REC, PFC, IRFC zoom over 200% in FY24. Time to exit PSU stocks?

Hope of higher capital expenditure ahead of state and general elections has proved to be a boon for stocks of public sector enterprises (PSEs) thus far in fiscal 2023-24 (FY24). The S&P BSE PSU index has surged nearly 51 per cent during this period, shows ACE Equity data, as compared to 17 per cent rise in the S&P BSE Sensex.

A large number of these PSU stocks, suggests G Chokkalingam, managing director for research at Equinomics Research, are from the small-cap segment that has seen a good run in the last few months. The rally, he said, has made valuations expensive in a lot of cases and investors, he suggests, should be mindful of this and book partial profit.

“Industry dynamics, too, have been playing out in some cases, such as oil where crude prices have been volatile and have, in turn, boosted the stocks. Though one cannot paint the entire PSU sector with the same brush, it is advisable to book profits where the stock prices have run up sharply. The next leg up for PSU stocks can come in case the government decides to do a strategic sale in select cases,” Chokkalingam said.

At the bourses, meanwhile, stocks of REC, ITI, Power Finance Corporation, Mazagon Dock Shipbuilders and Indian Railway Finance Corporation (IRFC) have zoomed up to 255 per cent thus far in FY24.

A K Prabhakar, head of research at IDBI Capital, too remains selective and suggests investors exit power sector stocks such as REC and PFC where the run up has been sharp and the valuations are expensive.

“Railway stocks should be avoided. PSU banks are a good bet and can be bought on a dip. Defence sector stocks can be held on to. Investors can also avoid oil & gas PSUs. Among the lot, I remain bullish on NMDC, NTPC, Cochin Shipyard and Hindustan Aeronautics (HAL),” he said.

Capital expenditure

The government had budgeted for a large 36 per cent YoY capital expenditure growth in FY24E. The year-to-date (YTD) expenditure growth has been strong at +34 per cent YoY, suggests a Jefferies note, with road and railway capex rising 32 per cent YoY.

Central government fiscal data for April – October 2023 shows tax collections growth 4 percentage points (ppt) ahead of budgeted at 14 per cent YoY to Rs 18.3 trillion. Strong direct tax performance (+24 per cent YTD) has been the revenue driver as corporate earnings and salary growth have stayed well in double digits, analysts said.

Assuming sustained tax revenue momentum, the government, according to a recent Jefferies note, has an extra 20-25 basis points (bps) - around Rs 0.6-0.8 trillion of spending headroom during the remainder of the fiscal.

“With the national elections nearing, a push for completing infrastructure projects is likely which should help to drive the spending growth for remainder of the year. The higher expenditure should get funded from the higher tax revenues,” wrote Mahesh Nandurkar, managing director (MD) at Jefferies, in a co-authored note with Abhinav Sinha and Nishant Poddar.

For the long term

Despite the short-term valuation related concerns, analysts remain bullish on the road ahead for the PSU stocks, and suggest if their earnings continue to improve over the next few years, some of them can even become multi-baggers.

The performance of public sector companies, according to Jitendra Arora, senior executive vice-president and fund manager for equity at ICICI Prudential Life Insurance, has also improved along with the private sector over the last few years, resulting in the rerating of many PSU stocks in the last 12-24 months.

“As these companies continue to deliver and improve their earnings potential, they will continue to compound. Also, with the indigenisation of certain sectors, such as defense, investing in PSU companies is the only way to participate in the long-term growth story,” he suggests.