6 Large Cap Stocks - Size Does Matter

For the first time in the history of Indian stock markets, Sensex has been trading at below the PE as compared to BSE midcap and smallcap indices. Large caps have been laggards while midcap and smallcap stocks have been resilient. Since January 29, 2015, the Sensex has fallen 15.5 per cent, dragged down by poor earnings in commodities, capital goods and public sector banks and the Chinese and Greek debacles. Midcaps and smallcaps have fallen only 3.4 and 8.7 per cent respectively which means broader markets outperformed the benchmark indices. One reason could be, over the last two years plenty of domestic fund houses and FIIs entered into the mid-cap and small category and second reason is medium and smaller companies have also been reporting better results than some of their large cap counterparts which is in turn making the institutional investors evaluate their potential in a new light.

Now things will be changed soon after the recent corrections. Most of the quality largecaps are available at present at decent valuations and offer good entry points for long-term investors. Given the fact that corporate earnings growth is still a couple of quarters away, still we can bet on largecaps which will provide more stability compared to midcap stocks in volatile market conditions. Investors and traders gave a thumbs up to India’s budget after it has shown commitment to fiscal discipline, while hoping that RBI could cut rates further. 

There are several largecap stocks available in the markets and those at present remain a buying opportunity at the current valuations. Look for investment in those companies that have a sound business generating a RoCE (Return on Capital Employed) that is consistently higher than their cost of capital-these are run by a team of capable management bodies and support the interests of minority shareholders. Anecdotally, during early economic recovery phase, largecaps tend to benefit more than midcaps due to large scale of operation, high degree of financial and operating leverage and stronger balance sheets.

Large-cap stocks are generally considered safer investment instruments, since they typically represent large, well-established companies that are expected to continue as profitable businesses but the rule is not universally applicable. For example, DLF, Unitech, Jindal Steel and Power, Jaiprakash Associates or Suzlon Energy where investors lost their money heavily despite those being large cap stocks. So the rule is, there is no such rule.

Large-cap stocks usually offer less potential for high growth and returns than mid- or small-cap companies. This is not always necessarily the case, since some large-cap firms, such as Infosys, TCS, Tata Motors, Ashok Leyland or Asian Paints, still offer excellent potential returns because of their presence in high-growth market sectors. Small and midcap stocks usually come with both higher profit potential and higher risk levels.

Because of their large size and resources, large-cap stocks are typically expected to weather the ups and downs of the business cycle better than smaller companies. This makes them potentially sound "building block" or "core" investment choices for many long-term investors.

The universe of small and midcap stocks is much larger than the typical large cap stocks. However, these small and midcap stocks are less liquid than large cap stocks. If you hold a largecap stock then, you can easily encash your equity investment whenever money is required.

Another potential advantage of large-cap stocks is dividend income. Dividends are the portion of a company's profits that are paid out to shareholders. Because total returns are based on not only the price appreciation of an investment, but also the reinvestment of capital gains and dividends, dividend income may help support returns during a declining or flat market.

While past performance is no guarantee of future results, however they may have long track records and hold dominant positions in their industry which gives confidence to the investors.

It is clear from the above table; we can see that BSE MidCap and BSE SmallCap indices gave fabulous return during a two years CAGR period from FY14-16. During a beginning of that period a new government takes charge at the centre and then after robust foreign fund inflows have been fuelling the rally in the domestic equity market. Retail investors are the major participants in midcap and smallcap segments.

After the stock markets had crashed down in the fourth quarter of FY08 and then after if you were invested in the stock markets and you remained invested throughout this period, you might be surprised to see the return due to BSE 200 was outperformed above all four indices and even Sensex also given returns at par with BSE 200.

If you observe longer duration 13 years CAGR period from FY04-16 then above all four indices have given a return in double digit. However whole point here will be mid and smaller market cap stocks usually have higher risk levels and in the longer time horizon period, if you were not getting much beyond return as compared to Sensex then it will not make sense to take such higher risk.

In the Indian equity markets, high quality small and mid cap stocks is limited and their valuations have run up to an extent. Therefore, in the long run their gap becomes narrow.

One more important point: Is investing in equity always supposed to give double-digit returns year-on-year? The answer is no. However, in the long-term you may get double-digit returns on CAGR basis. Such an exorbitant expectation is built after Indian stock market gave extraordinary return in 2014 and it’s illogical to expect year-on-year returns in the high-double digits from the market.

There may be a few opportunities in the mid-cap space, but if you are looking for undervalued stocks, there are far more opportunities in the large-cap space. Over the last two years, plenty of domestic fund houses and FIIs entered into the mid-cap and smallcap categories, as a result of which, these stocks appear to have crossed the rich valuation zone. Traditionally, large-cap stocks trade at premium to mid-caps, but mid-cap valuation went above large cap in the recent past. Therefore, we believe these fund houses and FIIs are likely to move into large caps now and begin the switch from mid caps purely on valuations.

There is no reason to rush into the midcap and smallcap stocks now at higher a valuation. From here on, the large-cap companies should do better than midcap and smallcap ones. Investors should not pour money into midcap and smallcap stocks, unless they have a longer investment horizon of 5-8 years. We are not suggesting investors to completely offload their midcap and smallcap stocks purely on the basis of high valuations. There are many midcap and smallcap companies which traded at high valuations due to maintain strong earnings growth.

You can start accumulating largecap stocks where results are looking strong or where the government policy impetus is likely to drive growth. However, we believe that not all large-caps will outperform and all mid-caps underperform. Hence, investors need to take a stock-specific and bottom-up approach

BSE Code: 523642

FV: Rs 1

CMP: Rs 562

M-Cap: Rs 7,681 crore

PI Industries (PI), a leading agro-chemical company, has a varied business model with focus on fast-growing custom synthesis and manufacturing (CSM) business, which contributes 60 per cent of its revenues. To sustain the growth momentum, the company has expanded its manufacturing capacity in Jambusar at a cost of Rs 300 crore. We believe that this expansion would be able to improve its revenue mix in favour of the relatively high-margin CSM business. On the agro-chemical front, the company is concentrating on a few niche products which have the ability to become blockbusters in future. It has only 25-30 products in the market i.e. one third of its peers and plans to launch two new products every year which will help it to increase its market share.

Revenue growth in 9M FY16 stood at 8 per cent driven by 3 per cent growth in domestic agri-input and 11 per cent upside in custom synthesis exports. EBITDA grew by 18 per cent to Rs 325.4 crore. Margins stood higher at 22 per cent, representing a growth of 194 bps. PAT grew by 19 per cent at Rs 218.1 crore.

Maruti Suzuki India

BSE Code: 532500

FV: Rs 5

CMP: Rs 3,701

M-Cap: Rs 1,11,800 crore

Maruti Suzuki India has maintained its market leadership despite the increase in competitive intensity. It has managed to increase its market share from around 45 per cent in FY15 to 47 per cent in 9MFY16. Around 8 per cent appreciation in Japanese yen in the last three months is bound to hit operating margin, given that about one-fifth of its cost (including royalty) is yen-denominated. It will impact the operating margin for FY17. This event already factored in the stock price. Work on the Gujarat plant is running as per schedule and Phase 1 with the capacity of 250,000 units per year is likely to be commissioned by March 2017. Undoubtedly, in the long run, higher capacity will kick in the benefits of operating leverage to get profitability back on track.

For nine months ended December 31, 2015, the company net profit grew by 41.65 per cent of Rs 3,437.78 crore and revenue registering growth of 16.76 per cent at Rs. 42,440.54 crore. EBITDA reported growth of 46.05 per cent at Rs 6,628.56 crore along with EBITDA margin expanded by 313 bps at 15.62 per cent.

LIC Housing Finance

BSE Code: 500253

FV: Rs 2

CMP: Rs 471

M-Cap: Rs 23,772 crore

LIC Housing Finance (LICHF), promoted by LIC of India, is the second largest Housing Finance Company (HFC) in India after HDFC Ltd. Including banks; it ranks third after HDFC and SBI... Since FY07, we observe that the company has increased its loan book at an aggressive pace of more than 25 per cent CAGR as against industry growth of around 15-17 per cent. Consequently, LICHF’s market share has almost doubled in the last seven years to around 10 per cent. The growth has been predominantly led by the individual loan book, which accounts for around 97.4 per cent of total book.

For nine months ended December 31, 2015, the company’s net profit grew by 20.3 per cent at Rs 1212...77 crore and its net interest income (NII) reported growth of 32.81 per cent at Rs 2,227.29 crore.

Asset quality is a major driver for growth for the company, GNPA ratio for the industry is around 0.8 per cent while LICHF’s Q2FY16 ratio is below industry levels at 0.6 per cent with absolute GNPA at Rs 683 crore.

BSE Code: 532779

FV: Rs 10

CMP: Rs 219

M-Cap: Rs 10,542 crore

Torrent Power is one of the leading brands in the Indian power sector, promoted by Torrent Group. Torrent is an integrated utility engaged in the business of power generation, transmission and distribution of electricity with operations in the states of Gujarat, Maharashtra and Uttar Pradesh.

Three of Torrent Power’s gas-based plants – SUGEN, UNOSUGEN and DGEN – are currently operating at sub-optimal levels. SUGEN, which has a long-term off-take agreement with RasGas, is likely to benefit the most from Petronet’s negotiation. Recently the company has abstaining from gas auctions due to high prices which is wise decision for them.

For nine months ended December 31, 2015, the company reported consolidated net profit jumped four and half fold to Rs 790.68 crore and revenue grew by 17 per cent at Rs 9,133.89 crore. EBITDA reported growth of 78.7 per cent at Rs 2,486.56 crore along with EBITDA margin expanded by 940 bps at 27.22 per cent.

Recently it has entered into a contract with a leading WTG manufacturing group for development of the 197.40 MW Wind Power Project in Gujarat and expected to be commissioned progressively by March 2017.

Apollo Tyres

BSE Code: 500877

FV: Rs 1

CMP: Rs 172

M-Cap: Rs 8,780 crore

Apollo Tyres is well placed to benefit from the radialisation story in India. At present, the company enjoys a market share of around 28 per cent in truck & bus tyres. The company is investing towards more diversified, rapid growth areas coupled with larger scale of business for coming years. It will invest as much as Rs 4,000 crore in FY17 to double capacity at its manufacturing facility in Chennai to cater largely to the domestic market. Once Hungary facility came on stream in January 2017 then it will target to scale up business in Europe and US.

Recently it entered into the two-wheeler tyre segment, launching the Apollo Acti series for motorcycles and scooters while the initial plan is to concentrate on the domestic replacement market. In 9mFY16, it’s consolidated profit grew by 27 per cent Rs 848 crore while net sales decline to Rs 8742 crore as against of Rs 9592 crore in the same period of the last year. However, a higher mix of radial tyres would support margins. Therefore EBITDA grew by 5 per cent at Rs 1541 crore.