Are PSU stocks riding a bubble? mixed results cast doubt on the rally

PSU stocks in the Indian market have emerged as significant wealth generators, demonstrating returns of up to 300% within less than a year. This surge is fueled by an increase in capital expenditure (capex), with PSU companies positioned as primary beneficiaries of government-led capex initiatives.

Furthermore, the anticipation of political stability, particularly with the expected victory of the BJP in the upcoming Lok Sabha elections in May, adds another dimension. This expectation suggests a continuation of the capex surge, further bolstering the outlook for PSU stocks.

Moreover, robust order acquisitions from the private sector, coupled with limited liquidity in these stocks due to the government's predominant stakeholdingthat, have contributed to a supply-demand disparity, consequently driving stock prices upward.

Also Read: Nifty 50 touches new all-time high, extends gain for 5th day in a row

However, amidst this bullish trend, analysts have raised questions regarding the continuity of the PSU stock rally. This skepticism arises from the mixed performance exhibited by PSU companies in the third quarter (Q3).

Companies in the BSE PSU Index beat analysts’ expectations by a mere 1% in the three months end December, the slowest pace in six quarters, according to data compiled by Bloomberg. That’s not enough to justify a rally that sent the gauge to a fresh record on February 15 and has more than doubled the measure’s market value to $750 billion in the past year, according to the Bloomberg report. 

The “risk-reward is not very good, so don’t bet on a broad rally. It’s time to become selective, many indicators are quite overbought for this space, and investors should avoid taking bullish calls in the short term," Ruchit Jain, an analyst at brokerage 5Paisa Capital, told Bloomberg. 

Also Read: Is market correction on the horizon amid high valuations?

Looking at earnings, stocks that have more than doubled investors' money have reported a weak set of numbers. For instance, SJVN, which rallied 265% in a year, has reported a 51.6% drop in its net profit to ₹139 crore in Q3FY24, compared to ₹287 crore during the same period last year.

BEML was another multi-bagger stock that posted a drop in Q3 net profit. Similarly, SAIL reported a 22% year-on-year decrease in net profit for the same period. Additionally, railway PSUs such as Indian Railway Finance Corporation and Rail Vikas Nigam both posted declines in their Q3 net profit. 

While some analysts have projected that weak fundamentals could potentially limit the upside rally in PSU stocks, others argue for its continuation.

In a recent note, global brokerage firm Jefferies pointed out that the price-earnings ratio of the BSE PSU Index is trading at a 40% discount compared to the Nifty 50 Index. The brokerage believes this presents a 15% rerating potential to reach an average level.

"Stocks across the PSU spectrum have rallied, partly supported by the government's accelerated capex spending but also for sector-specific reasons have helped. Despite this performance, the PSU Index PE at 12.1x is a 40% discount to Nifty vs. the pre-FY18 discount to Nifty PE of 31% on average," the brokerage said in its recent note.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.