Analysts weigh reasons for runaway PSU rally
The runaway rally in shares of public sector companies has made analysts dig deeper on the reasons driving the rally.
The BSE PSU index has risen by about 92 per cent in the last year compared with 18 per cent gains clocked by the Sensex. Capital goods, electric utilities, financials and oil, gas & consumable fuels have been the major leaders in the PSU rally.
While initially cautious about significantly increasing exposure to PSU names, recent data indicating improvements in operating performance has led DSP Mutual Fund to augment its holdings in these companies. The selection criteria, however, remain stringent, focusing on companies that meet fundamental parameters.
“Should these PSU entities sustain efficient operations, a continued trend of outperformance is expected due to increased business opportunities,” the fund said in a recent note.
Banks performance
Public Sector Banks have shown sustained improvement in their fundamentals over the past several years, including a decade-high capital adequacy ratio and a substantial reduction in gross non-performing assets ratios.
“Despite these improvements, the valuations of PSU Banks may not be fully reflecting the improved fundamentals, creating a potential opportunity for investors who have a high-risk appetite,” said a recent note by HDFC Mutual Fund, while announcing the launch of its PSU Bank ETF.
Kotak Institutional Equities finds certain assumptions surrounding the medium-to-long-term growth and profitability of these sectors to be highly optimistic.
“The market is overly focused on near-term ordering and profitability, while ignoring the large downside risks to medium-term profitability, business model challenges and disruption risks,” it said in a note on Wednesday.
Risky sectors
Capital goods PSUs, for instance, may not sustain their current high profitability indefinitely. These PSUs have experienced a significant revaluation in their multiples over the past year, propelled by a substantial surge in order books and enhanced profitability and returns. KIE contends that the market is undervaluing the potential downside risks associated with assuming prolonged large order inflows.
“Sectors such as thermal electricity generation will have a finite quantum of orders. In our view, the government’s three-in-one role of buyer, owner and policy-maker/regulator creates uncertainty regarding the companies’ future earnings and returns,” the brokerage said.
Electric utility PSUs are at risk of weakening RoE profile and long-term disruption. OMCs, which have seen a sharp rerating in their multiples over the past year on assumptions of high profitability, are at risk of high volatility in marketing margins and long-term disruption.
“We are puzzled by the market’s confidence given large volatility in marketing margins in the recent past and high sensitivity of EPS to the same. Our profitability assumptions are much higher than historic levels, with limited visibility on the government’s pricing policy,” KIE said.