Mid-Cap 250 In 2018

Mid-caps have taken a serious beating in the current wave of equity sell-off. Nikita Singh finds out whether the underperformance in mid-caps is a global phenomenon, while Yogesh Supekar highlights the merits of focusing on those mid-caps for the long term that pay higher dividends

Indian equity markets in 2018 have underperformed their emerging market peers on a YTD basis and that has led to pessimists in the markets to believe that maybe 2018 is the year where we will see a flattish to negative index (benchmark) returns. The mid-caps and small-caps have taken a beating in 2018 and these darlings of retail investors have underperformed the large-caps so far.

The pain in mid-caps is visible as of now and the relatively deeper correction in mid-caps has created a wonderful entry point for long term investors. For long-term investors who are convinced on the fundamentals of the fastest growing economy in the world, the mid-caps are one investing space that cannot be ignored. The year ahead of us is an eventful year with the elections in 2019 promising to create lot of uncertainty in the markets. Says Haresh Mehta, Chief Institutional Trader, First Global ,"The mid-cap and small-cap space remains the best bet without any doubt in my mind for the next 3-4 years, irrespective of the political outcome of 2019 Union elections."

While majority of the investors believe that the long term mid-cap bull story is intact, one cannot ignore the simple fact that investors' confidence is shaken as of now due to the ferocious drop in prices of majority of mid-caps. The mid-cap index is down by nearly 10 per cent on a YTD basis when compared to the Sensex, which is down by more than 2 per cent on a YTD basis. We saw that the small-cap index was down by 12.11 per cent in February 2018, while the mid-cap index was down by 10.65 per cent in March and Sensex was down by 2.43 per cent in March, since the beginning of the year.

The below table clearly shows that the mid-caps in India have clearly outperformed the mid-caps in emerging markets as well as mid-caps in other markets over the long term. However, the mid-caps in India have underperformed mid-caps in the emerging markets over the past one year and on a YTD basis.

Rahul Agarwal, Director, Wealth Discovery/EZ Wealth

"A snapshot of the top performing stocks in the Nifty Mid-cap 50 shows that companies such as Dalmia Bharat and Biocon have given returns that are unheard of in the large-cap space."

Will mid-caps outperform the large-caps in the coming year? 

We might not see the kind of outperformance which the mid-cap stocks have delivered vis-a-vis large-caps over the last 3-4 years. However, there will be certain pockets within the mid-cap segment which will outperform handsomely. 

What is your outlook on mid-caps? 

If you look at the last 3-4 years, there are many mid-cap and small-cap companies where prices have soared manifold without corresponding increase in earnings. The markets have given them the benefit of demonetisation, GST disruptions, etc. The expectations in earnings growth will be high going ahead and some of these companies may disappoint. The room for error is low in such cases and one needs to be cautious.

The mid-cap/small-cap universe is 6-7 times bigger as compared to the large-cap space, which offers better stock-picking opportunities even in a slightly stretched scenario.

What are the risks of investing in a predominantly mid-cap portfolio? 

The mid-cap/small-cap portfolio tends to have a higher beta (volatility). The businesses are evolving and the track record in many cases is limited. The risk is, therefore, high. However, the growth rates and returns also tend to be commensurately higher in the longer haul. The risks in a mid-cap portfolio can be minimised by good bottom-up stock-picking and adequately diversifying the portfolio.

The extra return expectations from mid-cap focused portfolio depends on the phase of the market that we are in. In a slightly matured bull markets, these expectations need to be moderated. As mentioned above, a larger universe of mid-cap stocks do offer much better stock-picking opportunities. However, stock selection becomes more critical as the bull market matures. On a longer time-frame, based on historical data, annualised outperformance of ~ 2% to 5% is possible.

BSE Mid-cap index, which was launched in the year 2003, has outperformed BSE Sensex index by around 4% (annualised) since inception. Though the time-frame in the above case is not long enough, historical global data run over longer periods do build a case for mid-cap outperformance. Logically also, the mid-cap stocks should compensate adequately for the higher risks as mentioned above.

However, as discussed above, one should be mindful of the phase of the market that we are in. In a bad phase, these tend to erode value faster. Investor must have the patience and appetite to wear bad phases to enjoy long-term wealth creation through mid-caps.

Mid-cap IT sector Some of the most important questions that need to be answered for investors is where in mid-cap space and what percentage of portfolio should be invested in mid-caps at this juncture. While it is always prudent to remain diversified across sectors, the mid-cap IT stocks have caught investors' attention and have been outperforming mid-cap stocks from other sectors in 2018 so far. It does look like mid-cap IT sector will continue its good run in the coming years. Hence, some decent weightage to mid-cap IT stocks is warranted. 

Says Sachin Relekar, Fund Manager, LIC MF, "Mid-cap IT stocks is an interesting area. However, each of the company from the pack is different in respect of revenues, margins, client mix and product/service mix. This is starkly different than large-cap IT companies. The technological changes happening are complex, impacting companies across the IT pack. Therefore, we are trying to understand which companies will benefit from the changes and whose business model could be under pressure. 

One needs better insights into the business models. The balance sheets of most of these companies are healthy. There are promising opportunities in the sector. To summarize, we are looking at it with bottoms-up approach, but at the same time, given the scale of transformation in the technology space, some of the names have large potential." 

Investors ought not to forget that asset allocation is one of the most important determinants of portfolio performance. As far as portfolio allocation goes for retail investors, there is a strong case to allocate a decent proportion of portfolio to the mid-caps. 

Says Achin Goel, Head of Wealth Management & Financial Planning, Bonanza Portfolio Ltd, "We would suggest that exposure in the mid-cap segment should be 30%-40% of the total portfolio and the remaining 60%-70% in the large-cap segment for the equity component of asset allocation."

• Nifty Mid-cap 100 index reported a sales growth of ~13% and EBITDA growth of ~20%. The EBITDA margins improved by ~100bps from 18.6% to 19.6% YoY. 

• However, PAT (ex financial) grew by meagre 2% due to lower other income (mainly in healthcare, industrials and telecom) and higher tax outflow (mainly in healthcare, transportation and auto. Nifty Mid-cap PAT (including financials) de-grew by ~19% due to higher provisions arising from rising NPA book.

• The Beat ratio (number up upgrades minus downgrades divided by total number of stocks) saw a slight deterioration from 8% (37 stocks beat estimates, while 29 stocks missed the estimates) to 5% (37 stocks beat estimates, while 32 stocks missed estimates)

• During Q3FY18 earnings season (since November 15, 2017), Nifty Mid-cap 100 saw 12% downgrade in FY18 consensus EPS estimate from 176 to 155

• The valuation do not appear attractive as mid-caps are currently trading at 1-year forward PE multiple of 19x (~0.4 Standard Deviation above average of 16.4x)

We expect mid-cap portfolios to deliver a modest ~10-12% return due to sustained domestic equity flows. We believe that large part of high earnings growth expectation (~39% EPS CAGR over 2017A-2020E) is already priced in the stock prices (1 year forward PE multiple of 19x: ~0.4 Standard Deviation above average of 16.4x).

Will large caps outperform mid-caps and small caps in 2018? Your take. 

Mid-cap is currently trading at 5% premium relative to large-cap (compared to ~9% discount on a long term average basis). In spite of steep valuation, we expect mid-cap to equal or slightly outperform large-cap due to sustained domestic equity flows and higher mid-cap earnings growth expectation relative to large cap.

What are the key risks of investing in mid-cap stocks at this juncture? 

Any earnings disappointment remains the key risk of investing in mid-cap at this juncture, given the markets are building in ~39% EPS CAGR over 2017A-2020E. As highlighted earlier, the current earnings season saw 12% downgrade in FY18 consensus earnings estimate.

Mid-caps have traditionally returned more than large-caps in big bull cycles. Though they come with risks, their return profile is good. One should invest in mid-cap stocks in sunrise sectors such as rating agency, aviation, auto component, retail, agro chemical, dairy, etc. where they are clear market leaders having significant economic moat (ability to maintain competitive advantage over its competitors). One can also look at mid-cap cement companies which have location advantages.

"Looking at the fundamental side of mid-cap companies, these usually tend to be less capital intensive businesses, having lower debt levels, presence in different business models and operating in niche area, which helps these companies to deliver faster earnings growth and justification of their higher valuations can be illustrated from the same."

Top Mid-Cap Dividend Yielding Stock Performance

We tried to ascertain if investing in mid-cap stocks that reflect the best dividend yield in the space would be a good idea. In the list of the top 20 dividend-yielding stocks, we found that these high dividend yielding stocks have delivered relatively superior returns compared to the benchmark, i.e Mid-cap index.

We can see in the table below that the dividend yielding mid-cap stocks have delivered 79 per cent returns in the past one year, thus outperforming the benchmark index returns handsomely. During the same period, Sensex was up by 11.78 per cent. On a long-term basis also, the evidence points towards outperformance of those mid-cap stocks that are distributing higher dividends. Over a three-year period, the top dividend yielding mid-cap stocks have generated annualised returns in excess of 44 per cent. The same set of stocks have generated returns in excess of 43 per cent on an annualised basis over a five-year period. This reflects consistent outperformance by dividend paying mid-cap stocks.

After being in the spotlight of investors' attention for long, the mid-cap stocks have suffered a setback in the stock market in recent times. However, the much sought-after segment remains the focus of investments in anticipation of a swift recovery. As mid-cap companies operate in niche industries, investments in these stocks mitigate the market risks due to the greater size of opportunities and the prospects of scalability. Bearing a lower risk than the fickle small-cap stocks, the mid-cap stocks have an edge due to their higher potential to grow than the large-cap stocks which may have already had their best run.

The large-cap company stocks are sought after as low risk investment options, but these may provide only limited growth prospects. The best return-yielding years of large-cap companies are often long gone but, in contrast, for the mid-cap companies, the best is yet to come as these companies carry on their operations aggressively and their stocks hit fresh highs. Thus, despite the corrections in the valuation in the short term, mid-caps are promising investments from a medium to long term perspective. Considering the historic performances, the mid-cap index has widely outperformed the large index over the last decade. Higher exposure to mid-cap stocks not only ensures diversification in the composition of the risk factors in the portfolio of the investors, but it also helps the investors to set higher targets and offers opportunity to acquire stocks having higher potential to generate returns. At this juncture, investor ought to be focused on high quality mid-cap stocks and remain invested for multi-year time horizon. One can also focus on the high quality dividend yielding mid-cap stocks for outperformance.

Bhansali Engineering Polymers (BEP) is in the business of manufacturing ABS and SAN resins. ABS resins are used in consumer electronics, appliances and automobiles sectors. BEP is increasing its manufacturing capacity by four-fold and in two stages to capture the domestic market, which is highly import-dependent. The industry's domestic capacity caters to 60 per cent of the demand.

In the near term, the company plans to increase capacity to 137,000 MT from 80, 000 MT by December 2018, involving a capex of Rs.50 crore.

Further, the company is expected to commission a greenfield expansion of 2 lakh TPA capacity by March 2021.In Q3 FY18, the company posted net sales of Rs.258 crore, up 4 per cent QoQ and 110 per cent YoY. 

The improvement in turnover can be attributed to higher pricing trend for ABS and increase in capacity utilisation. The company's EBITDA margins improved sequentially by 154 bps and 938 bps YoY on account of lower raw material costs and better realisations. Also, higher other income and moderate other expenses helped net profit to increase 16 per cent QoQ and 850 per cent YoY. 

BEP, with its greenfield expansion plans, is on course to become a dominant player in the domestic ABS market. Additionally, the company is incurring a capex of Rs.20 crore for the R&D centre in Abu Road, which would be useful for customised and high margin variants of ABS applications. 

Further, considering the positive outlook for the auto and consumer durables markets, we recommend a BUY on the stock.

Phillips Carbon Black

CMP : Rs.1094 
BSE CODE : 506590 
Face Value : Rs.10 
BSE Volume : 56,976

Phillips Carbon Black (PCBL) is the largest manufacturer of carbon black with a market share of about 40 per cent. Carbon black is used as a reinforcement material in manufacturing tyres. 

The company also provides a complete portfolio of products to meet the specific end requirements across rubber, plastics, coatings, inks and other niche industries globally. 

The company has an installed capacity of 4,80,000 tonnes across its four plants at Durgapur, Kochi, Mundra and Palej. The rise in coking coal price globally and the consequent rise in coal tar price is expected to limit the production from China. This augurs well for the company.

PCBL's revenue for Q3FY18 stood at Rs.612.4 crore, an increase of 26.2 per cent YoY The operating profits for Q3FY18 came in at Rs.96.95 crore, a rise of 49.8 per cent YoY. The EBITDA margin expanded by 249 bps YoY to 15.8 per cent in Q3FY18. The net profit after tax for the quarter stood at Rs.56.59 crore, rising 280.3 per cent YoY. 

The company is trading at a price-to-earnings ratio of 19.65x as against its peer Oriental Carbon & Chemicals (20.73x). The company has been maintaining a healthy dividend payout of 33.05 per cent. The company has reduced debt and has a debt-to-equity ratio of 0.67x. 

PCBL has also de-risked its business model from the fluctuations of crude prices, protecting itself from fluctuating profitability as witnessed in the past and adding strength to its business profile and ensuring robust profitability trend to continue, going forward. 

We recommend a BUY on the stock at the current level.

Suven Life Sciences

CMP : Rs 173.50 
BSE CODE : 530239 
Face Value : Rs 1 
BSE Volume : 19,460

Suven Life Sciences, which is in the business of design, manufacture and supply of bulk actives, drug intermediates and fine chemicals, caters to the needs of global life science industry. The company generated about 94 per cent of its revenues in H1FY18 from NCE CRAMS business and the rest from technical services.

The company has executed over 800 NCE-based CRAMS projects for 70 global clients. The company also has its own NCE pipeline, comprising 13 molecules, including four molecules in various stages of clinical trials.

The company has exclusive marketing licence for malathion lotion for the US and Canada from Taro Pharma, which is valid till 2018. The company has spent more than Rs 600 crore on the NCE R&D.

In the last quarter, the company secured 9 product patents covering Canada, India, Eurasia, Hong Kong, Norway and USA. The company is also working on high value, low volume eight to 10 molecules, which it expects to file by FY20.

In Q3FY18, the company reported 38.6 per cent increase in net sales to Rs 166.94 crore as compared to Rs 120.45 crore during the same period last year. The company’s PBDT increased 32.17 per cent to Rs 53.53 crore in Q3FY18.

The company has posted 42.52 per cent increase in its net profit to Rs 34.59 crore in Q3FY18 as against Rs 24.27 crore in Q3FY17. The company has a PE ratio of 16.28x as against its peer Caplin Point Laboratories (30.88x) and Shilpa Medicare (35.31x). The company with a debt-to-equity ratio of 0.10x is virtually debt-free. We recommend our reader-investors to BUY the stock.

Godawari Power and Ispat 

CMP : Rs 442
BSE CODE : 532734
Face Value : Rs 10
BSE Volume : 20378 

Godawari Power and Ispat is an end-to-end manufacturer of mild steel wires. The company manufactures sponge iron, billets, ferro alloys, captive power, wire rods, steel wires, oxygen gas, fly ash brick and iron ore pellets. 

Currently, most of the company’s competitors are suffering because of non-availability of iron ore and increasing iron ore prices due to a penalty imposed on mining in Odisha. Although Godawari too was hit marginally, its captive iron ore supply (about 60 per cent of its requirements) helped in keeping its costs low. 

On the financial front, the company’s net sales rose 57.6 per cent to Rs 672.08 crore in Q3FY18 over the same period last year. The company reported a consolidated net profit of Rs 74.40 crore in Q3FY17, compared with net loss of Rs 9.21 crore in Q3FY16. 

The company’s debt has decreased from Rs 2,215 crore at the end of FY17 to currently around Rs 1,950 crore. The company has also restructured its debt by increasing the tenure to a longer period, thereby shifting some of its liabilities to the future. The company is also planning to ramp up its iron ore mining from 1.5 million tonnes to about 1.8 million tonne and gradually move up the value chain with higher production and generate sufficient cash flows and repay its debt. 

The company is also focusing on increasing production of high value products like billets from 29,598 tonnes last year to around 45,000 tonnes in Q3FY18. 

Going forward, we expect the value-added products to generate higher profits. We recommend our reader-investors to BUY the stock.

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