PSU stocks in vogue; sustenance  of  rally  key

After a turbulent decade, shares of public sector undertakings (PSUs) have garnered increased investor attention lately. Year to date, the Nifty PSE Index has beaten the benchmark Nifty50, with returns of 9.64%. With that, the Nifty PSE index is inching closer to its all-time high in 2008.

According to analysts, a factor enticing investors towards these stocks is their dirt cheap valuation. Despite the rally, the Nifty PSE index is trading at a one-year FY24 price-to-earnings multiple of 8.14x, a steep discount to Nifty50’s 21.4x, showed Bloomberg data.

On the mend

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On the mend

Secondly, fears of a global recession have increased preference for value stocks over the growth category, and that has driven the ongoing rally in these once-shunned counters. Shares of companies trading below their intrinsic value are referred to as value stocks. PSU stocks being long-time underperformers, can be classified as value stocks.

Besides, investors might also be looking to bet on some of these stocks for attractive dividends. Further, analysts at Motilal Oswal Financial Services Ltd note that over FY20-22, listed PSUs have posted a 70% profit CAGR (compound annual growth rate) to reach 3.3 trillion versus private sector universe CAGR of 44% over the same period reaching 7.2 trillion. Also, the return on equity of PSUs rose to multi-year high in FY22. (See Chart)

PSU banks form one-third of the profit pool of PSUs. In the recent quarter, they have showcased better earnings performance than their private sector counterparts. A low base, improving credit growth, margins and asset quality helped.

Harendra Kumar, managing director of Elara Securities India, said there could be additional tailwinds for PSU banking stocks in terms of government disinvestment and privatization. Public sector banks are expected to hold the fort for PSUs as far as their overall earnings performance is concerned. “The pecking order segment-wise is banks, power, defence and railways,” Kumar further said.

In 2022, the PSU Bank index rallied by 15%. Not just banks, other PSU stocks such as Bharat Dynamics Ltd, Hindustan Aeronautics Ltd and Rail Vikas Nigam Ltd have rallied anywhere between 80 and 110% during the same period.

In the past few years, the government increased its budget outlay for railways. The Vande Bharat moment is said to be a turning point for Indian railways. Expectations are more Vande Bharat trains will be announced in the upcoming budget.

The ‘Make-in India’ initiative and favourable policies to boost exports have played out in the defence sector. Globally, manufacturers are looking for an alternative to China and Russia for equipment procurement, and India is filling the gap.

However, it’s worth noting that significant gains in some of these stocks have occurred over the past couple of months. This kind of rally which happens in a short span of time is a risk simply because once the euphoria fizzles out, the downturn in the stocks could be equally faster.

An analyst requesting anonymity said that the low valuation story in PSU stocks may have already played out.

“The PSUs need to improvise their service quality. Unless they execute some structural changes in their business, the rally in PSU stocks is unlikely to stay,” he added. This means external triggers aside, only those PSUs with internal transformation may sustain their rally.

Meanwhile, oil and gas PSUs are an exception here. Despite volatility in crude prices, companies have not changed fuel prices, impacting their earnings.

While the tide has turned in favour of PSU stocks, it remains to be seen whether the momentum will sustain.

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