The recent stock market correction in some of the ‘narrative’ investment and PSU stocks may reflect mild global risk-off sentiment, changed preference for defensives and increased focus on the fundamentals of the stocks, Kotak Institutional Equities said in its latest strategy note.
The domestic brokerage said ‘narrative’ stocks are still completely disconnected from fundamentals and their real values are 10-50 per cent of their prevailing market capitalisations! (Fair value table at the bottom)
The domestic brokerage noted that railway and defence stocks such as Mazagon Dock Shipbuilders Ltd, Bharat Dynamics Ltd, Cochin Shipyard Ltd, Hindustan Aeronautics Ltd (HAL), RailTel, Rail Vikas Nigam Ltd (RVNL) and IRFC, among others, have seen large corrections since July. Similarly shares of EMS players such as Amber Enterprises India Ltd, Dixon Technologies (India) Ltd, Kaynes Technology India Ltd and Syrma SGS Technology have been falling since April. Utilities and oil & gas shares such as NTPC, ONGC, Tata Power, NHPC, CESC, BPCL, SJVN and Power Grid have also seen some selling of late.
"However, we still see a large gap between the market caps and fundamental fair value of the ‘narrative’ stocks," the brokerage said.
The brokerage said the mild correction in the indices and large correction in ‘narrative’ stocks in the past few weeks may be due to moderation in domestic investment sentiment, with the shift in global sentiment to a slight risk-off mode. It could also be due to preference for defensives, which have supported headline market indices and possible shift to fundamentals for ‘narrative’ stocks.
That said, the overall sentiment still is euphoric, as can be seen in full-to-frothy valuations for most sectors and stocks and large inflows into domestic mutual funds from price-agnostic investors, it said.
"We ascribe the shift in sentiment to a somewhat risk-off mode due to (1) recent economic data indicating a slowdown in the US; a slowdown may pose downside risks to earnings but potential rate cuts may be largely priced in; (2) continued stasis in China’s economic policies, which have resulted in a crisis of confidence among companies and households both and (3) continued insipid performance of the EZ economy," Kotak said.
Among ‘global’ stocks in India, commodity stocks have seen a moderate correction but IT services stocks are holding firm, Kotak noted.
On the other hand, Kotak attributed the recent rally in defensives such as consumer staples at the expense of high-beta investment stocks to the risk-off mode. The stiff valuations of the defensive stocks, however, pose further challenges to portfolio construction.
"We had discussed the possibility of a gradual recovery in volumes of consumer staples about 2-3 quarters back related to our view of improved affordability (higher income for low-income households and stable product prices). It remains to be seen if the much-anticipated recovery in demand for IT services would be strong enough to justify the sharp re-rating in their multiples," Kotak said.
Kotak said the ‘narrative’ stocks trade at unfathomable valuations despite their supporting narratives being based on unrealistic assumptions of growth and profitability. A few ‘narrative' themes such as offshoring and premiumisation have disappointed and others such as privatization of PSUs, profitability recovery and sustenance have sustained despite contrary signs.