Financial Analysis of Navratnas Nine PSUs

Contemporary Issue: Final Report

Topic: “Navratna: A Financial Analysis of the 9 PSUs”

Faculty Guide: Prof. M. S. Bhatt

Submitted By:

Hardik Jain (8076)

Jain Amit Manraj (8077)

Submitted on: Saturday, 31st October, 2009

Navratna: A Financial Analysis of the 9 PSUs

Hardik Jain (PGDM No. 08076) & Jain Amit Manraj (PGDM No. 08077) 2

I. EXECUTIVE SUMMARY

Project title: Navratna – A Financial Analysis of the 9 PSUs

Project Guide : Prof. M. S. Bhat

Name of student : Hardik Jain & Jain Amit Manraj

Contemporary Issue means the current issue. It may be in the economy, in some sector,

some industry or some company. The event that is more in lime light because of some or the

other reason. Like everyone else, we also tried to find the most happening issue. We thought

of various issues and decided on our topic. Government‘s declaration of divestment of its

stake in the PSUs in budget, we were sceptical if such a move might help the government but

would it improve the companies‘ performance and gain investors‘ confidence in them? So we

thought government had already divested its funds from various companies so why not study

them and try to understand has the divestment had any positive impact on the companies.

Now, to decide which companies we should select, we thought of taking the Navratnas. The

government claims them to be their best, so why not test them.

Testing companies‘ performances needs lot of time and resources which were scarce for us.

So we decided to limit our study to whatever we have. Hence, using the available resources

like Capitaline Databases and Moneycontrol.com, we decided to do the financial analysis of

the companies. Financial Analysis is based on the evergreen ratio analysis. When we talk of

performance, we need certain benchmark to compare the performance so as to judge

whether it was good or poor. So we also performed competitor ratio analysis. We also found

the company valuations based on ECF, FCF & CCF and hence tried to ascertain which

company is undervalued and which is overvalued.

Tracking share prices also becomes an important part of our study. After the divestment, it‘s

general public‘s money which is invested in these companies. So it becomes essential to

ascertain as to which company has provided how much return to the shareholders. We used

the various tools of technical analysis to find the returns and expected price trends for the

stocks. Also, based on the CAPM (Capital Asset Price Model), we calculated the risks and

returns for the company.

The study was divided into two hypothesis:

1. ―The PSUs have not performed well over the years as compared to their competitors

in the same industry.‖



2. ―The Share prices of PSUs are not correlated with the Market performance.‖

The report contains the methodology for hypothesis testing and the summary of the

conclusions as to accept or reject the hypothesis.

Signature of the Student Signature of the Project Guide Hardik Jain Prof. M S Bhat Marakini

Professor-Operations, SDMIMD, Mysore

Jain Amit Manraj Date: 31/10/09



II. ACKNOWLEDGEMENT

We would like to thank almighty God for giving us an ability to perform our work

successfully.

We would like to thank SDMIMD for giving us an opportunity to work on the topic.

We would like to thank Prof. M. S. Bhatt for helping us in completing our research and

motivating and guiding us through the project.

We would like to thank each and every one who is directly or indirectly associated with our

project for providing us their constant support and help.

- Hardik Jain & Jain Amit Manraj



III. LIST OF ABBREVIATIONS

PSU Public Sector Unit

BHEL Bharat Heavy Electricals Ltd

BPCL Bharat Petroleum Corporation Ltd

HPCL Hindustan Petroleum Corporation Ltd

GAIL Gas Authority of India Ltd

IOCL Indian Oil Corporation Ltd

MTNL Mahanagar Telephone Nigam Ltd

SAIL Steel Authority of India Ltd

ONGC Oil and Natural Gas Corporation

NTPC National Thermal Power Corporation

FCF Free Cash Flow

ECF Equity Cash Flow

CCF Capital Cash Flow

NSE National Stock Exchange

HPR Holding Period Return

HPY Holding Period Yield

CAPM Capital Asset Pricing Model



IV. TABLE OF CONTENTS

I. EXECUTIVE SUMMARY .......................................................................................................................... 2

II. ACKNOWLEDGEMENT .......................................................................................................................... 4

III. LIST OF ABBREVIATIONS .................................................................................................................. 5

IV. TABLE OF CONTENTS ........................................................................................................................... 6

1. INTRODUCTION ......................................................................................................................................... 7

2. EMERGENCE OF PSUS & NAVRATNAS ............................................................................................ 8

3. SCOPE OF THE STUDY .......................................................................................................................... 11

4. PURPOSE OF THE STUDY ................................................................................................................... 11

5. HYPOTHESIS ............................................................................................................................................. 12

6. TESTING OF HYPOTHESIS -1 ............................................................................................................. 13

6.1 METHODOLOGY .................................................................................................................................... 13 6.1.1 Ratio Analysis ..................................................................................................................................... 13 6.1.2 Summary – Ratio Analysis .................................................................................................................. 21 6.1.3 Free Cash Flow (FCF) ....................................................................................................................... 22 6.1.4 Equity Cash Flow (ECF)..................................................................................................................... 22 6.1.5 Capital Cash Flows (CCF) ................................................................................................................. 23

6.2 SUMMARY TABLE ................................................................................................................................. 23 6.3 STATISTICAL ANALYSIS ...................................................................................................................... 24

7. TESTING OF HYPOTHESIS – II ......................................................................................................... 25

7.1 METHODOLOGY..................................................................................................................................... 25 7.1.1 Stock Analysis ..................................................................................................................................... 26 7.1.2 Regression Analysis ............................................................................................................................ 27 7.1.3 Technical Analysis .............................................................................................................................. 28 7.1.4 Trend Analysis .................................................................................................................................... 30 7.1.5 HPR - Holding Period Return ............................................................................................................. 31 7.1.6 HPY - Holding Period Yield ................................................................................................................ 31 7.1.7 Sharpe Ratio ....................................................................................................................................... 32 7.1.8 Treynor Ratio ...................................................................................................................................... 32

7.2 RESULT .................................................................................................................................................... 34

8. REFERENCES ............................................................................................................................................ 36



1. INTRODUCTION

Indian Economy has undergone a tremendous change over the last century. The Pre-

Independent Indian Economy was paralyzed by the Colonial system. The British

administration exploited the Indian resources to feed their British counterparts in Britain.

The advent of exploitation of farmers, labourers, etc. was very widespread. The trade and

commerce was very much restricted and the domestic producers were exploited.

Post-independence, Indian Economy faced many ups and downs. The implementation of

Nehru-Mahalanobis Model in the Indian Economy proved to be the stepping stone for

industrialization in the economy. The focus on industrial output in the second five year plan

(1956-61) drove huge investment in the industrial sector. The economy saw production rising

and new investments made. The government investment was seen heavily in the building of

infrastructure facilities. The various tasks of the second five year plan in India were:

To increase by 25% the national income

To make the country more industrialized

To increase employment opportunities so that every citizen gets a job

The domestic production of industrial goods in the public sector was encouraged by the

second five year plan in India. The total amount for development given allocated under the

second five year plan in India was Rs. 4,800 crore. This money had been distributed under

the second five year plan in India for the development of various sectors. They were:

Mining and industry

Community and agriculture development

Power and irrigation

Social services

Communications and transport

Miscellaneous

During the second five year plan India, 5 steel plants had been established, apart from a

hydro-electric power project which was also undertaken and implemented. The production

of coal increased during this period. Also, more railway lines were added in the north-east

part of the country, during the Indian second five year plan. Land reform measures had been

taken during the period of the second five year plan India, in order to remove the socio-

economic constraints of the rural population. The second five year plan India had, to a large

extent, improved the living standards of the people.



2. EMERGENCE OF PSUs & NAVRATNAs

The Government of India established various companies and corporations to achieve the

industrial production & improve the overall economy. The major sectors as described earlier

were the mining & industry, Power Generation, Social Services, etc. The overall economy

showed tremendous improvement but with hick ups. However, the efficiency of performance

of these entities was under question. Some enterprises performed extraordinarily while some

were not able to even perform well. Hence, the government came up with the concept of

NAVRATNAs. Under this, the government identified 9 companies in 1997 as its crown jewels

or the most prestigious PSUs, which allowed them greater autonomy to compete in the

global market. The following are the original 9 companies with brief details of each:

1) BHEL (Bharat Heavy Electrical Limited): BHEL is the largest

engineering and manufacturing enterprise in India in the energy-

related/infrastructure sector, today. BHEL was established more than 40

years ago, ushering in the indigenous Heavy Electrical Equipment industry in

India - a dream that has been more than realized with a well-recognized track

record of performance. BHEL's operations are organised around three

business sectors, namely Power, Industry - including Transmission,

Transportation, Telecommunication & Renewable Energy - and Overseas

Business. BHEL has a strong customer orientation and is sensitive to his

needs and responds quickly to the changes in the market.

2) SAIL (Steel Authority of India Limited): SAIL is the leading steel-

making company in India. It is a fully integrated iron and steel maker,

producing both basic and special steels for domestic construction,

engineering, power, railway, automotive and defense industries and for sale in

export markets. The company has the distinction of being India‘s largest

producer of iron ore and of having the country‘s second largest mines

network. This gives SAIL a competitive edge in terms of captive availability of

iron ore, limestone, and dolomite which are inputs for steel making. SAIL has

a well-equipped Research and Development Centre for Iron and Steel

(RDCIS) at Ranchi which helps to produce quality steel and develop new

technologies for the steel industry. SAIL's wide marketing spread ensures

availability of quality steel in virtually all the districts of the country.



3) GAIL (Gas Authority of India Limited): GAIL is India's flagship

Natural Gas company, integrating all aspects of the Natural Gas value chain

(including Exploration & Production, Processing, Transmission, Distribution

and Marketing) and its related services. GAIL today has reached new

milestones with its strategic diversification into Petrochemicals, Telecom and

Liquid Hydrocarbons besides gas infrastructure. The company has also

extended its presence in Power, Liquefied Natural Gas re-gasification, City

Gas Distribution and Exploration & Production through equity and joint

ventures participations.

4) HPCL (Hindustan Petroleum Corporation Limited): HPCL, a

fortune 500 company, is one of the major integrated oil refining and

marketing companies in India. It is a Mega Public Sector Undertaking (PSU)

with Navaratna status. HPCL accounts for about 20% of the market share and

about 10% of the nation's refining capacity. Business Process Re-Engineering

exercise, creation of Strategic Business Units, ERP implementation,

Organizational Transformation, Balanced Score Card, Competency Mapping,

benchmarking of refineries and terminals for product specifications, ISO

certification of Refineries and Supply Chain Management are some of the

initiatives that broke new grounds.

5) BPCL (Bharat Petroleum Corporation Ltd.) On 24th January

1976, the Burmah Shell Group of Companies was taken over by the

Government of India to form Bharat Refineries Limited. On 1st August 1977,

it was renamed Bharat Petroleum Corporation Limited. It was also the first

refinery to process newly found indigenous crude (Bombay High), in the

country. The core strength of BPCL has always been the ardent pursuit of

qualitative excellence for maximisation of customer satisfaction. Thus Bharat

Petroleum, the erstwhile Burmah Shell, has today become one of the most

formidable names in the petroleum industry. Bharat Petroleum produces a

diverse range of products, from petrochemicals and solvents to aircraft fuel

and specialty lubricants and markets them through its wide network of Petrol

Stations, Kerosene Dealers, LPG Distributors, Lube Shoppes, besides

supplying fuel directly to hundreds of industries, and several international

and domestic airlines.



6) IOCL (Indian Oil Corporation Limited): India‘s flagship national

oil company and downstream petroleum major, IOCL is celebrating its

Golden Jubilee in 2009. It is India's largest commercial enterprise, with a

sales turnover of Rs. 2, 85,337 crore – the highest-ever for an Indian company

– and a net profit of Rs. 2, 950 crore for the year 2008-09. IOCL is also the

highest ranked Indian company in the prestigious Fortune 'Global 500' listing

at 105th position in 2009. IOCL is currently forging ahead on a well laid-out

road map through vertical integration— upstream into oil exploration &

production (E&P) and downstream into petrochemicals – and diversification

into natural gas marketing, bio fuels, wind power projects, besides

globalisation of its downstream operations. IOCL has set up subsidiaries in Sri

Lanka, Mauritius and the United Arab Emirates (UAE), and is simultaneously

scouting for new business opportunities in the energy markets of Asia and

Africa.

7) ONGC (Oil and Natural Gas Corporation Limited): ONGC

(incorporated on June 23, 1993) is an Indian public sector petroleum

company. It is a Fortune Global 500 company ranked 335th, and contributes

77% of India's crude oil production and 81% of India's natural gas production.

It is the highest profit making corporation in India. ONGC is one of Asia's

largest and most active companies involved in exploration and production of

oil. It is involved in exploring for and exploiting hydrocarbons in 26

sedimentary basins of India. It produces about 30% of India's crude oil

requirement. It owns and operates more than 11,000 kilometers of pipelines

in India.

8) MTNL (Mahanagar Telephone Nigam Limited): MTNL is an

Indian Government-owned telephone service provider in the cities of

Mumbai, Thane, New Delhi, and Navi Mumbai in India. The company was a

monopoly until 2000, when the telecom sector was opened to other service

providers. MTNL provides fixed line telephones, cellular connection of both

GSM — Dolphin (Postpaid) and Trump (prepaid) and WLL (CDMA) —

Garuda-FW and Garuda-Mobile and internet services through dialup and DSL

— Broadband internet TriBand. MTNL has also started Games on demand,

video on demand and IPTV services in India through its Broadband Internet

service called Triband. MTNL is the first company to start 3G services in India



under the name of "MTNL 3G Jadoo" Services offered include Video call,

Mobile TV and Mobile Broadband with high speed data connectivity up to 2

Mbps speed from 11th December 2008, getting India on 3G map of the world.

9) NTPC (National Thermal Power Corporation): India‘s largest

power company, NTPC was set up in 1975 to accelerate power development in

India. NTPC is emerging as a diversified power major with presence in the

entire value chain of the power generation business. Apart from power

generation, which is the mainstay of the company, NTPC has already ventured

into consultancy, power trading, ash utilisation and coal mining. NTPC was

ranked 317th in the ‗2009, Forbes Global 2000‘ ranking of the World‘s biggest

companies. NTPC has adopted a multi-pronged growth strategy which

includes capacity addition through green field projects, expansion of existing

stations, joint ventures, subsidiaries and takeover of stations. NTPC has been

operating its plants at high efficiency levels. Although the company has

18.79% of the total national capacity it contributes 28.60% of total power

generation due to its focus on high efficiency.

3. SCOPE OF THE STUDY

The scope of our study will include financial analysis of the companies based on their past

performance. Also, we would like to make a comparative analysis of PSUs against their

respective industries. We also wish to make an analysis of the stock prices of the companies

against the markets.

4. PURPOSE OF THE STUDY

The purpose of study is to study the performance of the Navrtnas over the years. We wish to

ascertain whether the Navratnas have really grown to expected levels by doing the analysis of

their financial statements and stock prices. The study would enable us to have more

knowledge about the working of the PSUs, whether the PSUs performed at par with their

respective industries. We also wish to study whether the Navratna companies really proved

to be the jewels in the crown of the Indian Economy.



5. HYPOTHESIS

The study will try to test the following null hypothesis:

1. “The PSUs have not performed well over the years as compared to their

competitors in the same industry.”

2. “The Share prices of PSUs are not correlated with the Market

performance.”



6. TESTING OF HYPOTHESIS -1

As per the purpose of the study, we wish to compare the growth of the Navratnas as

compared to their respective competitors. Here we are looking forward to test the hypothesis

that is – “The PSUs have not performed well over the years as compared to their

competitors in the same industry.”

6.1 METHODOLOGY

The methodology used to test this hypothesis is as follows:

1. We tried to find the major competitors for the companies in their respective

industries. The best way we could find is using www.moneycontrol.com as our

reference site for deciding on the competitors to be analyzed.

2. After finalizing on the competitors, we calculated the ratios for the Navratnas and

their competitors for the financial years ending on 31st March 2008 and 31st

March 2009.

3. The respective ratios are then compared among the companies and the company

with the best ratio is given highest points and for the remaining companies

proportionate points are given. ( In case of negative ratio, a ‗0‘ (zero) is given)

4. Based on total score the companies are given rankings. Then the Navratnas are

compared and hence decided whether they have performed better than their

major competitors.( In case of unavailability of information for a ratio, that ratio

is excluded from calculation in all the companies to keep them on same level)

5. If the company lies in the top-2 rank, we have considered it to be better than the

major competitor, while at 3rd position its average performance and ranks below

that is poor performance compared to major competitors.

Also, the HPR, HPY, Sharpe & Treynor Ratios are calculated for the Navratnas.

6.1.1 Ratio Analysis

Ratios form an important part of any financial analysis. Just numbers do not matter

in the analysis of the financial statements of the company. We need ratios to compare

and contrast the company‘s performance over the years. The following part of the

report explains the ratios, their meaning, importance and hence their impact on

company‘s performance.

http://www.moneycontrol.com/



Ratios can be broadly divided in the following ways:

Liquidity Ratio

Current Ratio Quick Ratio

Profitability Indicator Ratios

Net Profit Margin Analysis Return on Assets Return on equity Return on Capital Employed

Debt Ratios

Debt Ratio Debt Equity Ratio Interest Coverage Ratio

Operating Performance Ratio

Fixed Asset Turnover Debtor Turnover Creditor Turnover Inventory Turnover

Cash Flow Indicator Ratio

Operating cash flow to turnover

FCF to operating cash flow

Investment Valuation Ratios

Book value per share Market price to book value

ratio EPS PE ratio Dividend Payout Ratio

1) Liquidity Ratio

Liquidity is a crucial factor for any business‘ success. It enables the company to honour

its short term commitments. These ratios show company‘s efficiency in managing its

cash and other short term resources.

a) Current Ratio

Current ratio is defined as the ratio of current assets to current liabilities. It shows the

proportion of current liabilities that can be served from its current assets. It is among the

most important ratios for a firm. It also enables company to assess its ability to get debt

and repay the same within time. Usual standards say that the ratio should be above 1 .i.e.

the company should be able to have so much of current assets so as to fulfil its liability

without using its capital assets or other investments.

Current Ratio = Current Assets

Current Liabilities



b) Quick ratio

Quick ratio shows the actual liquid position of the organization. It shows the ratio of the

most liquid of current assets to total current liabilities. The rationale behind this ratio is

to find how much of the total current liabilities can be paid off at any point of time.

Quick Ratio = Liquid Assets (Cash & Bank + Debtors)

Current Liabilities

2) Profitability Indicator Ratio

Profit is among the major objective for any organisation‘s survival and hence drives the

organization to work harder and efficiently to increase its profitability. Also, for an

investor, profit is the base for valuation of the shares and the company as a whole. Profits

are the moral boosters for all the stakeholders in the organization may it be owners,

employees, debtors, creditors, etc.

a) Net Profit Margin Analysis

The Net Profit Margin analysis shows the amount of revenues that actually turn into

profits after allowing for all possible expenses from the revenues.

Net Profit Margin = Net Profit (after Tax) .

Net Sales (Sales- Excise Duty)

b) Return on Assets

Return on assets tries to measure the recovery of investment in fixed assets from the net

profit.

Return on Assets= Net Profit (after Tax)

Average Fixed Assets

c) Return on Equity

Equity shareholders are the most important stakeholders for the organization. They

provide the much required fixed capital to the company. The equity investment stays till

the end of the company and hence is the most illiquid liability. However, it is the most

demanding liability. The expected return for an equity shareholder is always high and

keeps increasing over the year with the increasing experience of the company in its

business.



Return on Equity = Net Profit (after Tax) .

Average Equity Share Capital

d) Return on Capital Employed

Return on Equity shows the returns from the view of an equity investor. However, it is

not correct to evaluate a company‘s return only from the perspective of equity share

holders. It is also necessary to know the return on total capital employed in the business.

This approach helps us to value the firm as a whole. This also helps in assessing the value

of the firm for an M & A as it includes the debt aspect of the firm which will reduce its

profits.

3) Debt Ratio

Debt forms an important factor in today‘s business area. A levered company generally

creates more value to its equity share holders than a totally unlevered firm (excluding

exceptions like Infosys, etc.). However depending largely on debt can also be dangerous

for a business in a downturn when the revenues are lower than earlier but interest

burden is the same. Hence, it becomes important from the view of investing that the

company is levered but not too much levered that it may not be able to cover its debt

obligations in the future.

a) Debt ratio

Debt Ratio shows how much of total capital employed it the proportion of debt. In other

words, it shows what proportion of the company‘s assets are owned by the long term

secured and unsecured loans. Generally a high debt ratio is a sign of higher risk of

bankruptcy of the business in case of downturn or slowdowns.

Debt Ratio = Total Debt (secured+ unsecured)

Total Capital Employed

b) Debt- Equity Ratio

Debt to equity ratio helps an analyst to analyse what is the portion of long term debt as

compared to equity funding. It helps us understand the extent investment of debt for

each unit of equity investment.

Debt Equity Ratio = Total Debt (Secured + Unsecured)

Total Equity Share Capital (incl. Reserves &

surplus)



c) Interest Coverage Ratio

The most important element for deciding on proportion of debt is the interest

component. The interest burden is the limiting factor to company‘s ability to take debt

and hence take advantage of leveraging. The interest coverage ratio shows the extent of

profit over interest burden. The company is expected to earn more than its interest

burden or else it may not have any value for its equity shareholders.

Interest Coverage Ratio = EBIT .

Interest obligation

4) Operating Performance Ratio

All the above ratios are meaningless if the operating ratios of the company are not

analysed. These ratios show the operating efficiency of the company. The better the

efficiency means a better operations hence better profitability.

a) Fixed Asset turnover

This ratio enables us to get a rough idea on productivity of company‘s fixed assets in

generating sales. A growing company generally has an increasing investment in fixed

assets with increase in sales.

Fixed Asset Turnover = Sales (excl. Excise Duty)

Average Fixed Assets

d) Creditor Turnover Ratio

A creditor turnover ratio is another important feature of operations efficiency. The lower

the creditor turnover shows the higher availability of credit period for the company. The

creditor turnover ratio helps in determing the company‘s own credit policy for its

customers.

Creditor Turnover Ratio = COGS .

Average Creditors



e) Debtor Turnover Ratio

Debtor turnover ratio essentially shows company‘s credit policy towards it customers. A

high debtor turnover ratio translates to a lower credit policy in operations.

Debtor Turnover Ratio= Net Sales*(excl. Excise Duty)

Average Debtors

(* generally credit sales are used. However due to lack of information, net sales are assumed

to be credit sales)

f) Inventory Turnover Ratio

The importance of inventory management is increasing with increasing competition and

crushing profit margins. The companies are trying to reduce their inventory to the

optimum levels so as to reduce the carrying cost and other factors.

Inventory Turnover Ratio = COGS .

Average Inventory

5) Cash Flow Indicators

Cash flows are very crucial for a company‘s efficient cash and working capital

management system. They show a safety net over liquidity of the firm and hence help in

assessing the financial health and performance of the company.

The cash flows help in translating the book profits to cash profits hence eliminating non-

cash expenses and receipts.

a) Operating Cash Flow/ Sales Ratio

This ratio helps us in understnding what proportion of sales revenue actually turned into

cash flows for the business. It would be worrisome to see a company's sales grow without

a parallel growth in operating cash flow. Positive and negative changes in a company's

terms of sale and/or the collection experience of its accounts receivable will show up in

this indicator.

Operating Cash Flow/Sales = Operating Cash Flows .

Net Sales (excl. Excise Duty)



b) FCF/ Operating Cash Flow

Just calculating cash revenue from sales is not enough; we need to adjust for changes in

the fixed and working capital in the cash flows. This adjusted cash flow is called Free

Cash Flow (FCF) (more in later stage). The FCF is one step further to operating cash

flows and hence enhances the value of operating cash flow ratio.

FCF/Operating Cash Flows=FCF (operating cash flow – Capital Exp)

Operating Cash Flow

6) Investment Valuation Ratios

These set of ratios is what an investor is always looking at. It tells the investor the value

of his/her investment as against book values and other parameters. It is widely used by

investors to estimate the attractiveness of a potential or existing investment and get an

idea of its valuation.

a) Book Value of Share & Book value to Market value Ratio

The book value of the firm shows the actual worth of shares as per the value arrived in

the books of the company. The book value increases with the increase in net worth of the

company. Market value of the firm is based on various, micro and macro economic

factors that rule the securities market. However, the market price can also be said to be

an expected value of the firm based on its business environment.

Book Value = Total Equity Share Capital ( incl Reserves)

Number of Equity Shares Outstanding

b) EPS (Earning Per Share)

EPS (Earning Per Share) is an important measure for valuation of the company. It

reflects the amount of profits earned by the company per equity share. This is also a

barometer for rising returns over the investment.

EPS= Net Profit (after Tax) .

Number of Shares Outstanding



c) PE Ratio

Price to Earnings per share (PE) ratio is an important ratio used for various types of

valuation. The PE ratio is the most widely used mode of valuation. The company‘s PE

shows how much is the value of its earnings appreciated by the market price.

PE Ratio = Market Price

EPS

d) Dividend Pay out Ratio

Dividends aer the sole receipts that an investor earns from the company in the form of

cash return. The dividends are a part of profits that are disbursed by the company to its

shareholders so as to keep them satisfied as well as use the excess liquidity in a proper

way. The dividend for the company shows its confidence in its activities and future

returns.

Dividend Payout Ratio = Dividend per share

EPS

6.1.2 Summary – Ratio Analysis

Ratio BHEL BPCL GAIL HPCL IOCL MTNL NTPC SAIL ONGC

Liquidity Measurement Ratios a) Current Ratio 1.5034 1.2028 1.3541 1.3422 1.3822 1.6443 2.5127 1.3592 1.7475 b) Quick Ratio 0.8898 0.2137 0.584 0.1534 0.2496 0.4305 1.4387 0.6148 0.1796 2) Profitability Indicator Ratios a) Net Profit Margin Analysis 9.60% 2.07% 13.68% 2.26% 3.61% 18.32% 21.77% 6.19% 0.2654 b) Return On Assets 87.39% 15.27% 22.21% 15.59% 17.81% 16.58% 16.72% 19.81% 0.3361 c) Return On Equity 17.92% 19.59% 23.36% 16.51% 22.50% 11.93% 14.20% 18.21% 0.2555 d) Return On Capital Employed 16.14% 13.49% 19.68% 13.48% 15.09% 9.81% 12.84% 20.91% 0.2502 3) Debt Ratios a) Debt Ratio 0.082 0.453 0.2208 0.3516 0.4649 0.1165 0.303 0.5249 0.1552 b) Debt-Equity Ratio 0.0936 0.86 0.2999 0.6357 0.8986 0.1683 0.4358 2.1156 0.1892 c) Interest Coverage Ratio 39.73 8.4552 21.0456 13.5729 8.5389 139.4225 4.7627 12.1892 8.0377 4) Operating Performance Ratios a) Fixed-Asset Turnover 8.1052 7.5632 1.6049 7.1337 5.0464 0.877 0.7726 1.6835 1.2078 b) debtor turnover ratio 1.7664 54.8546 17.11 60.1311 27.5067 5.9745 11.8801 12.4001 13.6258 c) creditor turnover ratio 0.6176 5.8861 1.4266 5.9221 4.0435 0.2725 0.8541 1.5564 1.6776 d) inventory turnover ratio 2.9332 10.3854 20.1496 9.6431 8.1515 17.9662 7.5404 3.6946 7.5586 5) Cash Flow Indicator Ratios a) Operating Cash Flow/Sales Ratio 0.1074 0.0352 0.1822 0.028 0.0268 0.3558 0.2639 0.1818 0.3616 b) Free Cash Flow/Operating Cash Ratio 8.7025 -0.0594 0.801 0.5004 -0.9133 1.3507 0.8046 1.3045 0.7172 6) Investment Valuation Ratios a) book value per share 214.8499 207.0756 95.029 228.9995 203.6579 152.7195 312.9073 43.1923 330.16 b) Market Price/Book Value Ratio 340.63% 317.86% 184.48% 129.06% 152.78% 106.46% 113.47% 158.77% 296.99% c) EPS 38.8308 34.8076 20.9365 35.2557 42.34 16.1232 42.3739 11.7042 78.09 d) Price/Earnings Ratio 17.593 19.5478 8.3765 9.8211 7.54 10.38 8.3744 4.0433 12.56

e) Dividend Payout Ratio 20.49% 30.05% 33.67% 33.04% 28.50% 27.98% 27.81% 9.06% 40.98%

6.1.3 Free Cash Flow (FCF)

FCF is a measure of financial performance calculated as operating cash flow minus

capital expenditures. It represents the cash that a company is able to generate

after laying out the money required to maintain or expand its asset base. FCF is

important because it allows a company to pursue opportunities that enhance

shareholder value. Without cash, it's tough to develop new products, make

acquisitions, pay dividends and reduce debt. It is calculated as:

FCF = (NOPAT) – (Change in Net Operating Assets)

Where, NOPAT – Net Operating Assets after Tax (calculated as EBIT*[1-Tax Rate]).

Change in Net Operating Assets is calculated as change in capital expenditure and

change in working capital. In terms of Balance sheet particulars Net Operating Assets

can be calculated as summation of Total Fixed Assets and Net Current Assets. Net

Current Assets is again calculated by subtracting Total Current Liabilities from Total

Current Assets. Individually these components are calculated as:

Total Current Assets = Inventories + Sundry Debtors + Cash

&Bank + Loans & Advances + Fixed Deposits

Total Current Liabilities = Current Liabilities + Provisions

Total Fixed Assets = Net Block + Capital Work in Progress

Where, Net Block = Gross Block – Accumulated Depreciation

6.1.4 Equity Cash Flow (ECF)

ECF basically provides an outlook about a company with respect to its equity flows. It

describes the actual value for an investor or shareholder in a firm. Positive ECF value

suggests that the firm is making money for its investors even after repayment of its

debt liabilities. It can be calculated as:

ECF = (FCF) – (Net Repayments of Loans/Liabilities)

Where, Net repayment of loans = (Total Debt Repayment) – (Total

Debt Acquired)

In Net repayment of loans, change of equity is also taken care.



6.1.5 Capital Cash Flows (CCF)

As such there is no difference in FCF and CCF, leaving apart the factor of Tax Shield.

CCF also takes care of the tax shield and thus it is discounted with Pre-Tax WACC

while FCF is discounted with Post-Tax WACC. The final evaluation of Present Value

by both ways will approximately provide us the same value.

6.2 SUMMARY TABLE

PSU RANK vis-à-vis

COMPETITORS

PERFORMED

WELL AVERAGE POOR

ACCEPTANCE/

REJECTION OF

H0

BHEL 1 REJECT

BPCL 2 REJECT

GAIL 4 CANNOT BE

REJECTED

HPCL 2 REJECT

IOCL 3 CANNOT BE

REJECTED

MTNL 5 CANNOT BE

REJECTED

NTPC 2 REJECT

ONGC 4 CANNOT BE

REJECTED

SAIL 1 REJECT

TOTAL 5 1 3

Thus, the Hypothesis -‖ The PSUs have not performed well over the years as compared

to their competitors in the same industry”, Cannot be Rejected for 4 PSUs while is

Rejected for 5 PSUs. Hence, there is a mixed performance of the PSUs as a whole as

compared to their competitors.

6.3 STATISTICAL ANALYSIS

From 01-Aug-08 to 31-July-09 BHEL BPCL GAIL HPCL IOCL MTNL NTPC ONGC SAIL

Beta Value for the period* 0.0807 0.4319 0.8290 0.4560 0.4312 0.7808 (0.0398) 0.8522 1.3029

Average Return for the period* 0.4893 0.5059 0.1053 0.5967 0.4164 0.1231 0.6025 0.3009 0.5338

Annualized SD for the period* 0.4623 0.5033 0.6335 0.5601 0.4768 0.5320 0.4125 0.5293 0.7781

Treynor's Ratio 5.4936 1.0650 0.0716 1.2078 0.8590 0.0988 (13.9931) 0.2991 0.3745

Sharpe Ratio 0.9590 0.9138 0.0937 0.9834 0.7770 0.1451 1.3493 0.4816 0.6270

* Calculated during third submission.

The Sharpe & Treynor ratios describe the securities returns based on their standard deviations with respect to the market as well as the

securities own volatility. The Sharpe ratio that calculates risk-return based on the securities own standard deviation, has been healthy for most

of the Navratnas. However, only NTPC is able to provide a return more than per unit of volatility while BHEL, BPCL & HPCL are just around 1

while GAIL & MTNL are more towards zero which means that the risk is not giving adequate returns. The Treynor Ratio, which takes the

Market Volatility as the base, for most of the firms is not very satisfactory. Except for BHEL, BPCL & HPCL, the securities have not performed

well in comparison to the Benchmark index NIFTY‘s standard deviation. The PSUs‘ shares deviations have more unsystematic risk as compared

to the systematic risk because of which the Treynor ratio is not encouraging for most of the securities.

7. Testing of Hypothesis – II

As per the purpose of the study, we wish to quantify the growth of the Navratnas for the past

five years. To ascertain this fact we are looking into two major aspects which are taken as the

hypothesis for the study. Here we are looking forward to delve deeper into the second

hypothesis that is – “The Share prices of PSUs (Navratnas) are not correlated

with the Market performance.”

7.1 METHODOLOGY

The methodology used to test this hypothesis is as follows:

1. We have calculated the average annualized return and standard deviation for all

the PSUs as well as for the market that is NSE for the last five years on the basis

of NSE index.

2. Calculation of average return and standard deviation is done for different

timelines. It includes overall return and deviation for the last five years as well as

on annual and semiannual basis. It has been done for both PSUs and Market.

This will basically equip us to compare the average return of PSUs with respect to

Market for different periods for the tenure of last five years.

3. Followed by average annual return and standard deviation we have calculated the

covariance for different timelines as described above. This in turn helped us to

calculate the beta value of the PSUs. The meaning as well as the calculations of

the beta was described in our earlier submissions.

4. Further we have compared the return and risk related to a script with respect to

market in that period of time. This gave us a fair idea of the trend about a script

with respect to market. With the help of such trend analysis we can are in a

position to comment about the results of the second hypothesis.

5. Further to provide a proper comparative look of the study, we have used charts

and tables which again helping us to achieve our objective.



7.1.1 Stock Analysis

Expected Return

The return on most investments is uncertain; however it is possible to describe the

future returns statistically as a probability distribution or arithmetic mean of

historical data.

Calculation: Daily return has been calculated by using the formulae:

Daily Return E(x) = (Today’s Close – Previous Day Close) /

(Previous Day Close)

Arithmetic Mean of all the Daily Return has provided us the Daily Expected Return.

Annualized Expected Return is obtained by multiplying the daily expected return by a

factor of 252, which stands for the number of trading days in a year.

(NOTE: 5 year data has been used, 1st Aug‘ 04 to 31st July‘ 2009.)

Standard Deviation

It is a measure of the dispersion of a set of data from its mean. In finance, standard

deviation is applied to the annual rate of return of an investment to measure the

investment's volatility.

Calculation: Daily Standard deviation has been calculated using the formulae:

Daily S D = (Square root ((Daily return – Expected Daily

Return)^2)*(1/n-1)))

Annualized Standard Deviation is obtained by multiplying the factor of 252.

Covariance:

It can be defined as a measure of the degree to which returns on two risky assets

move in tandem. A positive covariance means that asset returns move together. A

negative covariance means returns move inversely.

Calculation: Daily Covariance between NSE and Navratnas has been calculated by

using the formulae:



Cov(A,B) = Sigma((A-E(A))*(B-E(B)))*(1/(n-1)

Where E(x) = expected value of x

n is the total number of observations

It is again annualized by multiplying it with the factor of 252.

Beta Calculation

In finance, the beta (β) of a stock or portfolio is a number describing the relation of

its returns with that of the financial market as a whole. An asset with a beta of 0

means that its price is not at all correlated with the market; that asset is independent.

A positive beta means that the asset generally follows the market. A negative beta

shows that the asset inversely follows the market; the asset generally decreases in

value if the market goes up and vice versa. It is also used as a measure of the

volatility, or systematic risk, of a security or a portfolio in comparison to the market

as a whole. Beta is used in the capital asset pricing model (CAPM), a model that

calculates the expected return of an asset based on its beta and expected market

returns.

Calculation:

We have used two procedures to calculate the β value. The procedures are as follows:

a. In the first procedure we have used the formulae –

β = Cov(Asset, Market) / SD(Market)^2

Cov(Asset, Market) Covariance of an asset with respect to market.

SD (Market) Standard Deviation of Market.

b. In the second procedure we have used the Regression analysis for the

calculation of β value, which is described in the next section.

7.1.2 Regression Analysis

In statistics, regression analysis refers to techniques for modeling and analyzing

several variables, when the focus is on the relationship between a dependent variable

and one or more independent variables. More specifically, regression analysis helps

us understand how the typical value of the dependent variable changes when any one



of the independent variables is varied, while the other independent variables

are held fixed.

Analysis of performance of stocks is incomplete if only fundamental analysis of the

economy, industry and company are undertaken. Technical analysis plays a vital role

in identifying various trends, movements that the stocks are making over a period.

Generally a one year analysis is carried out to find out the movements. Here, we have

taken two years for our study because the previous year was not a normal year

(normal year means a year free of any sudden economic, environmental or political

change). Keeping in mind the recession that set in the previous year, also the

parliamentary elections at central level, it becomes prudent to take more than one

year for the analysis. There are various techniques used by various analysts. However,

we confine our self to a few of them namely, Point & Figure Chart, Moving Averages

and Trend lines. The following report consists of the above charts of the Navratnas

and some analysis that we could come out with.

7.1.3 Technical Analysis

Fundamental analysis use economic data that are usually separate from the bond or

stock market. Technical analysis is an alternative method of making the investment

decision and helps in answering the fundamental question: ―What securities should

an investor buy and sell? When should he buy or sell them? Technical Analysis

involves the examination of past market data such as prices and volume of trading,

which leads to an estimate of future price trends and therefore investment decisions.

Technical analysts have a strong opinion that past data resembles the future trends.

Many investment firms recruit technical analysts along with fundamental analysts.

The following are the fundamental assumptions in technical analysis.

1. The market value of any good or service is determined solely by the

interaction of supply & demand.

2. Supply & demand are governed by numerous rational and irrational factors.

Included in these factors are those economic variable relied on by the

fundamental analysts as well as moods, opinion and guesses. The market

weighs all these factors continually and automatically.



3. Disregarding minor fluctuations, the prices for individual securities and the

overall value of the market tend to move in trends, which persist for

appreciable lengths of time.

4. Prevailing trends change in reaction to shifts in supply and demand

relationships. These shifts can be detected sooner or later in the action of the

market itself.

(Source: Investment Analysis & Portfolio Management, Reilly/Brown, 8th ed.,

South-Western Cengage Learning)

Advantages of Technical Analysis

Technical analysts believe that the fundamental analysis can result in better

returns only if they are able to get the new information much before the market

and investors get it and are able to process it correctly and quickly.

Technical analysts are sceptical about the quality of accounting or financial

statements. According to them, these statements hide a great deal of information

regarding the company‘s earnings and utilisation of sources. Also, the non-

quantifiable variables that affect the organisation can not be shown in the

financial statements. Even the procedures for recording of information differ over

various organisations.

Technical analysts need to recognise a movement to a new equilibrium value for

the change due to whatever the reason it may be.

Challenges to Technical Analysis

The assumption of gradual setting in of the changes in share prices is an example

of Weak-form of Efficient Market Hypothesis (EMH). The empirical studies have

supported the EMH. The Weak-form studies have found that prices do not move

in trends based on statistical tests of auto-correlation and runs.

The very basis of technical analysis is questionable. The past data or price

patterns may not be repeated.

The technical analysis requires great deal of subjective judgement and decision

making. Same graph or pattern can be read differently by different analysts.



7.1.4 Trend Analysis

Trend Analysis is the most basic form of analysis on a stock. The closing prices are

taken and a trend is derived. The trend may be derived using linear equation,

quadratic, cubic or even higher powers. The higher the powers, the stronger the trend

however, after certain limits the trend may not be clearly derived.

Point & Figure Chart

A Point and Figure chart or XO chart as it is known popularly is different from typical

price graphs. General Price graphs will show all the ending prices and volumes to

show a trend whereas the point & figure chart includes only significant price changes

regardless of their timing. Its upto the technician to decide what a significant price

change is and what would be reversal points.

The chart will help in knowing the breakouts in the trends so as to find certain price

trends for given significance level. A long horizontal movement with many reversals

but no major trends up or down is considered as a period of consolidation where in

stocks move from buyers to sellers and back again with no strong price consensus

about its direction. The longer the consolidation period, the larger will be the

subsequent movements. Also, these charts can be useful in showing the support and

resistance level for the stocks.

Moving Averages

Moving averages show the average price over a period of time rather than daily

change. The moving average lines help in ascertaining trends of price of stocks.

Generally, 50-day and 200-days moving averages are used for consideration. A 50-

days moving average line will show a short term trend and the 200-days line the

longer term trend. The two can be compared in the following aspects: If the overall

price trend has been down, the moving average lines would generally be above the

current prices. Any price breakthrough from below accompanied by higher volumes

is indication of price reversals in a positive change and an upward trend is

speculated. However, if the price breakthrough comes from above the moving line

accompanied by heavy volumes, tend to show negative change and downward trend

is expected. The two lines can be further compared as: if the 50days line crosses 200-

days line from below, it signals an upward movement of prices and gives a bullish



indication. In contrast, if the line crosses from above it shows a downward movement

and hence, bearish sentiments.

Candle Stick Graphs

Candle Stick Graphs are show the open, high, low and close prices of stock on a daily

basis. It can be used to show the variability of prices on a daily basis. However, with a

clutter of information, the chart may not seem very clear. The chart is still useful as it

also shows a trend based on high and low prices.

7.1.5 HPR - Holding Period Return

HPR is a method to track the activity of a portfolio or a stock over a time period. It is

defined as the how many times is the value of your portfolio currently with respect to

the initial state. Value more than one show that the portfolio has provided some

return for that holding period. Higher the value of the HPR better is the return

provided by that portfolio. It is calculated using:

HPR = (End price) / (Initial price)

7.1.6 HPY - Holding Period Yield

The return earned from the act of holding an asset over a given period. The return is

equal to the income and other gains (such as appreciation) earned from the asset,

divided by the original cost of the asset. This can be taken as a variant of HPR which

provides the return percentage of a stock or a portfolio over a period of time.

Higher the value of the HPY greater the return achieved by the holder. It is calculated

as:

HPY = HPR – 1

ANNUAL HPR & HPY

Annualized Holding Period Return describes the return obtained by the holder of

the stock or portfolio on the annual basis. It is calculated as:



Annual HPR = (HPR) ^ (1/r)

Where r is the number of years for which the stock is hold.

Annualized Holding Period Yield is calculated as:

Annual HPY = (Annual HPR – 1)

7.1.7 Sharpe Ratio

It was developed by William F. Sharpe, which measures a ratio of return to volatility.

It is useful in comparing two portfolios or stocks in terms of risk-adjusted return. It

basically takes care of total risk involved with a portfolio i.e. both systematic and

unsystematic risk. The higher the Sharpe Ratio, the more sufficient are returns for

each unit of risk. It is calculated by first subtracting the risk free rate from the return

of the portfolio, then dividing by the standard deviation of the portfolio.

Using Sharpe ratios to compare and select among investment alternatives can be

difficult because the measure of risk, portfolio standard deviation, penalizes

portfolios for positive upside returns as much as the undesirable downside returns.

The Sharpe ratio is calculated as follows:

7.1.8 Treynor Ratio

It is ratio for measuring the portfolio performance similar to Sharpe Ratio. The

Treynor Ratio differs from the Sharpe Ratio in so far as the beta to the Market

Benchmark is used as a measure of risk rather than the standard deviation of the

portfolio. It provides a measure of performance on the basis of only systematic risk.



Higher value of Treynor ratio denotes that the investor is provided with high yields by

each unit of market risk.

The Treynor ratio is calculated as follows:

Where,

Treynor ratio,

Portfolio i's return,

Risk free rate

Portfolio i's beta

http://www.answers.com/topic/beta-coefficient



7.2 RESULT

Ranking of companies based on their share market return

Rank Company Beta Value Annualized Average Return

NSE 25.77%

1 SAIL 1.38021 46.73%

2 BHEL 0.12095 41.92%

3 NTPC 0.00064 29.70%

4 GAIL 0.87175 21.72%

5 ONGC 0.91487 18.17%

6 BPCL 0.60784 15.42%

7 IOCL 0.63753 13.46%

8 HPCL 0.65711 10.62%

9 MTNL 0.91255 4.83%

From the above table and graph, it can be clearly seen that, out of the nine PSUs,

only 3 PSUs have outperformed the NIFTY while the rest have underperformed.

However, each of the stock has moved in tandem with the NIFTY though the



magnitude varies. All the share prices have risen over the period so has the

NIFTY. Hence, the Null Hypothesis: “The Share prices of PSUs

(Navratnas) are not correlated with the Market performance.” can

be rejected. However, the degree of relationship is not high in some of the

companies.



8. REFERENCES

Web Sites

http://nseindia.com/

http://bseindia.com/


http://en.wikipedia.org

http://www.investopedia.com/

Books & Material

Investment Analysis and Portfolio Management by Reilly & Brown

Technical Analysis by Mayur Shah

Financial Management by Brigham & Ehrhardt

Database

Capital Line

http://nseindia.com/

http://bseindia.com/


http://en.wikipedia.org/

http://www.investopedia.com/

Documents

Financial Analysis of Navratnas Nine PSUs