Unless you are averse, buying PSUs seems like a no-brainer, says Emkay
“The PSU story is synonymous with the India saga, a narration of several micro, albeit, powerful reforms (GST, RERA, JAM, digital infra, physical infra, PLI template, Bankruptcy Act, RBI’s inflation targeting and increasing credibility, etc) – each creating a small delta improvement, but in unison react in unpredictable, positive ways to generate waves. Force majeure luck events like ‘China plus one’ reinforce and accelerate the trend,” noted the brokerage.
PSU stocks have performed exceptionally well with some stocks soaring up to 300 percent in the last 1 year on the back of increased capital expenditure (capex) and a strong order book. Additionally, the expectation of political stability, especially with the projected victory of the BJP (Bharatiya Janata Party) in the forthcoming Lok Sabha elections in May, introduces another significant aspect. This anticipation implies a sustained surge in capital expenditure, thereby enhancing the outlook for PSU stocks even further.
However, amid this bullish trend, some experts have begun to raise concerns regarding the sustainability of the PSU stock rally. But Emkay is not on that boat.
The brokerage believes that there is absolutely no doubt that PSUs as a cohort are more efficiently run today. It stated that that there were three issues plaguing PSUs in general: 1) operational performance, 2) lack of clarity or sub-par IRRs on re-invested capital, and 3) supply overhang. Most of these issues are being addressed, in our opinion, said the brokerage.
The BSE PSU index has soared over 97 percent in the last 1 year and over 22 percent in 2024 YTD. Just in Feb, the index has advanced 10 percent, extending gains for the fourth straight session. Before this, it rose 11.2 percent in January 2024, 15.3 percent in December 2023 and 10.3 percent in November 2023.
The index hit its record high of 19,085.60 in the previous session, February 16, surging over 107 percent from its 52-week low of 9,196.42, hit March 2023.
PSU banks
The brokerage highlighted that over the last three years, the compound annual growth rate (CAGR) for loans in top PSU banks has averaged around 13.5%. SBI is projected to achieve an approximately 18% return on equity (ROE) in FY24, with an average forecast of 17.9% for FY25/26. Excluding SBI, other major PSUs are expected to achieve an average ROE of 14.9% for FY24, with forecasts of 15.5% and 15.7% for FY25 and FY26, respectively.
SBI’s earnings per share (EPS) CAGR through FY26 is estimated at about 15%, while other banks may report a wider range, from 8% to 45%. However, it’s noted that sustainable growth rates for PSU banks are expected to be lower than their reported ROEs.
Additionally, excluding SBI, the average gross non-performing assets (GNPA) reported is around 4.7%, with net non-performing assets (NNPAs) averaging around 1% and a provision cover of 79%. Many banks anticipate sustainable recoveries following an extended period of non-performing assets.
Despite the recent rally, SBI trades at 1.5x trailing twelve months (TTM) book value and approximately 1.4x FY25 adjusted book value (ABV). Other PSU banks have average multiples of 1.4x TTM ABV and 1.2x FY25E ABV. These multiples may seem elevated compared to historical averages but are justified by expected earnings growth and ROE estimates.
Comparatively, these metrics align favorably with peer private-sector banks. The average loan growth for major private peers (ICICI Bank, Kotak Mahindra Bank, HDFC Bank, Axis Bank) through FY26 is 17.7%, with EPS CAGR averaging 13%, ROE averaging 16.8% in FY24E, 16.7% in FY25E, and 16.5% in FY26E. However, their average valuations at 2.4x TTM BV and 2.1x FY25E ABV are at a significant premium to PSU peers. As the performance gap between PSU and private-sector banks narrows, so will the valuation gap, according to the brokerage.
Energy PSUs
According to the brokerage, the Energy basket, particularly OMCs (Oil Marketing Companies) and upstream companies, has experienced a remarkable 30% rally. Sabri, their esteemed energy analyst, accurately predicted this rally and remains bullish. However, the brokerage suggests that a deeper fundamental analysis might reveal the true trigger behind this surge.
For OMCs, earnings have consistently been upgraded over the past 12 months. The brokerage’s FY24 estimates for BPCL and HPCL have surged from Rs44 and Rs51 per share to Rs107 and Rs127, respectively, with nearly doubled estimates in the last 3 months alone. Meanwhile, estimates for upstream companies like ONGC have remained relatively flat, prompting further investigation.
The brokerage believes that regulators have subtly guided the market through consistent actions. Measures such as transparent windfall tax pricing, indexing gas pricing to oil (with a floor and cap), and OMCs retaining super-normal marketing margins in an election year (to offset previous losses) have gradually steered the market towards a more predictable earnings trajectory. As long as oil prices remain within a reasonable range, free market economics are expected to prevail. However, an overshoot in oil prices could significantly impact earnings in the short term, although a recovery is anticipated with reversals. Despite potential short-term fluctuations, the brokerage views this shift as a monumental change, suggesting that accretion to book value may remain largely unaffected across the economic cycle.
It further noted that the government now sees the PSU space as a wealth-generating opportunity, rather than a medium to periodically divest shares for fixing fiscal deficit.
Emkay expects OMCs and upstream companies to re-invest their cash flows to lead the renewables drive into charging network/green hydrogen, etc. This is no different than what NTPC is doing with its solar energy thrust, it added.
Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decision.
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Published: 19 Feb 2024, 02:42 PM IST
