Mutual funds cut stakes in frothy PSUs as large undervaluation vanishes

The largest sell-off was seen in SJVN, where holdings were cut by over 53%, followed by Ircon International and NMDC Steel, with reductions of around 47% and 30% respectively.

Mutual funds thronged the markets in February to pull out more than Rs 3,500 crore from stocks of state-run companies as concerns over inflated valuations and lack of earnings support to sustain a rally in certain counters.

The selloff spree left the BSE PSU index down 7 percent from its 52-week high reached in on March 6. But the index performance camouflages the price damage seen in some of the counters see as “frothy and speculative”. The stocks that saw biggest losses from the 52-week high are NBCC India, Mishra Dhatu Nigam, RCFL, MMTC, KIOCL, SJVN and RVNL. Some of these losses were triggered by fund dumping their holdings in the market.

The fund houses sold shares across 56 PSUs. Based on average price of these shares in the month of February, the estimated value of the selling amounted to Rs 3,524 crore. The total value of PSU stakes held by mutual funds, however, increased from Rs 3.95 lakh crore to Rs 4.2 lakh crore.

SJVN recorded the biggest divestment by mutual funds at more than 53 percent, followed by Ircon International and NMDC Steel around 47 percent and 30 percent. At the end of February, the fund houses held 6.25 crore SJVN shares valued at Rs 757 crore, down from 13.45 crore shares worth Rs 1,772 crore in end-January. The selloff triggered an almost 30 percent slump in the SJVN share price from its February peak.

In case of Ircon International, around 40 lakh shares were offloaded in February, driving the mutual fund holdings down to 45 lakh shares valued at Rs 103 crore, compared to 85 lakh shares worth Rs 201 crore a month back. Ircon shares traded 25 percent down after the selloff.

In the case of NMDC Steel, around 2.52 crore shares were sold, leaving mutual fund holding to around 5.92 crore shares valued at Rs 363 crore as against Rs 588 crore by end of January. Shares of NMDC Steel too recorded a 25 plunge in February.

Fund houses also sold 27.21 lakh shares in RITES to trim their holdings to around 81.16 lakh shares valued at Rs 634 crore, from 1.08 crore shares valued at Rs 805 crore. Engineers India and NMDC saw around 99.65 lakh and 5.45 crore shares being sold driving down their stake to around 3.42 crore shares of Engineers India and 19.33 crore shares of NMDC from 4.42 crore and 24.78 crore in the previous month. Punjab National Bank saw around 10.67 crore being disposed of, leaving the funds with around 38.6 crore shares, versus 49.28 crore shares a month previous.

IRFC, NHPC, BHEL and Canara Bank saw mutual funds lowering their exposure between 10 percent and 18 percent. Others such as SAIL, Life Insurance Corporation, Mangalore Refinery and Petrochemicals, General Insurance Corporation, Bank of Maharashtra and Hindustan Construction Company recorded 5-10 percent divestment by the funds.

RITES shares traded down 21 percent, Engineers India 28 percent, NMDC 20 percent, PNB 10 percent, IRFC 27 percent, NHPC 26 percent, and BHEL 18 percent after the selloff spree.

The BSE PSU Index rallied 80 percent between January 1, 2023 till March 15, 2024 driven by strong growth in earnings and a re-rating of stocks. After the stupendous rise, the market has been deeply divided on PSU stocks with some participants saying that the rally has more legs to move forward given potential for earnings growth as well as P/e expansion while others calling out rising speculative flavour in some of the counters. But most analysts and fund managers that the large undervaluation in state-owned companies is now over and investors will now have to be more stock-specific.

Kotak Institutional Equities in a recent note said that the rally in PSU stocks, including IRFC, BHEL and SJVN, was driven more by general bullish sentiment rather than significant fundamental developments.

Despite the fact that no PSU has delivered negative returns in FY24, analysts at Kotak pointed out that there was euphoria around the stocks, including unrealistic profitability assumptions and incorrect valuations. They believe government policies may offer short-term benefits but could hinder PSUs from addressing long-term disruption threats to their business models. Moreover, reinvestment in existing businesses may limit their ability to invest in future-proof ventures essential for long-term viability.

Ankit Jain, senior fund manager at Mirae Asset Investment Managers, said that in the last three years, the PSU basket across sectors has delivered stellar returns on account of better profitability outlook led by favourable government policies. This has resulted in PSUs bridging the valuation discount with private peers.

"Incrementally, we believe investors need to be stock-specific in the PSU basket now like any other segment of the market. Even a good government company trading at a high valuation is not a good investment as it leaves with no margin of safety. Having said that, PSUs have established distinct moats and capabilities in a few industries. For instance, PSUs benefit from lower borrowing costs in the power utility industry, while PSBs (public sector banks) have an advantage when it comes to liability franchises. We only buy such names if the business has both moats and is at a reasonable valuation," added Jain.

Amid this sell-off, there was also visible buying in some PSUs. Funds significantly increased their holdings in Indian Oil Corporation by 38 percent to 33.41 crore shares from 24.24 crore shares a month earlier. Oil India and Union Bank of India also saw a 16 percent increase in mutual fund stakes, with holdings rising to 9 crore shares from 7.74 crore shares and 25.90 crore shares from 22.34 crore shares, respectively. Additionally, the funds boosted their stake in Hindustan Petroleum by 12.4 percent to 21.11 crore shares from 19.34 lakh shares at the end of January.

Other PSU stocks that saw mutual fund buying of between 1 percent and 4 percent included Indian Bank, Oil and Natural Gas Corporation, Hindustan Aeronautics, Coal India, Gujarat Gas, Power Grid Corporation, Cochin Shipyard, Power Finance Corporation, Rail Vikas Nigam, GAIL India, New India Assurance and Rashtriya Chemicals and Fertilisers.

Ajay Bagga said “If you consider a 15-year, 12-year or even a 10-year perspective, these are value destroyers. It's only in the last two years that the cleanup process has finally caught up with them. Subsequently, over the past one and a half years, we've witnessed some positive performance." According to Bagga, the PSU story has been overdone, overhyped and oversold. He suggests treading with caution, especially in stocks where institutional investors are making an exit.

Source: Money Control