Additionally, most PSUs have witnessed significant EPS upgrades. Moving forward, sustaining both earnings growth and top-line expansion could fuel further re-rating.

Conducive Environment and Government Backing: The segment enjoys ongoing momentum fuelled by a favourable environment and government support. Enhanced capital expenditure further bolsters their foundation for enduring growth. The era of cyclicality has ceased, paving the way for a robust growth trajectory reminiscent of the early 2000s, fostering an environment conducive to sustained expansion. PSU stocks have surged across the spectrum, partly due to the Government's accelerated capex spending, along with sector-specific catalysts.

Market Share Recovery: Following a prolonged consolidation phase from 2008 to 2020, the PSU sector is now poised for outperformance. Historically, PSUs ceded ground in India's corporate profit pool and market capitalization. Nevertheless, a remarkable resurgence and operational turnaround have occurred, setting the stage for substantial revival. Of utmost significance is the cessation of market share loss, with the sector now actively reclaiming lost ground.

Source: Haitong Research

The Valuation Conundrum

While assessing broader valuations for PSUs might not be entirely appropriate due to the diverse sectors involved, it's worth noting that the PSU index currently reflects elevated valuation metrics. The forward price-to-earnings ratio (PE) stands at 11.2x, and the price-to-book ratio (PB) is at 1.8x, both exceeding the historical average by one standard deviation (+1SD). However, we should not look at index level valuation multiple and they remain cheaper vs Private sector / broader markets.

Valuations for select sectors seem stretched however, PSUs contribution to the Total Corporate Profit Pool and PSU Market Cap as a % of total Market cap is at 2 decades low as shown in the graphs above.

Despite the somewhat high valuations, investors are encouraged to look beyond short-term fluctuations, as the structural nature of the theme suggests long-term sustainability. Market turbulence may occur periodically due to various factors, but the underlying strength of the theme is expected to endure.

What’s the way forward?

I believe a reasonable valuation re-rating in select PSU stocks is stretched or pricing in a lot of positives. And there are still select PSU companies which are still at reasonably average or just above average valuations of their last five years or ten years average. So, for us, it is very important to try and understand where there is a stronger revenue profile, reasonable margin expansions and therefore good earnings growth or earnings upgrades and then look at valuations and to decide which companies to look at within the PSU pack.

PSU funds are expected to continue performing well in medium to long term due to several key factors (though taking a 6-12 month call after a sharp run-up is always a challenge). Firstly, the sector has moved beyond its traditional cyclicality, setting the stage for sustained growth due to visibility around select sectors' revenues/earnings (Railways, Defense, Banks, Power). Valuations across select sectors / industries look stretched (whereas Banks / Oil & Gas sector still seem to be cheaper vs their past high valuations), however, the structural story remains intact reflecting the growth potential of this theme over a medium to long term. Watch out for a detailed note that we will be releasing shortly on PSU Banks and PSUs in the Energy segment – sectors that look attractive.

It would also be prudent to highlight some of the factors that could result in a pullback. Factors such as political instability, divergence from intended capex deployment, profit realization by major shareholders, and the scope for incremental and ongoing earnings upgrades could affect the sector.

The views expressed in this article are for information purpose only and is not a recommendation, offer or solicitation of business or to buy or sell any securities or to adopt any investment strategy. Aditya Birla Sun Life AMC Limited (“ABSLAMC”) /Aditya Birla Sun Life Mutual Fund (“the Fund”) is not guaranteeing/offering/communicating any indicative yield/returns on investments. The sector(s)/stock(s)/issuer(s) mentioned do not constitute any research report/recommendation of the same and the Fund may or may not have any future position in these sector(s)/stock(s)/issuer(s). Views expressed herein should not be construed as investment advice. Recipients of this material should exercise due care and read the scheme information document (including if necessary, obtaining the advice of tax/legal/accounting/financial/other professional(s) prior to taking of any decision, acting or omitting to act. Past performance may or may not be sustained in the future.

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