Public sector enterprises stage a comeback in 2022 thanks to PSU banks – the future looks healthy, say analysts

• PSUs have staged a comeback in 2022 after a decade of underwhelming performance, powered by PSU banks.
• The PSU bank index is up over 61% in 2022 so far, making it the best sectoral index this year.
• However, analysts suggest there’s more juice left going forward, and the BFSI sector is expected to drive the bottomline of PSUs.

After a decade of underwhelming performance, public sector undertakings (PSUs) have staged a comeback in 2022, thanks largely to a robust recovery in banks – which had seen muted earnings due to the non-performing asset (NPA) crisis and a subsequent clean up.

For context, the Nifty50 index has gained 205% in the last 10 years, while the Nifty PSE index has gained only 49%.

However, the year 2022 has proved to be a boon for PSUs with PSU banks reporting an accelerated improvement in their bad loan ratios, while credit growth touched 20% in Q2 FY23, up from 3% in Q1 FY22.

“A large part of the FY12-22 decade was spent in cleaning up the balance sheets of Financials (sector), which took its toll on the overall PSU profits as PSU banks formed one-third of the profit pool of Indian PSUs. This, coupled with several other macro disruptions, kept the PSU profit pool suppressed over FY12-20,” said a report by Motilal Oswal.

According to the brokerage, most of the PSU companies are in sectors that are heavily cyclical in nature – these include oil & gas, metals, and financial services. However, given the dominance of financial services companies, or banks, the overall performance of PSUs mirrored the peaks and troughs of the banking sector.

PSU banks help boost PSU performance

The positive improvements in PSU banks’ performance have also had an impact on the Nifty PSE (public sector enterprise) index, helping it beat the benchmark Nifty50 index handily in 2022 so far – while the Nifty PSE index has gained 10.7% in 2022 till date, the Nifty50 index has lagged far behind with returns of just 2.5%.

Interestingly, both the indices were close to their 52-week lows in June when the markets crashed.

A big boost to the PSU index has come from PSU banks – the 13-stock Nifty PSU Bank index has gained over 61% in 2022 so far, making it the best sectoral index on the NSE this year.

Notably, all the 13 stocks in the PSU Bank index have gained this year, with six of them posting gains of 60% or more in this period.

PSU banks’ valuations still ‘reasonable’ – more juice left

Despite the strong rally in stocks of PSU banks, a report by ICICI Direct states that the valuations of PSU banks are still “reasonable”, suggesting that there’s more juice left going forward.

“Post the phase of significantly higher gross non-performing assets (GNPA), treasury mark-to-market (MTM) losses, lower capital and sub-par growth, there has been a turnaround with comfort on asset quality; reversal of treasury losses, credit growth pick-up and just adequate capital position for most of them. Despite the decent rally, valuation still looks reasonable for PSU banks,” said the ICICI Direct report.

For context, PSU banks’ price-to-earnings ratio (PE) currently stands at 9.9, while for the overall Nifty Bank index it is 17.4 and for the broader Nifty50, it is 21.4. The Nifty PSE index has a PE ratio of 7.9.

According to Motilal Oswal, the BFSI (banking, financial sector and insurance) sector will once again lead PSU growth – the brokerage estimates that it will contribute to 118% of the incremental profits of the PSU universe.

Healthy growth outlook for PSUs, says Motilal Oswal

Analysts at Motilal Oswal expect a healthy outlook for the public sector companies in the next two financial years. “We estimate an FY22-24 PAT (profit after tax) CAGR (compounded annual growth rate) of 8% for the PSU stocks having consensus estimates,” said a report by Motilal Oswal.

Majority of the earnings growth contribution comes from BFSI, capital goods and utilities, while conversely metals and oil & gas are likely to drag down the momentum.

“BFSI will lead the earnings CAGR with 28%, followed by Capital Goods (+11%), and Utilities (+9%). On the other hand, Metals (-31%), and O&G (-5%) would report an earnings decline over FY22-24E,” said the report.

This also aligns with the analysis of ICICI Securities, which said in a previous report that cyclical, capital-intensive and value stocks have outperformed since FY21. These stocks reversed the trend observed between FY12 to FY20, when stocks which were either expensive or less volatile had outperformed others in the market.

“The above trend is the longest period of outperformance seen from the aforementioned factors since the peak of the investment and credit cycle in India in 2011-12,” said the ICICI Securities report.

The report further added that this is not a false beta rally since the cyclical, capital-intensive and value stocks have continued to outperform despite the aggressive quantitative tightening cycle and interest rate hikes by the US Fed.

Thus, with banks having got their act together and looking set to power through another year of growth and analysts expecting strong momentum in key sectors like capital goods and utilities, the PSU sector looks set for another year of outperformance in 2023.

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