'Quite bizarre': What Kotak says on Cochin Shipyard, BHEL & other PSU shares, valuations

Kotak Institutional Equities in its latest strategy note said the strong rally in select PSU counters such as Bharat Heavy Electricals Ltd (BHEL), Cochin Shipyard Ltd, Bharat Dynamics Ltd, and among private two-wheeler makers, is making no sense. It finds disconnect between narratives and numbers. While the brokearge does not dispute themes such as electrification and higher spending on defense, it struggles with the egregious market caps of the ‘beneficiary’ companies.

"We find the valuations of many PSU stocks to be quite bizarre, when compared with their fundamentals. Most of these companies trade at very high P/E, P/B or EV/assets, and many have not seen any meaningful improvement in their fundamentals; some make losses. Some of these companies will require extraordinary assumptions and a massive turnaround in their operations (and financials) to justify their current market caps," it said.

In the case of BHEL, the PSU has added Rs 77,800 crore addition to its market cap (m-cap) in the past year. This compares with a hypothetical profit pool of Rs 32,000-64,000 crore for the entire thermal BTG equipment industry, assuming 80GW of new thermal capacity addition, in line with India’s FY2032 target, Rs 8000 crore per GW and 5-10 per cent net profit margin.

"The entire sector’s and BHEL’s profit opportunity would be even lower on an NPV basis or if profit margins were to be lower. BHEL’s current market cap implies that the company will need to execute 25 GW of annual thermal ordering in perpetuity, which is clearly absurd," Kotak said.

Similarly, in the case of Cochin Shipyard, the stock added Rs 67,300 crore to its market cap in the past one year and Rs 51,700 crore in the past three months against hypothetical profit pool of Rs 5,000-9,000 crore, assuming Rs 40,000-50,000 crore cost of a new aircraft carrier and 12-18 per cent net profit margin.

"Cochin Shipyard's value accretion would be even lower on an NPV basis; an aircraft carrier will take years to build and deliver. CSL may not be able to participate in other opportunities. Our reverse valuation exercise implies that the company will deliver 9-13 aircraft carriers. For context, the US currently has 11 aircraft carriers and China has three," Kotak said.

Kotak also appear unhappy with valuations of two-wheeler stocks.

"2W stocks have seen a sharp increase in stock prices, resulting in Rs1.4 lakh crore of market cap addition in the past 12 months. Our reverse valuation exercises, baking in the current elevated profitability, suggest that India’s 2W market will need to significantly expand beyond the probable terminal penetration levels, to justify the combined market cap of these stocks. Indian 2W market has not yet recovered to FY2019 levels. The extant elevated profitability and high return ratios of incumbents are unlikely to sustain for long," it said.