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How will proposed mergers impact PSU banks' stocks?

Investors should wait and watch as the situation is still fluid. This is because the exact framework of these mergers is still being worked out.

, ET Bureau|
Updated: Aug 28, 2017, 04.30 PM IST
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There’s rising uncertainty in the PSU banking segment due to the government’s plans to merge entities.
There’s rising uncertainty in the PSU banking segment due to the government’s plans to merge entities.
There’s bad news for investors in listed PSU companies. The government has announced its plans to reduce the number of PSU banks from 21 at present to 10-12 by merging them.

This is the first phase of the plan. At a later stage, the government may bring this number down further.

It also plans to cut down the number of PSU oil and gas companies to two or three. So, how should investors play this structural change?

SBI has taken a hit, so can other PSU banks
The mergers will conflate the NPA burdens of the entities and create logistical issues.

How will proposed mergers impact PSU banks' stocks?
Since the situation is still volatile, investors need to be careful.

How will proposed mergers impact PSU banks' stocks?

Source: ETIG Database

What’s in store?
Although the downsizing will help the government and the economy over the long term, in the short term it can create serious issues for these companies. Investors are also worried about the causes of these mergers. As a general rule, mergers are based on business needs. They’re not motivated by the promoter’s desire to reduce the number of companies.

The government’s budget compulsion is also playing a role in the merger decisions. For instance, the decision to sell its 51% stake in refining and marketing company HPCL to oil exploration and production company ONGC will fetch the government around Rs 29,000 crore, which will be used to meet its divestment target. However, experts say that the long-term strategy of creating larger entities is good. “Since it offers more pricing power and increases operational efficiencies, it’s a good idea to create large, global-scale corporations,” says Vinay Khattar, Senior VP and Head of Research, Edelweiss Investment Research. Let’s analyse what is happening in the banking and oil sectors.

Oil and gas PSUs are much better off
The sector is on more solid ground and the merged entities will emerge stronger

How will proposed mergers impact PSU banks' stocks?
Oil companies are coming out of a difficult phase

How will proposed mergers impact PSU banks' stocks?

Source: ETIG Database

Saddled with laggards
The government has already kickstarted the process by merging SBI with its subsidiaries and Bharatiya Mahila Bank, effective from April 1, 2017. Since most of the subsidiaries were laden with nonperforming assets (NPA), SBI’s gross NPA jumped to Rs 1,881 crore in the first quarter of 2017-18, from Rs 1,377 crore during same period last year, a jump of 37% on a year-on-year basis. The gross NPA, in percentage terms, also jumped up by 256 basis points on yoy to 9.98%.

Since the combined entity already account around 25% of the total loan outstanding in the system, government may not bother SBI with more mergers. What about other PSU banks, like the NPA laden IDBI Bank? IDBI has reported a record net loss of Rs 3,200 crore in the fourth quarter of 2016-17 and additional net loss of Rs 853 crore in the first quarter of 2017-18. Worse still is that its gross NPA jumped further to 24.11% of gross advances, compared to 21.25% in March 2017 and 11.92% in June 2016. IDBI Bank will end up becoming a millstone around the neck of the PSU bank that takes it over, because it still has a net NPA of 15.8%.

In addition to the NPAs, these mergers will also create other logistical issues. Most of these banks have geographical overlap and that means the merged entities may end up with several branches in the same street. Unless the new entity closes down these branches and reduces cost, these forced mergers will only result in bringing down the well-managed entity. If the government uses size as a criterion, some smaller well-run PSU banks also may lose out.

What should investors do now?
It’s best to wait and watch because the situation is still fluid. This is because the exact framework of these mergers is still being worked out. The government has asked banks to come up with plans. “Since we don’t know the structure of possible merger (that is, whether smaller banks will be absorbed by large ones or if they will come together to form a large bank), there is not much investors can play here”, says Kajal Gandhi, Banking Analyst at ICICI Direct. And only investors, who are ready to take a ‘long-term’ view, should consider entering during this turmoil. “We have a cautious view on the PSU banking sector now. Though the government’s current move is positive for the sector, its impact will be visible only in the long term”, says Siddharth Purohit, Banking Analyst at Angel Broking.

Getting a better deal
Things are in much better shape in the oil and gas sector. First, there is a clarity because ONGC has already passed board resolution to buy government’s 51% stake in HPCL. The government’s plan to merge IOC with Oil India is also at an advanced stage. Further, while PSU banks are in a downturn, oil companies are coming out of a difficult phase. “Unlike PSU banks, there is no direct competition and duplication of assets between ONGC and HPCL. The trade unions at oil companies are also not as strong as those of PSU banks”, says Vinay Khattar, Senior VP and Head Research, Edelweiss Investment Research.

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