PSU Stocks Retreat: What should investors do?

Public sector undertakings (PSUs) have long been a significant force in India’s equity markets, and recent years have seen a resurgence of investor interest in these companies. After delivering stellar returns in recent years, many PSU stocks are currently facing a sharp correction. The question on every investor’s mind is: what led to this downturn, and what should they do next? Let’s explore the factors driving this correction and how investors can manage their portfolios amidst this cyclical volatility.

What Happened to PSU Stocks?

PSU stocks enjoyed a remarkable rally in recent years, driven by a variety of factors, including government reforms, high dividend payouts, and an overall improvement in operational efficiency. In particular, PSU banks and defence stocks stood out as top performers, delivering triple-digit returns in some cases.

1. The PSU Boom:
   • Between March 2022 and June 2024, the number of PSU stocks in the top 200 surged from 26 to 41, and PSU market share rose from 9% in December 2021 to 16% in mid-2024.
   • The BSE PSU index delivered a massive 234.3% return over the past five years and 81.1% in the past year, reflecting the strong momentum that characterized this space.

However, the momentum that once propelled PSU stocks higher appears to have reversed. In recent months, PSU stocks have undergone a significant correction. The BSE PSU index declined by 1.7% in the last two months, raising concerns about the sustainability of the earlier rally.

Key Factors Behind the Correction

1. Earnings Disappointment: One of the primary reasons for the PSU stock correction is the underperformance in earnings. Investors initially expected strong financial results from key sectors like banking, capital goods, and metals. However, recent earnings reports fell short of expectations, prompting a reassessment of valuations. This significant decline in earnings contribution from PSUs has raised concerns about their fundamental strength, leading to a natural correction in their stock prices.
2. High Valuations and Profit Booking: Following their rally, PSU stocks reached valuations that made them less attractive to new buyers. Investors who had seen substantial gains opted to book profits, further adding to the downward pressure. For instance, Cochin Shipyard saw a 30% drop from its peak despite its PE ratio still hovering at 56x, while Mazagon Dock trades at a PE of 40x after a 22% correction.

With stocks becoming overvalued, especially in sectors like defence and banking, institutional investors began reducing their positions. This profit-taking phase was a key driver behind the recent market correction.

3. Institutional Selling: Both domestic and foreign institutional investors (FIIs) played a role in the PSU correction. Domestic institutions have significantly reduced their holdings in PSU stocks—from 17% in March 2022 to just over 13% by June 2024—despite strong inflows into domestic funds. FIIs, while reducing their positions more modestly, showed a preference for smaller PSU stocks and largely exited frontline companies, further contributing to the stock weakness.
4. Political and Economic Factors: The outcome of the general elections also played a role, particularly in the performance of PSU banks. Investor concerns about increased social spending impacting banks have driven down sentiment in the PSU banking space. With no clear majority for the ruling party, market participants feared that PSU banks might bear the financial burden of government expenditures, further eroding investor confidence.

What Should Investors Do?

The PSU stock correction has left many investors questioning the next steps. While PSU stocks have lost momentum in the short term, this doesn’t necessarily signal the end of their potential as a part of a diversified portfolio.

1. Focus on Fundamentals: Investors should shift their focus toward PSUs with strong earnings growth and solid fundamentals. Not all PSUs are created equal, and those with robust balance sheets and capital expenditure plans are likely to recover in the long term. For instance, railways and defence sectors, with their strong order books, may still offer attractive investment opportunities.
2. Avoid Speculative Buying: The rally in PSU stocks over the past year was driven by narratives of government support and reform. However, as these stories begin to fade, the fundamentals of individual companies will take precedence. Investors should avoid speculative buying and focus on companies where valuations are aligned with their earnings potential.
3. Cyclical Sector Allocation: One of the lessons from this correction is that sector-based cyclical allocations can be risky. While PSUs were top performers last year, the current market correction has shown that sector-specific rallies can quickly lose steam. Investors should be wary of over-concentration in any one sector, especially when valuations run ahead of fundamentals.

Risks of Cyclical Sector Allocation

Cyclical sectors, like PSUs, are subject to large swings based on economic conditions and market sentiment. While they can offer substantial returns during bullish periods, they are also prone to sharp corrections when the tide turns.

Key Risks	Description
Overvaluation	Stocks may become overvalued during market rallies, making them vulnerable.
Profit Booking	Investors often exit positions quickly, leading to sudden downturns.
Institutional Exit	Institutional investors may reduce holdings, amplifying market corrections.
Earnings Underperformance	Companies may fail to meet heightened expectations, driving sharp sell-offs.
Sector-Specific Risks	External factors like government policy changes can disproportionately impact cyclical sectors.

Conclusion

PSU stocks have been on a wild ride over the past few years, delivering substantial returns but now facing a notable correction. The rally in these stocks was driven by narratives of reform, high dividend payouts, and strong government backing, but this momentum appears to have faded. Investors should now prioritize fundamentals over speculation and avoid cyclical sector overconcentration.

While the short-term outlook for many PSU stocks may seem bleak, long-term opportunities remain, especially in sectors with solid growth prospects like railways and defence. Investors should stay cautious, diversify their portfolios, and focus on companies with strong earnings potential to navigate the current market environment successfully.

Market this week

	02nd Sep 2024 (Open)	06th Sep 2024 (Close)	%Change
Nifty 50	₹ 25,334	₹ 24,852	-1.90%
Sensex	₹ 82,725	₹ 81,184	-1.86%

• The Indian stock market experienced a continuous decline, attributed to uncertainty ahead of the US Federal Reserve meeting and overbought conditions on Dalal Street.
• A bounce back in US dollar rates, spurred by a revision in the US inflation average, added to market pressures.
• Weak US job data and flat jobless claim numbers also contributed to the negative sentiment, affecting the Indian market for three consecutive sessions.
• Investor sentiment weakened further ahead of the US jobs report, which is expected to provide guidance on the potential scale of a US interest rate cut.
• Many investors chose to stay on the sidelines, holding cash while awaiting the outcome of the US jobs data and its implications for monetary policy.

Weekly Leaderboard

NSE Top Gainers			NSE Top Losers
Stock		Change (%)	Stock		Change (%)
HeroMoto Corp	▲	5.29 %	Coal India	▼	(6.93) %
Asian Paints Ltd	▲	4.70 %	ONGC	▼	(6.64) %
Bajaj Finserv	▲	4.16 %	TATA Motors	▼	(5.58) %
Titan Company	▲	3.66 %	Dr Reddy’s	▼	(5.18) %
SBI Life Insurance	▲	2.49 %	NTPC	▼	(5.14) %

Stocks that made the news this week:

• Gains in pharmaceutical and healthcare stocks, including Glenmark Lifesciences and Suven Pharma, helped cushion broader market losses on September 6 as investors turned to the defensive sector amid heightened volatility. The Nifty Pharma Index has surged 36% year-to-date in 2024, outpacing the Nifty 50’s 14% gain. Known for its defensive nature, the pharma sector is drawing increased investor interest as a diversification option, further fueling its strong performance

• Shares of oil marketing companies (OMCs) – Indian Oil Corp, Hindustan Petroleum Corp, and Bharat Petroleum Corp – dropped over 2% on September 6, hitting intraday lows following reports that the government may consider reducing fuel prices in response to the recent decline in global crude oil prices.

• Premier Energies continued its impressive run on September 6, surging over 18% to a new high of ₹1,188, following a 120% jump in its market debut on September 3. The stock has gained over 30% in just two days, buoyed by a ₹215-crore order for the supply, installation, and commissioning of 8,085 solar water pumping systems in Uttar Pradesh, with execution slated by March 2025.