Modi Is Back, And So Should The Reminder About Investing Wisely

The one thing successful investors do well is keep investment decisions separate from sentiments. Sentiments ran high on a lot of sectors when the Narendra Modi-led Bharatiya Janata Party came to power in 2014. Infrastructure, power, defence and manufacturing were all believed to be clear winners over the five-year term. But the ensuing five years showed that investors who chose wisely may have made some money and lost a lot less than those who bet on popular sentiment.

Simply put, buying stocks in sectors where the market believes reforms will be enacted might turn out to be the recipe for disaster. Some sectors like power, defence and public sector banks have shown this investing mantra to be true, especially in the last five years. Mind you, not everything that was fancied has gone south. Infrastructure stocks and businesses have done well selectively, and there are state-run companies that created tremendous wealth. But there are lessons that one can draw from the five-year behaviour of the sectors mentioned below:

Power

This is what a brokerage wrote in May 19, 2014:

“But we expect the new government to undertake politically difficult reforms. With the BJP led by Mr Narendra Modi winning the elections decisively, we expect a stable and decisive government at the centre to prod states to undertake politically tough reforms of discoms. This is borne out by the turnaround of Gujarat discoms by the BJP government there—the discoms brought down theft and technical losses from 20 percent in FY07 to 15 percent in FY12. The BJP government’s focus on infrastructure should also result in faster clearances for new power and coal mining projects.”

A quick snapshot of what the companies in the sector have done in the last five years shows that the markets have anything but rewarded them.

Torrent Power Ltd., the best performing power stock on the BSE Power Index, has given annualised returns of 10.33 percent in five years.

Renewables were also in focus. But all the renewable power firms, including Suzlon Ltd. and Orient Green Company Ltd. as well as lenders like PTC India Financial Services Ltd. have lost tremendous value.

Railways

The government increased passenger fare and freight rates from June 25, 2014. Pace of electrification and renewal of rail lines touched an all-time high early this year. The over-arching belief was that railway finances would gradually improve and orders for all suppliers would increase. Locomotive companies, signal and other equipment makers were expected to benefit. But investments in the railway stocks didn’t yield great returns.

PSU Banks

Here’s an excerpt from an institutional desk of an international brokerage on May 17, 2014:

We expect the new NDA government, winning with a strong majority, to fast-track low-hanging and much-needed reforms in coal, power and roads—sectors that have contributed the most to stress loans in the past three years. Fast-track reforms should help reduce new stress loan formation, especially in PSU banks that have seen sharp deterioration in asset quality. It should also help improve loan growth, albeit gradually as the capex cycle recovers.

And the recapitalisation of public sector banks announced in 2017 led people to believe that the state-run banks could finally be turned around.

But the returns have been mixed at best. While State Bank of India has gained a measly 24.9 percent over the last five years, the cumulative returns for a lot of its state-owned peers have been dismal.

Even Bank of Baroda, the second largest PSU bank with a CEO considered to be a master at work, has struggled, falling 8 percent in each of the last five years.

Other PSUs

The expectation was that the way Modi turned around some of the ailing state-run units of Gujarat in his tenure as the chief minister, the fortunes of the central public sector units would turn around as well. News of Clean Ganga led to expectation that Dredging Corp Ltd. would stand to gain, and talk of exporting power to Pakistan held out potential for financiers like Power Finance Corp Ltd. and REC Ltd.

A research report of June 9, 2014 had the following advice for its institutional clients.

PSU reforms are likely to be among the first tasks for the newly installed Modi government, given the new premier’s stellar track record in his home state of Gujarat. The knock-on effect on the economy can be significant, since many PSUs operate in segments of vital national importance. Our top six picks, Coal India, SBI, REC, Power Grid, BEL, and ONGC, are expected to deliver more than 70-100 percent returns in our bull case scenario, over the next three years.

Power Grid did deliver positive returns over the last five years but the index at large and other stocks gave dismal returns.

Defence

Prime Minister Modi aims to make India self-sufficient in defence. That was expected to be a $250-billion opportunity.

In early 2015, motorcycle maker Hero Group, the Tata Group, and automotive companies like Bharat Forge Ltd. and Ashok Leyland Ltd. took the defence plunge. Valuations of pureplay defence companies started shooting up because of the confidence that they wouldn’t spend on capex without visibility on orders.

But the inflow of orders was slow and erratic. A listed explosives maker operated at sub-50 percent capacity utilisation after enhancing capacity. Others announced to increase capacity but didn’t go beyond that. Stocks from the sector that were fancied in the first two years of Modi’s first term didn’t return gains.

The data cited above makes it clear that investors lost serious wealth in transformation-by-perception themes. The important investment lesson as Modi has returned to power is to be very careful about where to park the money. Signs of activity in a sector may not always lead to returns, even if backed by intent from the prime minister. Earnings are the only recipe for success.