The phrase public sector undertakings (PSUs) / public sector enterprise (PSEs) or ‘sarkari company’ would always give rise to a question mark in the minds of foreign and domestic investors alike. The government’s stakeholding and its interference in the affairs of these company, along with lack of competitiveness, made investors ‘wary’ of investing in the stocks of these enterprises. Barring a few names, the stocks of most government-owned companies were giving abysmal returns.
But over the last 18-24 months, the tide has changed for many PSUs. The government’s concerted efforts to clean up the stressed balance sheets of public sector banks (PSBs) have injected a new lease of life in these lenders and many of them are now presenting a good investment opportunity at attractive valuations. Similarly, the ‘make in India’ push augers well for some of the government-owned companies, especially in the fields of defense, railways, ship-building, energy, etc.
The clean-up of the Indian banking system was a step in the right direction and the shares of a number of banks owned by the government have started looking up. Their performance has responded to the government’s actions, and their valuations, which till recently were at rock bottom, have made some smart recovery.
According to Vikas V. Gupta, CEO & Chief Investment Strategist, OmniScience Capital, “If any good company keeps performing, eventually, Mr. Market would be forced to take notice.” This is what is happening now with some of the banking names.
If a good bank keeps performing well and retains some portion of its earnings it will grow its book value. If the market doesn’t take notice of this, its price-to-book (PB) keeps coming down. If the bank is a dividend payer, its dividend yield will keep increasing. At some point the difference between the average or median market valuation ratios and the company becomes so stark that sophisticated investors who are willing to go against the market perceptions, start noticing it.
“The smart investors do deep dive into the financials and future strategy to understand any potential risks that they might be missing,” added Gupta. They also conduct a detailed valuation analysis to understand the difference between the market value and the intrinsic value, and, if the risk-reward is favourable, they start buying the stock, thus driving the price up, which eventually results in a changed market perception and bringing in other investors.
“PSBs have come back into focus with continuous improvement in asset quality (net NPA reduced to 1.7 percent in the banking sector as on March 31, 2022 from 5.9 percent four years ago) and pick-up in advances growth in the past few months,” said Gaurav Dua, Head - Capital Market Strategy, Sharekhan by BNP Paribas.
Also, the provision coverage ratio (PCR) for most banks is in excess of 70 percent now, and the balance sheet is well capitalized to support growth in core operations. Thus, some value buying has emerged in the PSB space.
“Given the comfort of valuations along with improving business outlook, there is a strong case for a re-rating of PSBs over the next 18-24 months. And, in fact, we have been advising increasing exposure to select PSBs for the past few quarters,” Dua added.
In short, the perception about PSBs will change bank by bank, and not en masse, starting with the best ones. Over the next three to five years a huge capex (public + private) of Rs 200 lakh crore is expected. Majority of this capex will be through debt, and banks with clean balance sheets and clear strategy will be able to capture this opportunity.
Having said that, the PSU Bank index has outperformed the Private Bank index in the recent past. “A change in momentum for the PSU Bank index was caused by the listed banks reporting the highest ever total net profit (Rs 1.8 lakh crore), with all public sector banks reporting profit (up by 109 percent), stable NIMs (net interest margins) across the board, steady rise in CASA (current account, savings account) ratio, and improvement in the CD (credit-deposit) ratio for the industry from 73 percent to 74 percent,” said Mohit Nigam, Head - PMS, Hem Securities.
Apart from measures taken on the asset quality side, banks like SBI and Bank of Baroda have also become aggressive on the retail lending side, especially in mortgages which bodes well for them. “We have seen their NIMs expand over time, RoEs improving, and growth coming back, and we firmly believe that for the better-run PSBs, this momentum should be sustainable, especially since the Indian economy seems strong at the current juncture,” said Nishit Master, Portfolio Manager, Axis Securities.
It may be noted that the top two banks in the PSB index make up 50 percent of it and the top five make up more than 80 percent. “The movement of the index is driven mostly by the few largest banks,” said Gupta of Omniscience Capital. Currently, the PB ratio is at 0.71 for the index, which looks quite attractive, and the trailing ROE is also below 10.“As the banks’ performance improves, the earnings and ROE should also increase, making them even more attractive on a PE basis,” added Gupta.
According to Siddarth Bhamre, Head of Research, Religare Broking Limited, State Bank of India and Bank of Baroda will continue to outperform the space and any allocation in this sector should remain confined to these two names only.
So, has the Indian banking system become free of all its old ailments and is in for a strong ride? As time has elapsed after the clean-up, there’s talk doing the rounds that some of the PSBs have already started out on a new cycle of NPAs/bad loans. But experts believe that for now, these talks about fresh NPAs do not hold any merit.
Dua of Sharekhan by BNP Paribas, says, “PSBs are starting a new credit growth cycle, and normally, these cycles last for five to eight years before the mistakes of the past cycle emerge as fresh bad assets and NPA cycle.” So, it would not be prudent to worry about the possibility of a new NPA cycle at this stage. “Rather the focus should be on the opportunity to generate index-beating returns that PSBs can generate over the next couple of years.”Total recovery as a percentage of initial gross non-performing assets (GNPA), write-off as a percentage of the initial GNPA, percentage upgrade upon opening GNPA and slippages as a percentage of opening Gross Advances are some of the key metrics to judge the overall health of any bank/sector.
“In the last financial years, the PSB category has shown improvements in each of these metrics,” said Nigam of Hem Securities.
The PSBs’ PCR, which shows how much money the lenders set aside to cover bad loans, increased from 46 percent at the end of March 2015 to 86.9 percent by the end of FY22. By the end of FY22, the state-owned banks' gross NPA ratio had decreased from 14.6 percent in FY18 to 7.4 percent.
Not just PSBsApart from PSBs, experts see scope for re-rating in the stocks of companies in the defence sector, railway engineering, power generation, etc.
The government is looking at completely revamping the power generation sector with introduction of the Electricity Amendment Act 2022, which would be positive for large public sector companies in the power value chain. Consequently, “if the new change addresses the recurring issue of losses in State Electricity Boards, there is scope for healthy returns from NTPC, Coal India and Power Grid Corporation over the next few years”, said Dua.
Coal India delivered better-than-expected results. “The company has been able to produce and ship higher coal volumes, which has been a pleasant surprise. And even on the realisation front, with e-auction realisation being strong, we believe Coal India should do well,” said Master of Axis Securities.
There are numerous companies in the defence sector which have high capital efficiencies, huge order books lasting five to seven years or more into the future and are available at significant discounts to their intrinsic values. These have strong monopolies and are now sought after by foreign militaries as well.
“With India having the third-largest defence budget in the world of $70 billion and being on a large modernisation drive, the opportunity for these companies is huge,” said Gupta.
Also, with railways working on multiple high-speed rail and semi-high-speed metro projects, and other modernisation initiatives, some of the railway engineering companies have order books lasting two to five years with growth rates of 20-30 percent.
“We would prefer going for large-cap public sector enterprises based on reasonable valuations and strong fundamentals. But having said that, we would also focus on some mid-cap stocks that are leaders in their sector because they are the ones that will become large-caps in the future,” suggested Raj Vyas, Portfolio Manager, Teji Mandi.