Kotak Institutional Equities is finding it difficult to subscribe to the new market narrative surrounding PSUs, which have contributed to the recent rally in these stocks.
It believes that assumptions surrounding the medium-to-long-term growth and profitability of capital goods, electric utilities, financials and oil, gas & consumable fuels is "highly optimistic."
After a stellar 80% rally in 2023, the PSE index is already up 20% in the first 40 days of the new year.
"We agree with the brighter prospects of the companies, but believe that the market is underestimating the downside risks in assuming large order inflows for an extended timeframe, and perpetually elevated margin / return profile," the Kotak note said.
"In our view, government's three-in-one role of buyer, owner and policy-maker creates uncertainties regarding the companies' future earnings and returns," the brokerage note further said.
Kotak cited the example of NTPC, whose current valuation of nearly 2 times price to book value is meaningfully higher than the logical 1.25 times to 1.5 times. It believes that the street is ignoring its likely lower return profile in the long term, given the eventual transition to solar electricity, which will also consume Operating Cash Flow of the extant coal-based plants.
The street is also overestimating the growth opportunity in Power Grid compared to its own growth targets and underestimating the risks to the company's Return on Equity (RoE) profile from competitive TBCB projects, according to Kotak Institutional Equities.
"We are puzzled by the market's confidence in the same, given the large volatility in marketing margins in the recent past and high sensitivity of Earnings per Share (EPS) to the same," the note said.
Kotak Institutional Equities has exited from its positions in Power Grid, which was at 190 basis points. It has added Pidilite instead to the model portfolio with a 150 basis points weightage and the remaining 40 basis points are allocated to SBI Life.
