The basic tenet of investing is to look for companies which make free cashflow. And then if they become cheap, buy tons of it,” he said.
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