PSUs: After impressive three-year growth, what to expect in 2025?

In 2024, the BSE PSU Index gained 21%, and over the past three years, it delivered an impressive 132% growth. This reflects the strong performance of public sector undertakings (PSUs). According to ACE Equity data, Rail Vikas Nigam was the top performer, surging by an incredible 1,116% over three years. Cochin Shipyard followed with a 765% return, while Garden Reach Shipbuilders & Engineers and Hindustan Aeronautics posted significant gains of 625% and 589%, respectively.

Chennai Petroleum Corporation gained 511%, and Housing & Urban Development Corporation recorded a 503% return. Bharat Dynamics, REC, and Ircon International also showed strong growth, with returns of 475%, 399%, and 376%, respectively. Power Finance Corporation rounded out the list of top performers with a solid 368% increase.

PSU Earnings and Stock Performance: A Mixed Outlook for FY25 and Beyond
Dhimant Kothari, Fund Manager at Invesco Mutual Fund, highlighted that the BSE PSU Index has experienced an extraordinary three-year run, delivering a compound annual growth rate (CAGR) of 45.32% as of March 31, 2024. This performance far outpaced the Nifty 50’s CAGR of 16.35% and even surpassed the BSE 250 Small Cap Index, which grew at a 27.55% CAGR during the same period. 

Robust earnings growth has been the key driver behind this exceptional performance.
Financial PSUs saw net earnings expand at a remarkable CAGR of 45%, fueled by post-COVID credit growth, lower credit costs, and recoveries of non-performing assets. 

Non-financial PSUs also displayed strength, with net earnings growing at a CAGR of 23%, supported by higher government spending, rising commodity prices, and an overall economic recovery. The return on equity (RoE) for PSUs, which ranged from 12-13% during FY18-20, surged to 18% in FY24, reflecting broad-based growth in both earnings and stock prices.

FY25: A Year of Mixed Outcomes
Looking ahead to FY25, the outlook for PSUs is more nuanced. Financial PSUs are expected to sustain healthy earnings growth of 16%, while non-financial PSUs may face a 17% decline, primarily due to challenges faced by oil marketing companies and gas utilities. Government capital expenditure (capex), a critical driver for PSUs, has slowed in the first half of FY25, with only 37.3% of the budgeted capex utilized, largely due to the Lok Sabha and state elections, Kothari explained.

Revival Expected in FY26
Despite these challenges, the outlook for FY26 appears more optimistic. Overall PSU earnings are projected to grow by 11%, rebounding from an expected 4% contraction in FY25. Non-financial PSUs are likely to see earnings growth of 15%, while financial PSUs may post modest growth of 7%. RoE is expected to remain strong at 18% for non-financials and 16% for financials.

Government capex is anticipated to revive in the second half of FY25, supported by buoyant tax collections and controlled fiscal deficits. Sectors closely tied to government spending, such as defense and railways, are projected to grow at mid-teen rates over the next two years. Oil marketing companies, after a weak FY25, are expected to recover due to improved refining margins and stable marketing margins. The power sector, evolving to include diverse energy sources, is also poised for healthy earnings growth.

Sector-Specific Challenges
Kothari added that some sectors are likely to face headwinds. Financial PSUs’ earnings growth is expected to moderate to 7% in FY26 due to slowing credit growth and bottoming-out credit costs. The commodity sector may experience mixed outcomes, with weak energy and petrochemical prices offset by improved steel spreads and a positive outlook for aluminum prices. Gas utilities may face challenges due to changes in domestic gas allocation policies.

Importance of Stock Selection
Given the varied performance across sectors, stock selection will be critical for generating strong portfolio returns. Bottom-up stock picking is expected to gain prominence as PSU earnings growth becomes more company-specific. Funds like the Invesco India PSU Equity Fund emphasize identifying fundamentally sound PSUs with dominant market positions and superior growth potential, aiming to outperform benchmarks over the long term.