Duggad further says that despite a significant rally in PSU market capitalization, the PSU index’s PE ratio remains elevated at 14-15, exceeding its historical average. Defence stocks are trading at high PE ratios of 40-50, limiting further rerating potential. PSU banks and select commodity stocks are the only areas within the PSU sector offering reasonable valuations.
In your note, you have written that you expect corporate earnings to outpace the GDP growth going ahead. What is driving this confidence overall because in the recent Q4 earnings, we have had mixed commentary across sectors, where individual stocks have been doing well within a particular sector, but not necessarily the entire sector. This can be seen across autos as well as FMCG. What is the outlook going ahead and what is driving your confidence?
Gautam Duggad: I beg to differ. Q4 was a very strong quarter. The spread, the quality, the number of beats that we have seen in this quarter we have not seen in any quarter of FY25. This is the best quarter of FY25. We have exited a very good momentum. Compared to an expectation of 2%, we got 10% growth. Out of 22 sectors for which we forecast earnings, 19 delivered numbers which are better or ahead of expectations.
Out of 300 companies that we forecast earnings for, 220, that is roughly 75% of the coverage universe, have delivered numbers either in line or ahead of expectations. This is a far better number because this number usually is between 60% and 65%. So whichever way you slice and dice the earnings, the fourth quarter was one of the best quarters that we have had both from an absolute earnings point of view as well as the spread and quality and internals of that corporate performance.
In fact, if you dig slightly deeper, out of the 10% earnings growth, midcaps earnings have grown at 19% in our coverage universe and we cover 100 midcaps. Around 85 to 90 largecaps posted 10% earnings growth. And smallcap earnings were flat, except financials. So, the fourth quarter earnings have set the pace now. We are entering FY26 with a good momentum.
There is a lot of support from the macros coming in. RBI delivering 100 basis point rate cut, government cutting income tax rate, inflation trending close to 3%, that leaves more room for RBI in second quarter of FY26 to cut another 25-50 basis points. Liquidity conditions are improving. GST data is strong. Your E-Way bill numbers are strong. So, 12% to 15% earnings growth is not a very far-fetched expectation to have. Yes, the sectoral mix within that 12-15% expectation that we have might change along the way. Some other sectors will contribute versus what we are thinking right now.
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But broadly, I would also expect the capex cycle to revive. The large part of FY25 is spent on the slowdown in capex. But look at the March numbers. The government spent Rs 2.4 lakh crore. For context, this number was the total annual spend in FY25 which we now spend in one month. April also began on a strong note. We spent 1.6 lakh crore in capex. So, between March and April, we spent close to Rs 4 lakh crore. Slowly, capex spending will also come back in. It might grow at 10-11% or maybe slightly higher because the government has budgeted about 10% growth for FY26 at about Rs 11.5 lakh crore; we closed at Rs 10.5 lakh crore last year versus budgeted estimate of Rs 10.2 lakh crore. Nobody would have thought that the government will exceed the capex spend for FY25 if you had asked them in February or even the first week of March. So, March came like that big slog over where the government completely achieved the target and exceeded by 2-3%. So, those are some of the contributing factors for earnings in my view. The only place where we have our reservations is on global commodities because they are completely difficult to forecast. The underlying mark to market on the commodity prices basis the moment that we are seeing in commodities that takes a huge toll on Nifty earnings because commodities contribute 20% of the profit pool. If you look at the number ex of commodities, even FY25 Nifty earnings growth is about 10%, and that is giving us the confidence that given the many parameters which are in play at both macro and micro level on consumption, capex, financials, the 12-15% earnings growth that we are projecting for FY25 to FY27 is in the realm of achievement.
We all must agree to the fact that post COVID, we have seen reratings for many of these PSUs. Yes, government spending did play a critical role, but better execution was also something that helped fuel the stock prices. The government spending is still quite robust, but the PSU stocks are not doing that well. Do you believe in the next earning cycle select PSUs should participate once again and if yes, then which are the pockets?
Gautam Duggad: When you look at PSUs, there are the cohorts – multiple subsegments within that. There is banking, utility, commodity and defence. If you look at defence, on July 24, the peak defence market cap was close to Rs 11 lakh crore. From there to February 25, the market cap came down to Rs 7 lakh crore, almost a 35% decline. Now between February to June that is a four-month period, the market cap has crossed the previous high of Rs 11 lakh crore.
Now, it is almost trending towards Rs 11.5-12 lakh crore. So, there has been a 70% increase in market cap in four months for defence PSUs. A large part of the defence market cap is contributed by PSUs. In the same breath, railways have had a phenomenal rally from 2021 to 2024. The combined market cap of a railway plus defence used to be Rs 2 lakh crore in July ‘21. It went to Rs 18 lakh crore in July ‘24. From there, both the sectors had corrected.
Within that, defence has rallied and crossed its earlier peak but the Railways is still to cross it. PSU banks have been flatlining for almost a year now. So, where are we positive? We are positive on select PSU banks, which is why I am still overweight on PSUs in our model portfolio in financials, even though our bigger overweight stems from non-lending financials and capital market plays where we are far more bullish. Then, selectively in commodities, we like Coal India, Power Grid. One cannot have a basket approach because of the underlying undervaluation of PSUs prevailing in 2020. A large part of that got corrected between 2020 and 2024.
A year-and-a-half back, we had detailed in the PSU strategy note where we said that despite the big rally in the market cap for PSU companies, the PSU index was still trading at 14-15 PE while its average used to be eight-nine times. I do not think the PE has more room for rerating, even in defence stocks now because now even defence stocks are trading at 40-50 PE. The only place where valuations are reasonable in PSU space today is PSU bank and some commodity stocks.
