Jefferies bets on PSU stocks

Despite a massive bull run in PSU stocks, there is still a lot of room left for gains, says Jefferies, a leading international investment bank and capital market firm, in its recently published report. Taking into account valuation metrics like price to book (P/B) and price to earnings (P/E), Jefferies points out there is a significant valuation upside in most PSU stocks compared to its 2006-2012 average premium /(discount) over Nifty-50.

Jefferies' top PSU picks are SBI, Coal India and NTPC. Also, based on P/B metrics, ONGC, BHEL and Coal India emerged as the top three stocks that have a potential upside of 138%, 104% and 71% respectively, to match the average multiple of years between 2006 and 2012. Similarly, it says, based on price-to-earnings multiple, ONGC, Coal India and HPCL have a potential valuation upside of 110%, 109% and 85%, respectively, to the average multiple between 2006 and 2012.

BSE PSU Index has outperformed the Nifty 50 by 70% in the past 12 months due to huge improvements in return on equity (RoE) and earning per share (EPS) upgrades. PSU Index outperformed Nifty by 40% in the calendar year 2023 and another 15% in 2024 (till mid-February). Stocks across the PSU spectrum rallied, partly due to the government's accelerated Capex spending. Also, sector-specific reasons helped in the massive rally in the past year, the report adds.

The return on equity of the BSE PSU Index had declined from 14.9% in FY12 to 4.7% in FY19. In FY24, Jefferies expects it to bounce back to 13.5%. The overall RoEs have improved back to 12%-13% level as the profitability has recovered and may improve further, the report states.

The outperformance of the PSU Index came after a decade of underperformance. Despite this, the BSE PSU Index PE at 12.1 times is a 40% discount to Nifty versus the Pre-FY18 discount to Nifty P/E of 31.2% on average, says the report. Since FY18, P/E multiples of the PSU Index started moving down on account of lacklustre performance by PSU Banks due to mounting NPAs. Thus, considering the historical P/E valuation, the BSE PSU Index could offer a 15% upside potential.

Though the PSU Bank Index is 78% up on a year-on-year basis and has outperformed the Private Bank Index by 70%, still PSU Bank Index is trading at relatively lower multiples. On the basis of one-year forward P/B ratio, PSU Banks are currently trading at 1.3 times or a 20% discount to the last Capex cycle average of 1.6 times.

A sharp earnings turnaround on asset quality improvements and attractive valuations contributed to their positive stock performance. PSU banks have also typically enjoyed lower loan-deposit ratios, allowing them to push loan growth. PSU bank credit growth in FY24 is within 2-3% of private, against the 8-10% gap in growth seen pre-COVID. A comparison of PSU Bank valuations versus the 2006-12 period, a time similar to strong fundamentals and a rising capex cycle suggests a rerating potential of 25% to 30% on P/E and P/B valuations. The report says that normal RoE compounding-based returns of 15% plus would be over and above.

The Oil PSU performance stocks saw a sharp rally since October 2023 as the government chose not to cut auto fuel prices despite a busy election calendar, and a drop in crude oil prices. The message was reinforced in the interim budget, which implies that it is reasonable to assume average marketing margins in future. However, a potential oil price increase shall continue to be a risk.

Most PSUs have also seen large EPS upgrades, with notable exceptions being ONGC, Concor, and BHEL.