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PNB Gilts: Hold

Sanjiv Shankaran

SPECULATION about future interest rate movement takes up a lot of space in the financial newspapers today. The Government suggests that policy measures will push for a soft interest trend, but the financial market seems to think otherwise.

In the recent past, price trends in debt securities suggested that the market thinks interest rates will rise in future. The contradictions matter to everyone, but perhaps the most to a company such as PNB Gilts, that can see a sharp change in fortunes if the interest rate level hardens.

Background: PNB Gilts, a subsidiary of Punjab National Bank, is a primary market dealer. The company derives its revenue from brokerage arising out of dealing in government securities (gilts), and interest income and trading profit in the same. Therefore, the company's fortunes hinge on interest rate movement and its ability to forecast the same correctly.

To illustrate, in 2000, an increase in interest rate level led to a fall in gilt prices, and PNB Gilts had to make a massive provision for the fall in the value of securities it held as inventory.

Strengths: PNB Gilts is not as vulnerable to interest rate fluctuations as it was two years ago. The company has changed tack since 2000, relying less on interest income and more on trading profits. The implication of the new strategy is that PNB Gilts' is unlikely to be as badly affected by an interest rate hike as it was two years ago.

The new strategy has also resulted in a sharp growth in profitability in the financial year 2001-02.

Unlike most financial intermediaries, the company does not carry out lending operations, and is, therefore, insulated from bad debts that arise out of an industrial slowdown. An incidental consequence is that the company's dependence on capital for growth is relatively lower.

Weakness: Despite the Government's intentions, external conditions may lead to a hike in interest rates. Once that happens, PNB Gilts may be hit, though not to the extent as in 2000.

Investment recommendation: At the current price, PNB Gilts trades about 2.5 times its 2002 earnings per share share (EPS) of Rs 8.34.

The stock has witnessed considerable volatility in the last month; first a sharp rise soon after the credit policy in April followed by a slide over the last few days.

At the current level, shareholders may stay invested while fresh purchase can be avoided for the following reasons:

  • An interest rate hike looks more likely at the current juncture than at any period in the last year. As long as the threat remains, it may not be prudent to make new purchases.

  • At the same time, the company's strategy of relying heavily on short-term trading in gilts rather than holding them for interest income has resulted in a notable improvement in 2001-02 profit. Net profit increased about 139 per cent to Rs 112.59 crore.

    The profitability of operations also increased sharply. The same strategy cushions the company from a big blow in case of an interest hike.

    The marked improvement in the company's operations suggest that shareholders may be better off waiting out an uncertain period rather than selling now. Stay invested.

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