Mint Primer: Is the market’s PSU narrative overstretched?

The BSE
The BSE

Summary

  • The BSE PSU Index has doubled to 18,918.03 in the current fiscal year through 20 February as mutual funds and retail investors have stepped up buying stocks with relatively lower free float

Stocks of public sector undertakings (PSU) have had a sterling rally this year. The 56-stock BSE PSU Index’s doubling outshines the Sensex’ modest 24% return this fiscal amid a valuation re-rating backed by earnings. But this rally isn’t a mere bubble. Mint explains:

Why have PSU stocks risen so sharply?

The BSE PSU Index has doubled to 18,918.03 in the current fiscal year through 20 February as mutual funds and retail investors have stepped up buying stocks with relatively lower free float. From a cumulative 12.57 trillion PSU shares as of June end, active and passive mutual funds’ holding had jumped to 12.94 trillion shares at the end of January, says Fisdom research. That’s an incremental 370 billion shares over seven months. PSU holdings jumped 56% between June and January to 3.94 trillion.

Why are money managers buying PSU stocks?

PSUs are asset rich for one. There’s been favourable revaluation of these assets (land, plant and machinery) given the exorbitant cost of replacing these at current prices. Order books have grown from government spending and operational efficiency has improved too. The government has budgeted for a capex of 11.11 trillion in FY25, up 11.1% from the record capex of 10 trillion targeted at infra and energy sectors, etc. This has seen PSU bank and power stocks rally furiously in the last one year. SBI is up 47% over a year at a record closing high of 771 and NTPC up a whopping 94% at 336.1.

Is the rise in valuation merely narrative-based?

In the fiscal year so far, the trailing price-to-earnings multiple of the PSU index has risen 48% to 13.74 times. While the index price doubled, its earnings per share (EPS) expanded 35% to 1,376. It shows that valuations have risen not only because of price growth but also due to earnings growth. Interestingly, the current PE is below the historic median of 14.15 times.

Which stocks have driven the PSU rally ?

In the current fiscal the top 10 stocks that have contributed to 54% of the PSU index rally (5,081.37 out of 9,421 points) include SBI, NTPC, Power Grid Corporation, Coal India and ONGC. (Not because of dividend but you can add this if it suits )Traditionally dividend paying PSUs generated low returns on equity -- net income /shareholders equity plus free reserves --but with expectations of profits growing due to improved operational efficiency the RoE is also expected to improve . Coal India whose current dividend yield stands at 5.6% has an RoE of 56% which could improve further .

What must investors be mindful about?

While earnings have risen alongside prices, further upside will hinge on how earnings play out in the coming quarters. If earnings growth slows, valuations will look stretched and prices could correct. Technically, the BSE PSU index’s relative strength index, which gauges the magnitude of upmoves relative to its downmoves, is at a superbought 93.63 on a weekly basis. The normal reading is between 30 and 70 , with a move above 70 putting the asset in overbought zone. Below 30 refers to an oversold zone.

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