PSU index has outperformed benchmarks only thrice since 2009, stay cautious

The BSE PSU index underperformed the broader markets in 2018, losing 21 per cent, as against the Nifty and the Sensex that were up between 3 per cent and 6 per cent. In fact, over the last 10 years, the index has beaten the broader benchmarks only thrice.
 
The last time the sector did better than the benchmark indices was in 2016, led by oil PSUs, select banks and power sector plays. Since then, the sector has stagnated and is available at the same levels.
 
The reason for the underperformance has been the flip-flop in government policies. While a number of these businesses have good potential, inconsistent government policies hurt investor confidence.
 
Analysts at CLSA cite the rising fiscal deficit, cross-holdings and PSUs being called to do national duties as key reasons for the derating.
 
A case in point is the oil marketing companies that were asked to share the subsidy burden. This is why institutional investors usually stay away from these counters. A domestic money manager says: “Long-term institutional companies are sceptical as they typically buy larger chunks. When the government does a flip-flop on policy and the stock falls sharply, they are in a fix as they cannot exit overnight from their positions. They would rather avoid being in such a situation.”

 
This, however, opens up opportunities for investors as prices across the PSU spectrum have corrected quite a bit and valuations are at multi-year lows. Pankaj Murarka, founder, Renaissance Investment Managers, believes that there is deep value in the PSU pack. “Valuations move from extreme pessimism to extreme exuberance and currently, PSUs are at the extreme pessimism part of the valuation spectrum with consumption stocks are at the other end,” he says.
 
Echoing Murarka, analysts at CLSA argue that India is the only emerging market trading above its historical average, but its state-owned enterprises are trading at close to all-time lows at a forward price to earnings ratio of 8.8 times.
 
The other reason investors seek out PSUs is the attractive dividend yields. Analysts at Axis Capital believe that there is a high probability of the government pushing the cash-rich PSUs to pay higher dividends or buy back shares using their cash reserves, so as to help meet its budget deficit. NHPC, Oil India, BHEL, Nalco, Cochin Shipyard and ONGC, among others, have already announced a buyback while Coal India and RITES have announced interim dividends. Dividend yields in the case of Coal India and NMDC were 4-6 per cent in FY18.
 

While brokerages are bullish on oil PSUs largely due to lower valuations, ONGC is a preferred bet given valuations at under four times FY20 earnings estimates and more gains if the company continues to be exempted from sharing the subsidy burden. Strong dividend yield, attractive valuations of nine times the FY20 earnings estimates and improving prospects/profit growth are positive for Coal India and NTPC.
 
On the financials side, there has been a gradual improvement in bad loans and asset quality. Capital infusion, favourable bond market conditions and expectation of credit growth bode well for state-run banks. Brokerages believe that larger public sector banks such as SBI are well positioned to capitalise on the growth opportunity and move away from the underperformance cycle that has been hurting the banks in the last three years.
 
Even while analysts suggest that investors look at beaten-down companies in the PSU space, which are dominant in the sector, with strong earnings growth and high return ratios, they suggest a cautious and selective approach. Analysts believe there is always the risk of underperformance in these stocks. The track record over the last decade has not been very good and investors have to be cautious, says Murarka.