BSE PSU index rallied 95% in a year; will this run continue?

PSU stocks are witnessing a strong rally over the past 12 months. Amid this bull run, the BSE PSU index has surged nearly 95% and the BSE Sensex has gained 23% in the same duration. In an interaction with Business Today, Dhimant Kothari, market expert and Fund Manager at Invesco Mutual Fund, shared his insights on why PSUs are performing well, the major factors behind this PSU turnaround,  expectations from banking, power and infra sector, will this PSU’s performance sustain going ahead, and more.

Edited excerpts 

PSUs are performing well in the stock market; What is your view on the PSU theme?

We are constructive on the PSU theme for the foreseeable future. Different companies within the broader theme will have varied outcomes, but overall earnings momentum is expected to remain strong for the next few years. The non-commodity sectors (i.e. excluding metals and oil & gas) in the PSU space will witness healthy earnings compounded annual growth rate (CAGR) of 15-16% between FY24 and FY26e. The commodity-oriented sectors are likely to see muted earnings in general due to macroeconomic concerns in China and Europe, the key consumers of commodities.

What, in your opinion, has led to the outperformance of PSU banks in the past few years? Will this strong run continue going ahead?

PSU banks have witnessed a strong turnaround in profitability. Historical bad assets marred its profitability in the last decade from FY11 to FY20. However, by FY21, their balance sheets got cleaned up. Many historical bad assets witnessed recoveries which boosted profits. The government also infused capital into these banks, which helped improve their capital adequacy. The general economic uptick post-Covid helped them increase credit growth as well.

Thus, rising credit growth, low credit costs, and a healthy balance sheet have led to a solid earnings rebound for the PSU banking sector, with 43% earnings CAGR between FY21-24. From RoE of 0% and 2% in FY19 and FY20 respectively, PSU banks saw RoE increase to 15% in FY24, which is likely to be sustained in FY25e and FY26e. Similarly, the earnings are likely to grow at CAGR of 16% between FY24 and FY26e. These strong earnings and RoE will be reflected in the stock price performance of the PSU bank stocks. Banks and finance companies in the PSU space will also witness derived benefits of increased credit growth opportunities from rising infrastructure spending.

Why PSUs from the power and infra sectors are doing well and what are your expectations for the near future?

The need to be ‘Atma Nirbhar’ and ‘Make in India’ is critical from various aspects, including satisfying the rising consumption in India, reducing import dependency, and providing job opportunities to the soaring mid-age (20-45 years) population, in addition to boosting the economic growth and reducing trade deficit.

The power and infrastructure sectors will play a critical role in realizing these aspirations. The power sector is likely to witness a mammoth investment of more than Rs. 6 trillion till FY32 across generation and transmission, which will benefit power utilities.   This segment is likely to witness 10-12% earnings CAGR for FY24 to FY26e.

Additionally, spending towards expansion and improvisation of railways is also witnessing healthy growth. Railway-focussed PSUs should benefit from the government’s spends on augmenting capacities and routes. Railway-focussed companies will see earnings CAGR of 14-16% for FY24 to FY26e.

The government is focussing more on defence sector, what is your view on defence PSUs?

The Defence Production and Export Promotion Policy of 2020 (DPEPP-2020) has provided the strong push to India’s defence production as well as promoting exports. With the ‘Atma Nirbhar Bharat’ initiative, the focus is directed towards self-reliance or reduction in imports and increase of exports. Thus, the defence companies are beneficiaries of ‘Make in India’. Approximately 68% of defence budget is earmarked for indigenous equipment, which will help domestic companies, largely from the PSU space.

In absolute terms, the defence expenditure has gone up from Rs. 3.79 lakh crores in 2017-18 to nearly Rs. 6.22 lakh crores in Union Budget 2024-25 (BE). This is reflected in the rising order book of defence companies (select large companies; non exhaustive), which grew from Rs. 1.5 trillion in FY20 to Rs. 2.3 trillion in F24, a healthy CAGR of 11%. The growth momentum is likely to be sustained in the foreseeable future as well.

Which sectors do you think will outperform going ahead?

We believe domestic-oriented sectors like defence, railways, power, logistics, and financials will continue to witness strong earnings momentum. While rising capital expenditure and buoyancy in economic activities will benefit defence, railways, power utilities and logistics companies, healthy credit growth, benign credit costs and increasing penetration of financial products will support earnings growth in financial companies.

On the other hand, commodity-oriented sectors like metals and oil & gas may see relatively lower earnings momentum in general due to macroeconomic concerns in China and Europe, the key consumers of commodities.

While the capital goods, which include companies in defence and railways space is likely to witness strong earnings CAGR of around 20-22% between FY24 and FY26e, financials will witness a healthy 15-16% CAGR during the same period. Power utilities is likely to see earnings grow at 10-12%. On the other hand, metals and oil & gas related companies will witness flattish earnings during this period. Nevertheless, company-level outcomes may vary and bottom-up stock picking will be the key.