PSU stocks: Modi government sees PSUs as a wealth-generating opportunity, says Emkay Global

PSU stocks: Modi government sees PSUs as a wealth-generating opportunity, says Emkay Global

Should investors consider PSU stocks as a trading pack or investment bets? Emkay Global said the government now sees the PSU space as a wealth-generating opportunity, rather than a medium to periodically divest shares for fixing fiscal deficit. It said PSUs as a cohort are more efficiently run today. Three issues plaguing PSUs in general namely operational performance, lack of clarity or sub-par IRRs on re-invested capital, and supply overhang are mostly being addressed by the government, the domestic brokerage said.

Emkay Global in a strategy note basically addressed the issue by separating PSU banks and energy PSUs.

In the case of PSU banks, Emkay Global said loan growth for top PSU banks compounded annually over the last three years has been about 13.5 per cent. State Bank of India (SBI) will earn about 18 per cent return on equity in FY24, it estimated. Excluding-SBI, other large PSUs’ average ROE estimate for FY24 is 14.9 per cent. SBI’s EPS CAGR through to FY26 is about 15 per cent, while other banks are likely to report a wide variance, from 8 per cent to 45 per cent.

“In almost all cases, sustainable growth rates for PSU banks will be lower than their reported ROEs. Additionally, ex-SBI, the reported GNPA average is about 4.7 per cent, while the NNPAs average is around 1 per cent, with provision cover of 79 per cent. Most banks expect sustainable recoveries after a long protracted NPA cycle. Despite this rally, SBI trades at 1.5 times TTM BV and about 1.4 times FY25 ABV. For other PSU banks, the average multiples are 1.4 times TTM ABV and 1.2 times ABV FY25E,” it said.

Emkay Global said while the valuations seem elevated compared with the historical average, they are reasonable against the expected earnings growth and ROE estimates.

“Interestingly, such comparisons stack up very well against peer private-sector banks. While the average loan growth for the large private peer-set (ICICI Bank, Kotak Mahindra Bank, HDFC Bank, Axis Bank) is 17.7 per cent through to FY26, EPS CAGR over the same period averages at only 13 per cent, just in line with that of PSUs. The ROE average, meanwhile, is 16.8 per cent, 16.7 per cent and 16.5 per cent in FY24E, FY25E and FY26E – again in line with that of PSUs,” it aid.

Emkay Global said the sum substance of quality, technology & governance will eventually have to reflect in the reported numbers and the longevity of such numbers. As the performance gap narrows, so will the valuation gap.

“Unlike in the past, PSUs will not be compelled to dilute below the book. Actually, they may not need to dilute at all, as growth rates are well below reported ROEs. We expect PSUs to take the lead in infrastructure financing and corporate project loans – and if our hypothesis is right, the loan and earnings growth will decisively outpace that of private sector peers,” it said.

The quality & capital market awareness of top management, the RBI’s micro audits, quality of underwriting, etc have evolved significantly over the last decade. If true, the asset cycle reversal will mostly be influenced by economic cycles and will have a similar impact for most banks adjusted for the product mix. Rear view driving will be dangerous, Emkay Global said.

In the case of energy PSUs, predominantly, OMCs and upstream companies have seen a staggering 30 per cent rally. Ekay said its energy analyst is still bullish.

“We feel that a deeper analysis with a fundamental orientation will, perhaps, unearth the real trigger to the rally. For OMCs, earnings have been consistently upgraded over the preceding 12 months – Our FY24 estimates of BPCL and HPCL’s have moved, from Rs 44 and Rs 51 a share to Rs 107 and Rs 127, respectively. Estimates have nearly doubled in the last 3 months itself. For upstream companies like ONGC, estimates have remained flat, but we will delve into this a bit later. We believe that the regulators, through their consistent actions, have guided the market subtly,” it said.

Emkay said a transparent windfall tax pricing, indexing gas pricing to oil (with a floor & cap), OMCs retaining super-normal marketing margins in an election year (to offset the previous losses) – have all gradually nudged the market to a more predictable earnings slope. As long as oil is within a reasonable band, free market economics will work. An overshoot will have a substantial hit on earnings in a year, but a recoup is likely with reversals. Across a cycle, accretion to book value may actually stay unaffected. We see this a colossal change.

“We believe that the government now sees the PSU space as a wealth-generating opportunity, rather than a medium to periodically divest shares for fixing fiscal deficit. We believe that OMCs and upstream companies will re-invest their cash-flows to lead the renewables drive into charging network/green hydrogen, etc. This is no different than what

NTPC is doing with its solar energy thrust,” Emkay Global said.

While Emkay admitted that IRRs are a bit hazy in the new ventures, but markets usually initially applaud such initiatives. Also, for most such companies, the incremental return on capital employed was low to start with – portfolio impact may still be positive overall. Nevertheless, this removes the overhang of persistent OFS supply, Emkay said.

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