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Summary: Fund manager at ICICI Prudential Mutual Fund breaks down the reasons behind turnaround in the performance of PSU companies across multiple sectors.
Once synonymous with weak returns and governance concerns, public sector undertakings (PSUs) have undergone a remarkable transformation in recent years. This revival has caught the attention of both mutual funds and retail investors.
Anand Sharma, Fund Manager of ICICI Prudential PSU Equity Fund, attributes the growing interest to three key factors: a fundamental improvement in business cycles across key sectors, historically attractive valuations and a rise in investor confidence driven by better profitability, governance reforms and policy support. As a result, PSUs are no longer viewed as value traps but are increasingly being recognised as long-term wealth creators.
In this interview, Sharma unpacks the key drivers behind the improved performance across various PSU sectors, explains why a sustained re-rating hinges on consistent earnings growth and offers his take on the current valuation landscape of public sector companies.
PSU banks have posted record profits in FY25, a significant milestone. From your perspective, what has fundamentally changed for these banks over the past few years to enable this turnaround?
Public sector banks faced two major challenges about five to six years ago. First, many large PSU banks were undergoing mergers with smaller banks, which presented operational and cultural challenges. Second, they were still grappling with the recognition and resolution of NPAs from the previous credit cycle. The overall economic environment was also not supportive, which further added to their stress. These factors collectively took a toll on their performance.
However, over the last three to four years, the business cycle for PSU banks has shown significant improvement. Challenges related to NPAs and credit costs are largely behind them and consolidation challenges from past mergers have also been resolved. Also, the market perception of tier-2 PSU banks, which was once cautious, has improved due to better operational and financial performance.
Another key factor is the contribution of subsidiaries. Many PSU banks, for example, have strong businesses in areas such as general insurance, life insurance, asset management and housing finance, which are adding significant value. As a result, from a valuation standpoint, PSUs have become favourable, but sustained gains have come from a combination of both improved fundamentals and an upturn in the business cycle.
Beyond banking, we have seen strong performance in PSUs across power, defence and infrastructure. What factors have contributed to the revival of cross-sector PSUs?
The revival is broad-based, and each sector has its own drivers. A decade ago, defence spending rarely featured prominently in the Union Budget. Whenever there were fiscal challenges, this was one area which faced allocation cuts. That's no longer the case. Over the past three to four years, geopolitical tensions have led to a structural increase in global defence expenditure, and India is no exception.
There is a clear policy signal that allocations towards national security need to rise-both in absolute terms and as a share of GDP. Additionally, better working capital management has strengthened listed defence companies, which previously faced delays in payments.
In the Power sector, five years ago, power was considered an ESG-sensitive sector, with little appetite for new thermal capacity. Today, thermal power remains a crucial part of India's energy mix. PSUs, which account for 55-60 per cent of installed capacity, have benefited from rising demand driven by data centres, manufacturing and household consumption.
Moreover, concerns related to discoms — a major drag in the past — have improved and power shortages in tier-2 and tier-3 cities highlight the need for further capacity addition.
In infrastructure, the last three to four years have seen a sharp rise in government-led capex through PSUs, especially in logistics, railways and freight corridors. This trend is expected to persist, as the government remains committed to infrastructure-led growth.
Corporate governance has historically been a concern with PSUs. Have reforms, such as professional management appointments, independent directors and digital initiatives, improved your confidence in these companies?
Yes. Earlier, investors considered PSUs primarily for their predictable dividends. Today, many large PSUs have professional leadership teams, independent boards and stronger governance frameworks. Digital initiatives and better capital allocation practices have further improved efficiency. Whether public or private, capable management is critical and PSUs are making meaningful strides in this area.
Do you believe we are witnessing a structural re-rating of PSU stocks, or is this still a cyclical rally driven by policy support and commodity prices?
It is a mix of both. Over the last three to four years, PSU stocks have benefited from three key factors: A fundamental improvement in business cycles across banking, power, defence and infrastructure, historically low valuations and renewed investor sentiment driven by profitability, governance and policy tailwinds.
That said, it's essential to note that a common controlling authority oversees PSUs. As a result, policy shifts or broader political outcomes – like election outcomes – can have a wide-ranging impact on sentiment across the entire PSU basket. Sustained re-rating will depend on consistent earnings growth and strong fundamentals.
Mutual funds have been increasing their exposure to PSUs. How do you evaluate opportunities across PSU sectors, such as Infrastructure, Capital Goods and Energy?
PSUs span across six to seven sectors, offering a broad investment universe. Our focus is on companies with strong earnings visibility and fundamentals over the next two to three years. We categorise PSUs into two buckets. First, domestic structural plays, such as banks, insurance, power and infrastructure, are largely insulated from global events. Second, global cyclicals, like oil & gas or metals, depend heavily on global commodity trends and geopolitical factors. Balancing between the two categories helps us build a resilient portfolio.
PSUs were once considered 'value traps’. Is that perception now behind us?
For an extended period, PSUs delivered negative or negligible returns, resulting in the 'value trap' label. Investors believed PSUs were good for dividends but not long-term wealth creation. Over the past few years, the changes brought about by the government have aided in improving profitability, enhancing market capitalisation and delivering higher dividends, all of which have helped in creating better value for all the stakeholders. Combined with better capex visibility and profitability, the perception of PSUs as value traps are fading.
After the surge in PSU stock prices, do you think valuations are becoming expensive?
Valuations are not uniform across the PSU universe. Some sub-sectors with a limited investable universe have seen stretched valuations due to concentrated investor interest. However, there are several PSU segments where valuations are still reasonable. It is best to evaluate them sector by sector, rather than as a single basket.
Also read: We see value in Power and Consumer durables: Meenakshi Dawar of Nippon India Mutual Fund
Disclaimer: This content is for information only and should not be considered investment advice or a recommendation.
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