PSU stocks surge. Should you buy?

Led by a rally in banking counters, stocks of public sector undertakings (PSUs) have been among the top performers, gaining up to 50 per cent in this month. The up-move continued on Monday, with the S&P PSU index on the BSE exchange rising 2.4 per cent as compared to a 1.4 per cent rise in the benchmark indices, the S&P BSE Sensex and CNX Nifty on the National Stock Exchange.

Thus far in March, the S&P BSE PSU index has gained nine per cent as compared to a 4.4 per cent rise in the benchmark indices. The performance has been a clear contrast to the movement in the first two months of 2014, when the S&P BSE PSU index massively underperformed the S&P BSE Sensex (down 0.2 per cent) by slipping nearly seven per cent.

Despite the rally, the index is still far away from its all-time high of 11,205, hit on January 4, 2008. It hit a 52-week high of 7,078 in May 2013.

What’s driving PSUs?
Analysts attribute the recent rally to a tactical shift to riskier cyclical counters, amid hopes of a stable government after the election. An improvement in key economic indicators – inflation that dipped to a 25-month low in February and an improvement in the current account deficit (CAD) — has aided the sentiment.

“After its surprise January rate hike, we expect the Reserve Bank of India (RBI) to stay on hold in April, while the new government’s economic policies and monsoon trends will likely have considerable influence on monetary policy in the second half of 2014,” say Siddhartha Sanyal and Rahul Bajoria of Barclays, in a recent report. “The recent positive rupee momentum, on the back of a narrowing current account deficit, softer inflation prints, enhanced policy credibility and strong capital inflows, will continue in the near term.”

Says Amar Ambani, head of research, India Infoline Group: “One reason for the rally is that the recent polls have reaffirmed the elections will see a National Democratic Alliance (NDA)-led government at the centre. There are expectations that the new government will give more autonomy to public sector companies and there are chances that the divestment in select PSUs could see a revival.”

Among individual stocks, BEML, Engineers India, MOIL, Container Corporation and GAIL rose by five to eight per cent. Oil and Natural Gas Corporation, Chennai Petroleum Corporation, Bharat Electronics, MRPL, Indian Oil Corporation and NMDC gained a little over four per cent each in trade on Monday.

Stock strategy
Despite the rally, analysts believe these stocks have more headroom but one has to be careful while investing, especially in the PSU banking pack.

“The rally in the banking space is a hope rally, based on expectations that the economy will turn around for the better, post elections. Banking stocks, which are high-beta cyclicals, are available at attractive valuations and are likely to do well. Our top PSU picks in the banking pack are SBI and PNB,” says Vaibhav Agrawal, vice-president of research (banking), Angel Broking.

Varun Goel, head of portfolio management services, Karvy Stock Broking, says stocks of PSU banks are trading at attractive valuations and he expects a significant outperformance from that space in the next two to three years. “The capex cycle will take some time to revive and we will be cautious on the space for now. We would avoid some of the power sector players in both private and government space, as there are no signs of earnings revival in that space. Downstream oil and gas companies can get significantly re-rated from current price levels,” he says.  Ambani of IIFL believes despite attractive valuations, investors are also buying PSU stocks for high dividend yields. He expects the market rally to continue till June. Within the PSU basket, he prefers ONGC, Oil India, NMDC and Bank of Baroda.