Staging a comeback: PSU stocks climb peaks, but valuation cliff awaits

Analysts warn of price peaks amid government spending surge. Is the rally running out of steam? Brokerages sound caution as upside targets falter

Listed central public sector undertakings (PSUs) such as Cochin Shipyard, REC, Bharat Heavy Electricals, Hindustan Aeronautics (HAL), and Punjab National Bank, among others, are some of the most loved stocks on the bourses after being off investor radar for many years.

The S&P BSE PSU, which tracks the market capitalisation of 56 listed PSUs, has been the top-performing index in recent months and touched a record high earlier this month. It is up 99.5 per cent in the past year compared to a 19.4 per cent rally in the benchmark S&P BSE Sensex during the same period.

Analysts attribute the rally in PSU stocks to investor expectations of a sharp rise in government capital expenditure (capex), resulting in a higher order book and increased revenues and profits for state-owned companies.

Most of the non-bank and non-financial PSUs are in investment and capex-dependent sectors such as capital goods, project finance, power, oil and gas, engineering, defence equipment, and metals and mining.

Defence equipment manufacturers such as Cochin Shipyard, HAL, and Bharat Electronics (BEL) have been the biggest beneficiaries of investors’ newfound love for PSU stocks.

Cochin Shipyard is the top performer, with its share price up 442.6 per cent in the past year. Similarly, HAL is up 205.7 per cent, while BEL is up 140.5 per cent in the same period.

Defence stocks are also some of the most expensive in terms of price-to-earnings and price-to-book value multiples.

This is where the good news ends.

Most brokerages believe that the stocks are expensive and there are potential downside risks, given their average one-year target prices.

According to Bloomberg consensus estimates, the one-year forward target price for eight of the 10 top-performing PSUs in the Business Standard sample is 6-44 per cent lower than their current share price. REC and Oil India are exceptions, where brokerages expect an 8.3 per cent and 0.3 per cent upside, respectively, over next year.

Listed are the top 10 performing PSUs based on share price gains seen in the past year and brokerages’ estimates about their future trajectory. The Business Standard sample has only selected PSUs tracked by at least six brokerages.

COCHIN SHIPYARD

·         The shipbuilder Cochin Shipyard is the top-performing public sector undertaking (PSU) stock, with its share price up 443 per cent in the past year

·         In comparison, the S&P BSE PSU Index is up 100 per cent, and the market benchmark S&P BSE Sensex is up around 20 per cent in the same period

·         The rally in Cochin Shipyard has been fuelled by investors’ expectations of the company winning large defence orders

·         It is also supported by a sharp rise in the company’s earnings in the third quarter of 2023-24, with net sales up 61.9 per cent year-on-year (Y-o-Y) and net profit up 109.5 per cent Y-o-Y

·         Brokerages, however, see a downside in the stock from current levels due to its high valuation

·         The average one-year target price of brokerages for the stock is Rs 828.3 compared to its current price of Rs 1,483.8

·         The stock is currently trading at a trailing price-to-earnings ratio of 74.8x and a price-to-book value ratio of 8.3x

REC

·         The power project financier REC (formerly Rural Electrification Corporation) is also among the top-performing public sector undertaking (PSU) stocks in the past year

·         Its stock price is up 320.5 per cent in the last year, outperforming the S&P BSE PSU Index and the S&P BSE Sensex

·         The rally in REC has been fuelled by a turnaround in its earnings over the past two years, and brokerages expect the momentum to persist

·         The company’s net profit was up 26.7 per cent in the latest trailing 12 months, while its gross interest income was up 20.3 per cent in the period

·         Brokerages see further upside in the stock as the company expands into new segments like financing renewable energy projects

·         Brokerages’ average one-year target price is Rs 589.8, suggesting a potential upside of 8.3 per cent from its current share price of Rs 544.5

·         The stock is trading at a trailing price-to-earnings ratio of 10.1x and a price-to-book value ratio of 3x

BHARAT HEAVY ELECTRICALS

·         Power generation equipment maker Bharat Heavy Electricals (BHEL) has rallied on investors’ expectations of faster capital expenditure growth in the power sector

·         BHEL’s stock price is up 280 per cent in the past year, outperforming the BSE PSU Index and the S&P BSE Sensex

·         The rally is, however, not supported by earnings growth. The company’s net sales were up by just 4.3 per cent year-on-year in the trailing 12 months ending December 2023, and it reported a net loss of Rs 120 crore in the period against a net profit of Rs 778.9 crore a year ago. Fourth-quarter results are scheduled for Tuesday

·         Brokerages expect a big downside in BHEL’s stock price, given its high valuation and slower-than-anticipated revival in new thermal power projects

·         Based on the one-year average target price, analysts value BHEL’s stock at Rs 202.8, which is lower than its current share price of Rs 310.1

·         The stock is currently trading at a price-to-book value ratio of 4.1x and its price-to-earnings multiple is negative due to a net loss in the last trailing 12 months

HINDUSTAN AERONAUTICS

·         The aircraft maker Hindustan Aeronautics (HAL) has been an investor darling, with its stock price up 205.7 per cent in the past year, outperforming the S&P BSE PSU Index and the S&P BSE Sensex

·         The rally in HAL has been fuelled by investors’ expectations of big order wins for military jets and helicopters, as well as continued improvement in its operating margins

·         The company’s net sales rose 12.8 per cent in 2023-24 (FY24), while its net profit was up 30.8 per cent in 2022-23

·         HAL’s earnings before interest, tax, depreciation, and amortisation margins jumped to a record high of 39.4 per cent of revenues in FY24 from 24.63 per cent in 2018-19

·         There are currently 13 ‘buy’ ratings on the stock, but brokerages expect a downside from the current price

·         The average one-year target price of brokerages is Rs 4,306.2, lower than its current stock price of Rs 4,729.3

·         HAL’s stock is trading at a price-to-earnings ratio of 41.5x and a price-to-book value ratio of 10.9x

ENGINEERS INDIA

·         Engineers India (EIL) is a global project engineering consultancy and project management major, primarily focused on the oil and gas and petrochemical sectors. EIL has also forayed into sectors like infrastructure, water and waste management, solar and nuclear power, and fertiliser

·         The sharp rise of 177 per cent in its share price in the past year is due to investors betting on a capital expenditure (capex) revival in the Indian economy. EIL, a leading engineering, procurement, and construction contractor and project manager, is seen as a top beneficiary of faster capex growth

·         The company’s net sales were up 2.7 per cent year-on-year (Y-o-Y) during the trailing 12 months ending December 2023, while its net profit was up 121 per cent Y-o-Y on margin gains

·         Brokerages, however, expect a 5.6 per cent downside in EIL’s stock price over the next 12 months due to high valuation and lower-than-expected earnings growth

·         The stock is currently trading at a trailing price-to-earnings ratio of 29x and a price-to-book value ratio of 7x

NMDC

·         The country’s largest iron ore miner, NMDC (formerly National Mineral Development Corporation), has been among the top-performing public sector companies in recent quarters

·         The company’s stock price is up 167.2 per cent in the past year, outperforming the S&P BSE PSU Index and the S&P BSE Sensex

·         The rally in NMDC has been fuelled by a sharp rise in its revenues and earnings in recent quarters

·         NMDC’s net sales were up 45.4 per cent year-on-year (Y-o-Y) in the third quarter (Q3) of 2023-24 (FY24), while its net profit was up 62.7 per cent Y-o-Y in the period

·         It gained from higher sales volumes (up 19 per cent Y-o-Y) and higher realisations (up 22 per cent Y-o-Y) in Q3FY24

·         Brokerages expect NMDC’s earnings momentum to continue on higher demand for iron ore but see a 16 per cent downside in its stock price over the next year due to its rich valuation

·         The stock is currently trading at a trailing price-to-earnings ratio of 14.1x and a price-to-book value ratio of 3.4x

PUNJAB NATIONAL BANK

·         The public sector banking major Punjab National Bank (PNB) has been another top performer, with a 160.1 per cent rise in its share price in the past year

·         The rally in PNB’s stock price has been driven by a sharp rise in its revenues and profits in recent quarters

·         The bank’s gross interest income was up 16.7 per cent year-on-year (Y-o-Y) in 2023-24, while its net profit was up 172 per cent Y-o-Y in 2022-23

·         Earnings growth was driven by lower provisions and faster growth in the loan book

·         Many brokerages expect the earnings momentum to continue in 2024-25

·         However, rich valuations mean that brokerages see a 13 per cent decline in PNB’s stock price in the next 12 months

·         The stock is trading at a trailing price-to-earnings ratio of 15.2x and a price-to-book value ratio of 1.4x, both high compared to PNB’s historical valuation

NATIONAL ALUMINIUM COMPANY

·         National Aluminium Company (Nalco), one of India’s largest integrated bauxite-alumina-aluminium-power producers, has been one of the top-performing metal companies on the bourses, with its stock price up 147 per cent in the past year

·         The rally has been caused by an improvement in Nalco’s revenues and earnings in the third quarter (Q3) of 2023-24 after a steady decline in the previous three quarters

·         Net sales were up 1.5 per cent year-on-year (Y-o-Y) in Q3 of 2022-23, while its net profit was up 83.6 per cent Y-o-Y in the period

·         However, Nalco’s net sales and net profit are down 11.3 per cent and 24.3 per cent Y-o-Y- respectively, during the trailing 12 months ending December 2023

·         Brokerages expect its earnings momentum to improve in 2024-25 on the back of higher volumes and realisations

·         However, a high valuation indicates a potential downside. Brokerages expect Nalco’s share price to decline by 25 per cent over the next year from Rs 199.9 currently

·         The stock is currently trading at a trailing price-to-earnings ratio of 24.7x and a price-to-book value ratio of 2.7x

OIL INDIA

·         The crude oil and natural gas producer Oil India’s (OIL’s) share price rally has been fuelled by the recent rise in crude oil prices

·         The company’s stock price is up 141.4 per cent in the past year, outperforming the S&P BSE PSU Index and the S&P BSE Sensex

·         The rally was also supported by an improvement in OIL’s revenues and profits in the third quarter (Q3) of 2023-24 (FY24) after they contracted year-on-year (Y-o-Y) in the previous three quarters

·         The company’s net sales were up 3.4 per cent Y-o-Y in Q3FY24, while its net profit was up 2.7 per cent Y-o-Y in the period

·         In contrast, its net sales were down 16 per cent Y-o-Y and net profit was down 34.8 per cent Y-o-Y in the trailing 12 months ending December 2023

·         Brokerages see little upside in the stock over the next 12 months, given its relatively high valuation and a moderation in crude oil prices in recent weeks

·         The stock is currently trading at a trailing price-to-earnings ratio of 9.3x and a price-to-book value ratio of 1.7x

BHARAT ELECTRONICS

·         The defence electronics equipment maker Bharat Electronics (BEL) is among the beneficiaries of the increase in India’s capital expenditure on defence equipment and localisation

·         The company’s stock price is up 140.5 per cent in the past year, outperforming the S&P BSE PSU Index and the S&P BSE Sensex

·         The rally has been driven by investors’ expectations of BEL winning large defence orders and higher margins

·         However, the company’s revenue growth has been muted in recent quarters, with earnings driven by improvement in margins

·         The company’s net sales were up just 3.5 per cent year-on-year (Y-o-Y), and net profit was up 29.5 per cent Y-o-Y during the trailing 12 months ending December 2023

·         Brokerages’ target price suggests a 9 per cent downside in BEL’s stock price from current levels, which analysts attribute to BEL’s rich valuation and subpar revenue growth

·         The stock is currently trading at a trailing price-to-earnings ratio of 53x and a price-to-book value ratio of 12.8x — both of which are high on a historical basis