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A deeper probe into the PSU space have led us to a remarkable revelation. Oil & Gas stocks have consistently traded lower vis-à-vis their PSU counterparts despite a robust rally soaring on significant positives like higher dividends and stronger cash flows. Since Oil & Gas players exude discernible stability led by an ascendent profitability and reduced government intervention, they are low on risk and high on reward, and hence ripe candidates to achieve a higher multiple.

As the z score method unfolds an upside in valuation multiples, we have upgraded key stocks as follows: Oil India, GAIL, GSPL {ADD to BUY}; ONGC {NEUTRAL to BUY}; Petronet LNG {SELL to NEUTRAL} The only downgrade is MAHGL {ADD to NEUTRAL} following a sharp stock price rally.

Our top picks are BPCL, Oil India, HPCL, CPCL and ONGC.

Indian PSU stocks rally big in last 3-6 months

The strong rally across PSU stocks is the outcome of re-rating, given significant increase in government capex. Prime Minister Narendra Modi's pro-PSU endorsement has also helped in good measure.

Following a deeper probe, we observe that in the last decade, Oil & Gas is the only sector still close to +1std trading valuations which reveals vast potential for massive value creation. For the study, we considered top thirty-five PSUs across sectors - large market capitalization sectors like Electric/Power Utilities, Capital Goods, Railways, Metals and Mining, Banks, Transportation and Construction and engineering. All are trading above or at +2std which shows a re-rating already at play. However, the commensurate effect on Oil & Gas sector is yet to be reflected.

Oil & Gas PSUs: lucrative ventures with minimal government intervention

The rally in Indian Oil & Gas PSU is based on many favourable factors that have gotten even better: 1) Oil price in a range of ~USD74-84/bbl despite disruptions and OPEC+ cuts 2) No govt intervention on any policy impacting the sector at large, no fuel retail price cut announcements; 3) Higher global petroleum product demand given the shortage, which keeps cracks on the higher side, accentuated by the red sea impact; 4) Government focus on expansion and energy transition will help elevated capex Oil & Gas PSUs clock higher profitability and stronger cashflows; 5) Peak cycle profitability will likely expand multiples.

Notwithstanding the positives, a few risks remain: increase in crude prices, further narrowing of crude discounts (which now stands ~USD2/bbl), higher windfall taxes, a decrease in capping, falling product cracks and marketing margins, delay in execution of investment in expansions, and inefficient capital allocation.

Higher multiple to Indian O&G PSUs: Our rationale

We build our valuation base on a data-driven analysis of 35 PSUs across various industries, focused on the Oil & Gas sector as to its standing amongst the pack. We blend traditional valuation metrics (1-year Bloomberg consensus forward multiple) with standardized z-scores to identify potentially undervalued PSUs. Additionally, we include factors like higher government shareholding risk, return ratios, and earnings growth for a more holistic view. Our analysis reveals an impending buoyant trend: among the top ten-ranked PSUs based on our weighted average z-score methodology, six belong to the Oil & Gas sector within a consideration thirty-five. It's important to acknowledge that our approach prioritizes valuation metrics and financial performance, excluding assessments of potential liquidity and idiosyncratic concerns. This seamless alignment with the ongoing strong sectoral performance hints at the substantial potential upside that investments in these stocks are likely to fetch.

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