Should you stick to PSU stocks or exit after multibagger returns? Kotak Equities recommends this

The broad-based rally in PSU stocks is largely driven by top-down bullish sentiment for PSUs in general, Kotak said, adding that bullish short-term profitability and volume assumptions were driving the PSU counters. To add to the madness are incorrect valuation methodologies and unrealistic narratives in several sectors related to government agenda, policies and regulations, the domestic brokerage noted.

It said that the broad-based rally in PSU stocks across sectors is in itself a problem considering that this has happened without any meaningful change in the fundamentals or structural reforms in most sectors and the massive outperformance of PSUs versus private sector peers in the same sectors highlights the inherent flaw with the rally in PSU stocks.

"Government ownership seems to be the only common factor for the performance of PSU stocks, with disparate sector- and company-specific fundamentals," the note said.

Citing examples of defence stocks under its coverage viz. , , , , Hindustan Aeronautics (HAL) and whose 1-year returns range between 166% and 91%, Kotak said that their current valuations suggest a massive upturn in ordering and execution for defence companies.

"...these companies will need to execute around Rs 1.9 trillion of defence orders annually to justify their current , assuming they maintain their current margin profiles. For context, these companies had combined revenues of Rs 612 billion in FY2023 versus Rs 1.5 trillion of government capex in defence," the note said.

Multibagger has delivered 104% return in the past year, driven by strong rerating in its multiples and the market likes the counter owing to cheap valuations and likely strong increase in volume growth over the next few years.

It also highlighted how PSU stocks with low free floats generated 68-410% returns over the past 12 months. The note further said that government-owned , which historically has had a "dubious track record" on project completion is currently trading at a large premium to its historical valuations.

Agencies

Key takeaways:

-- In its view, investors should look to exit rather than get carried away.

-- Most non-financial stocks in the electric utilities, metals & mining and oil, gas & consumable fuels sectors are trading at very expensive valuations based on their premium to private sector peers.

-- Rally is despite weaker fundamentals (metals & mining) or their weak business models in certain goods and electric utilities stocks and all oil, gas & consumable fuels stocks in the context of mediocre FCF-to-PAT ratios, low or negative terminal value and growing risks of existential irrelevance.

-- Government may have to review strategy as its benign policies and regulations may benefit PSUs in the short term, but ironically prevent them from addressing the large disruption threats to their business models in the medium term.

The government’s current policies may advertently (electric utilities) or inadvertently (oil, gas and consumable fuels) boost the earnings and cash flows of PSUs. However, continued large reinvestment of cash flows by PSUs into their extant businesses (mostly sunset industries) may constrain their ability to invest in more future-proof businesses—key to their longer-term viability.

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(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)