PSU Stocks: Where do we go from here?

How will PSU stocks fare in the possible third term of the NDA?

Railways

The return of the incumbent government would entail continued focus on developing and enhancing the railway infrastructure. From 2019 to 2024, the capital expenditure on the railways sector saw a 28.7 percent CAGR, as the government focused on increasing rail freight and rail infrastructure.

The government will aim to construct new tracks, increase ticket availability, expand the coverage of new-age trains and widen the scope of Vande Sleeper trains. RVNL, IRFC, IRCTC, and IRCON are all railway-focused PSUs that could see a further rally.

But it is not all smooth sailing for the sector. Over the past year, RVNL's order book has dropped from around Rs 1 lakh crore crore to approximately Rs 85,000 crore. As a result, its revenue grew around 8 percent on-year as against a 200 percent surge in its stock price.

Similarly, IRCON's order book fell to Rs 25,000 crore due to a lack of new orders, leading its revenue for the quarter ended March to fall one percent. The revenue guidance for the current fiscal year is flat.

Despite this, investors continued to remain optimistic around the railway theme, with railway stocks some of the top gainers on the bourses over the past few months.

Banks

The asset quality of the banking sector over the past couple years has seen a sharp improvement, both for private banks and PSUs.

Banks, which constitute a bulk of the PSU pack, have managed to clean up their books after a prolonged period of bad loans. They're now clocking good Return on Equity (RoE), with SBI achieving double-digit RoEs, bettering several private sector banks.

This transformation has prompted a rerating of PSU bank stocks and a reduction in the gap between multiples of PSUs and private firms.

India’s public banks are also seeing a boom, as borrowing for infrastructure and manufacturing projects, led by the central government's drive to boost the economy, surged sharply.

If the government continues its capex thrust, the high demand for capital for infrastructure will result in strong credit growth, overall improving return on equity (ROE), and the inclusion of Indian bonds in the global bond index, are expected to make the case for PSU banks stronger.

However, if the government slows down on capex, the private sector might follow suit. This will hurt public-sector banks which are seen as the primary beneficiaries of the projected pick-up in private capex.

Defense

India is the second-largest importer of defence equipment and ranks among the top three global defence spenders but trails significantly behind the US and China. Despite its sizable coastline and land area, defence spending remains comparatively low.

The government had realigned its focus to indigenous production of defence equipment, with the indigenisation efforts driving domestic defence spending growth. It aims to export more defence equipment, with exports expected to reach $7 billion by FY30.

The efforts are driven as a result of streamlining defence procurement procedures, incentivizing local manufacturing under ‘Aatmanirbhar Bharat’ program, and the Strategic Partnership model.

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As a result, in the past three years, defence stocks have notably outperformed other PSU stocks. Firms like Hindustan Aeronautics, Mazagon Dock, Cochin Shipyard, Bharat Dynamics, and Bharat Electronics Limited have led the pack.

However, Neeraj Chadawar, Head of Fundamental and Quantitative Research at Axis Securities emphasised the importance of being selective in investing in PSUs with clear earnings visibility and consistent order books.

He said, "It's crucial to have assurance in execution efficiencies, particularly in defence orders, which span multiple years. While there are substantial orders in the defence sector, uncertainties about execution efficiencies remain for the next three to four years."

Renewable Energy

Renewable energy is likely to grow faster in all forms of energy capex over the next decade, as the world shifts to greener, cleaner resources and decarbonization initiatives.

India is well-placed and growing robustly in this fast-growing market to sustain strong growth in the years to come, buoyed by robust capacity additions, developed nations significantly diversifying from China and a strong policy framework, said Nomura.

Energy, especially solar energy, PSUs are set to benefit as a result. The BJP manifesto said it will tap into India's renewable energy potential, aiming for 500 GW of renewable energy by establishing mega solar parks, wind parks, and implementing projects like the Green Energy Corridor.

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Beneficiaries of this move towards cleaner and greener energy would be Power Grid, NHPC and REC among others. However, as a result of the election uncertainty, power financiers were among the top losers in trade, with PFC, IREDA, and REC tanking around 25 percent.

Outlook for PSU stocks?

Ahead of the election results, experts suggested that the PSU stocks were in a bubble, with the rise a result of the market sentiment rather than fundamentals. There are concerns regarding the valuations of PSUs, as they factor in optimistic volume and profitability assumptions.

“Forward earnings do not justify these valuations, especially in sectors that are linked to government policy actions, such as defence, railways, and power”, said Elara Securities.

Further upside in repeat names looks unlikely, as fundamentals are not in sync with the stock prices.

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