Stocks of public sector companies have surged, with the BSE PSU index nearly doubling in the last one year. The rally continues into the current year, with the index up 20 percent year-to-date, widely outperforming Sensex’s less-than-1-percent rise.
The rally in PSU stocks has the market divided. Some say that the government stocks are finally getting their due, backed by improving fundamentals, clean balance sheets, robust order books, and strong execution. While others say that this is just momentum, and analyst estimates are too optimistic vis-à-vis actual earnings.
This explainer tries to analyse whether PSU stocks are rising backed by fundamentals, or momentum.
Are PSU valuations high?
Depends on which sector you are looking at. Research firm Bernstein said in a recent note that the PSU index is expensive, trading at 11.2x forward P/E (price-to-earnings) and 1.8x PB (price-to-book value), which is above the historical averages. Industrial PSUs are particularly stretched, trading at a +2.5 standard deviation to their 10-year PE average. Utilities, the second most stretched sector, is trading at 1.5 standard deviation, meaning 1.5 times further from its usual value than usual.
What is the bull argument?
Research firm Jefferies says government stocks’ valuations are still at a discount. The PSU Index PE at 12.1x is at a 40 percent discount to the Nifty. Pre-FY18, the PSU index was at a 31 percent discount to Nifty PE on average.
Since PSU stocks have had a sharp rally, the gap between the PSU index and Nifty valuation should narrow down.
Yes and no. Meaning forward PE is based on estimated earnings. The earnings outlook for PSU stocks is much better than what it was before the Covid pandemic. If the denominator (E) expands, the P/E multiple will be lower. But remember, companies can miss estimates. But we will know that only in hindsight.
PSU stocks used to be seen as good dividend yield plays. Is that still the case?
Not really any longer. Because dividend yield is price divided by dividend per share. So, a Rs 100 stock that pays Rs 10 as dividend annually works out to a 10 percent dividend yield. But if the stock price rises to Rs 400, and unless the dividend payout keeps pace, the yield will now be 2.5 percent (Rs 400/10).
So how is the market viewing PSU stocks?
As growth stocks. In simple words, stocks which hold the promise of a rapid growth in earnings. This was not the case in the past when earnings grew at a much sedate pace.
Fund houses are buying the PSU story. Mutual fund holdings in public sector firms scaled a record high of 7.58 percent of total assets under management in January, up from 5.72 percent a year.
Are PSUs’ fundamentals actually improving?
Research firm Jefferies thinks so. According to its calculations, overall RoEs (Return on Equity)have improved back up to 12-13 percent as the profitability has recovered and this should improve further. Most PSUs have also seen large EPS upgrades, according to Jefferies.
What is the bear argument on earnings?
Kotak sees the three-in-one role of the government - buyer, owner, policy-maker/regulator) as creating uncertainty about future earnings and returns for PSU capital goods companies. Also, while the outlook has improved, Kotak is of the view that strong order flows cannot continue forever.
If there are concerns, why are PSU stocks continuing to rally?
Higher prices attract more buyers which drives prices even higher. It is a self-fulling prophecy of sorts. Plus, mutual funds are now coming with schemes dedicated to PSU stocks. That too is driving up prices. Also, in some PSU stocks, the government and state-owned institutions own anywhere between 85-97 percent of the equity. Such stocks rise faster because of low floating stock in the market.
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