Mid-Cap Stocks To Cheer Up Your Portfolio

Equities have taken a beating recently. Indian volatility index (VIX) is noticeably up, while the mid-caps are lying low with already approx. 20 per cent correction. In such a scenario, should one buy mid-cap stocks? Dnyanada Kulkarni along with Yogesh Supekar discuss the outlook on mid-cap stocks, while the DSIJ research team shares its top 4 mid-cap picks for the season.



It looks like market sentiment more than anything else is the most powerful factor driving the market right now. Within a couple of weeks, the whole market has moved to the 'risk-off' mode from the 'risk-on' mode without much fuss. The Sensex is down by almost 11.50 per cent from its all-time high, even as the Indian rupee slides along with the equity prices. 

{On YTD basis, Sensex is up by ~2 per cent. But in dollar terms because of the weakening Indian rupee it is down nearly 12 per cent.}


The sliding rupee has made Indian markets less attractive for foreign investors. Owing to the market correction and weakening rupee, the market cap of Indian equities has come down to $1.98 trillion from its peak at $2.45 trillion, thus indicating a 20 per cent drop in the market capitalisation of Indian equities. This drop of 20 per cent in market cap has pushed India out of the elite club of nations with $2 trillion m-cap. 

While rising crude oil prices, weakening rupee, liquidity crunch among NBFCs, trade war escalation and fear of inflationary environment are seen as detrimental factors affecting the stock prices negatively, the long-term growth story remains intact for India. Indian equities have been outperforming its emerging market peers on a YTD basis so far. Mid-caps have been under performing the large-caps since the beginning of the year. 

After heavy correction in the mid-caps, investors ought to find out if investing in mid-caps at this juncture is a good bet or one needs to wait a little more. Time and again, it is proven that market timing and catching the bottom is almost impossible. Should one wait for the bottom or start hunting for quality mid-cap stocks right now? 

Myths of mid-cap investing 
If large-caps enjoy blind faith of investors, small-caps beget the temptation of being the next multi-bagger stocks. On the other hand, mid-caps are neither too big and well-discovered as largecaps, nor too small to vanish like some small-caps, and this makes them the ideal choice of investment for any retail investor. Despite being popular with investors, mid-cap investments are surrounded by loads of myth regarding their size, returns and performance in different market conditions. 

Here Are A Few Myths That Investors Have Regarding Mid-Caps 
Myth-1 : 
Mid Caps Are High Risk Investments 

Although risk and reward form the base of any investment philosophy, investors tend to avoid risk and chase reward. Investors think mid-caps are high-risk investments as they tend to be more volatile than large-caps. Large-caps are favoured in volatile markets as these companies have the benefit of large balance sheets which help them to tide over the downcycles. However, if we look at long investment tenures, it is evident that mid-caps give more returns than large-caps because, in the long run, the growth potential gets more valuation from the market than the size of the balance sheet. Thus, mid-cap companies with a good business model have a high return-on-equity (ROE) potential. 

On risk-adjusted basis, there is no evidence that large-caps are superior to mid-caps. In other words, the volatility in mid-caps in not unjustifiably higher when compared to large-caps. 

Myth 2 : 
Mid-caps are of inferior quality 

Many investors believe that mid-caps are inferior to large-caps in terms of quality simply because large-cap companies enjoy higher cash flows, bigger revenues and have larger balance sheets. It is not always that higher absolute profit figures and revenue figures are tantamount to good fundamentals. Growth, and indeed sustainable growth, in profits is of paramount importance for investors. Instead of higher profits and larger balance sheet size of large-caps, investors should focus on those mid-cap stocks that display higher margins, enjoy free cash flows and higher return on capital employed (ROCE) that drives the EPS growth. 

The chances of identifying companies with these parameters are higher in the mid-cap space. Many mid-cap companies are able to generate higher free cash flows and ROCE. 

Myth 3 : 
Mid-caps should be bought only through demat account 

Most investors believe the multi-bagger mid-caps can be bought only through the demat account directly. Investors ignore opportunities of buying mid-caps through quality MF scheme that invests in mid-cap stocks.






Mid-cap stocks historical performance
As per SEBI guidelines, the top 100 stocks by market capitalisation will be classified as large-cap stocks, while the next 150 stocks will be considered as mid-cap stocks. If we consider the 150 stocks by market capitalisation as per the SEBI guideline, we find that almost 6 stocks have more than doubled in the one year period, with 67 stocks generating positive returns and 83 companies delivering negative returns. Almost 31 mid-cap companies have generated more than 25 per cent returns in the past one year.




Sorbh Gupta 
Fund Manager, Quantum Tax Savings Fund.


"Indian macro’s have deteriorated in the past 12-18 months as reflected in the fiscal deficit and current account deficit"


After recent correction, are mid-caps looking attractive to you? 
The Mid-Cap index is still at a substantial premium to the Sensex, indicating that the mid-caps in general are still expensive. In the past couple years, lot of mid-cap names have rallied without any change in underlying fundamentals, resulting in bloated valuations.

This is now correcting. In our bottom-up research process, we are finding few stocks which are coming close to our buy levels, but these names are few and far between. Hence, we believe the risk-reward is still unfavourable in mid-caps. 

Will India outperform the global markets or should we expect under performance? 
Indian macro’s have deteriorated in the past 12-18 months as reflected in the fiscal deficit and current account deficit. The increase in Brent crude prices have also brought India’s external vulnerabilities to the fore. Further, the rally witnessed in Indian equities in the past few years was more to do with easy global liquidity than earnings growth. This easy liquidity is now reversing as interest rates are rising in the developed world. So, the Indian markets could underperform in the near term. However, the structural story of demographic dividend, higher consumption driven by rising per capita income and increased spending in infra is intact. In the long haul, India will continue to outperform global markets driven by aforementioned factors.

Jimeet Modi 
Founder & CEO, SAMCO Securities & StockNote 


Do you think mid-caps will correct even further? 
When will we see the bottom for mid-caps? 2018 has been a traumatic year for the mid-cap space, which fell by almost 20% from the highs of 18,321 in January. However, after witnessing such a significant fall, the correction now seems to be almost over and we feel the bottom is near, as not much room is left for these stocks to fall further. However, in case of panic-like situation, the stocks might still go lower just for a while, but recovery will be swift and sharp.

What are the risks in buying mid-caps at this juncture?
 
Getting into mid-caps at this point in time will expose an investor to liquidity risk, global equity sell-off and high interest rates. Nonetheless, given that significant correction is almost over, there is limited downside risk and fresh funds should be allocated in buying mid-cap quality stocks.

Vineeta Sharma 
Head of Research, Narnolia Financial Advisors


How should investors evaluate those stocks (mostly midcaps) that have fallen in the range of 30 to 50 per cent? 
The sharp outperformance and then this sharp fall in mid-cap and small-cap stocks should be seen from the perspective that an investor who had invested in Nifty at the beginning of 2015 would have made 25% and an investor who had invested in BSE Mid-cap 150 would have made a return of 60%. Mid-caps usually have a valuation multiple higher than the benchmark index Sensex. When the index was trading at its peak, the ratio of valuations of mid-cap to Sensex went up to 1.60 times and now the valuation ratio has reached 1.44 times. Normally, there is usually a 30% valuation premium that mid-caps command over the benchmark index considering the higher earnings growth potential of smaller companies over the larger companies. For an investor who holds any of these stocks in his portfolio, he should recheck the hypothesis based on which he has bought the stock earlier and see if all the business drivers that were considered remain valid or not. If no fundamental change has happened, then staying on is advisable. On the other hand, if the stock was bought just on the basis of rising price, then every interim rally should be used to divest those companies. In general, as a thumb rule, companies with ROE<10%, growth<10% and PE> 20 should be avoided in the portfolio, unless one has in mind some strong earning re-rating hypothesis for the stock.

Do you see mid-caps recovering from the current levels? 

On an aggregate basis, another 10% correction will bring the valuation ratio back to normal. Considering the higher growth that can be factored into mid-caps, there may be another 5-6% fall in the mid-caps and that should normalise the valuation equation. The large part of outperformance in smaller companies was on account of benefit post the GST era. The larger companies already operate in a formalised business environment, whereas the small organised listed companies were operating in direct competition to the unorganised companies. So, formalisation of the economy will help the smaller companies in the future. But the sharp rally in 2017 led to a sharp overvaluation, whereas the positive impact on earnings due to GST would take 2-3 years to get reflected.

Jayant Manglik 
President, Religare Broking Ltd


Do you think mid-caps will correct even further? What is your outlook on midcap

Apart from the erstwhile valuation concerns, the current market correction is a factor of not just the challenges on the macro fundamentals front, but also the corporate governance issues and/or regulatory challenges being faced by few companies. This has had a contagion effect on the entire mid-cap category and is putting investors’ conviction to test. In such a scenario, when sentiments tend to overshadow the medium to long-term fundamentals enjoyed by a company, it becomes very difficult to predict the short-term direction of a particular stock/sector.

What are you advising your clients who are stuck with mid-caps that are underperforming? 
Our stance with respect to investing has always been tilted towards fundamentals-based medium to long-term horizon. Admittedly, while the entire mid-cap segment has been affected by the recent carnage with most companies hit merely by virtue of the fact that they belong to the mid-cap category, we are advising our clients to continue to hold-on or add-on to quality companies. 

What are the risks in buying mid-caps at this juncture? 
Considering that sentiments towards mid-caps are quite sour at the current juncture, volatility could continue in the segment for some more time. Despite this, we believe there will always be a few interesting companies in the mid-cap space that would tick all the right boxes. However, considering the challenges and uncertainties on the horizon, investors must remain highly selective. 

Conclusion
In a bull market scenario, the investors ignore the market concerns and the market often inches upwards. In a bearish market, a change in sentiment simply infuses an element of fear in the investors' minds, thus forcing them to ignore buying opportunities. Mid-caps have been battered down this calendar year. While it is difficult to predict a bottom for mid-caps, it can be said that we are near the bottom and hence one should start identifying the opportunities in this space. Looking at the market scenario and the worsening sentiment, it is quite possible that the market situation will worsen before improving. Hence it is advisable that investors should invest in a staggered manner, more so while investing in mid-caps. It has been observed in the previous eight years that whenever the benchmark index BSE Sensex and the BSE Mid-cap index has fallen by approximately 10 per cent, the markets have mostly generated positive returns in 1 year, 3 years and 5 years down the line. 

Mid-cap stocks are usually less diversified into non-crore businesses and hence have a focused approach, which makes them adopt a capital light business model. This allows the mid-caps to report higher RoEs when compared to large-caps. Due to higher RoEs and sustainable growth rate, the valuations are usually higher for mid-caps when compared to the large caps. Our advice to investors will be to choose a mid-cap company with clear earnings visibility, good cash flows and a capacity to maintain stable profit margins. 

Here are four stocks selected by DSIJ research team

Bhansali Engineering Polymers

BSE CODE 500052 Face Value Rs.1
Market Cap F F (Cr.) 974.28
CMP Rs. 130.50


Here is why
Capacity expansion
Increasing consumption
on ABS
Strong financial performance

Bhansali Engineering Polymers Limited (BEPL) is a major petrochemical company in India engaged in the manufacturing of ABS & SAN. ABS is a raw material for companies dealing in automobiles, home appliances, telecommunications, luggage and much more. 





The quarterly financial performance is not very satisfactory. The revenue from operations dropped 33.16 per cent to Rs.201.69 crore in Q1FY19 from Rs.301.79 crore in Q4FY18. EBITDA plummeted 37.12 per cent to Rs.27.5202 crore in Q1FY19 as against Rs. 43.773 crore in Q4FY18. Net profit slumped 41.36 per cent to Rs.16.77 crore in Q1FY19 from Rs.28.60 crore in Q4FY18.

The consolidated annual performance is much more promising. Revenue from operations surged 50.38 per cent to Rs.1,058.83 crore in FY18 in comparison to Rs.704.08 crore in FY17. EBITDA reported a marked increase of 143.15 per cent to Rs.154.43 crore in FY18 versus Rs.63.51 crore in FY17. Net profit from continuing operations increased to Rs.100.02 crore in FY18 from Rs.35.45 crore in FY17, registering an impressive growth of 182.13 per cent. The earnings per share (EPS) increased to Rs.6.01 in FY18 from Rs.2.15 in FY17. 

During FY 2017-2018, the production rose by 26.38 per cent to 65,008 tonnes. By 2022, the company plans to establish a new port-based plant with a minimum capacity of 2,00,000 TPA. Once accomplished, this endeavour would give the company a competitive edge and enhance its market share considerably. The company has tremendous potential for success as the consumption of ABS in India is exponentially larger than the combined output of two domestic manufacturers namely – BEPL and Styrolution. This is evident as the company has generated consistent profit growth of 142.42 per cent over the last five years and has a good return on equity track record of 31.93 per cent over 3 years.

It is important to note that the company is exposed to the risk of foreign exchange fluctuation. This is because its raw materials have to be imported and their prices keep fluctuating. BEPL has shared a bullish outlook pertaining to the growth of the Indian economy. This is crucial for bolstering the demand of ABS. In the last two years, the global consumption of ABS has shot up to 90 per cent from a previous capacity utilisation of 70 per cent. The ABS market in India continues to grow at a CAGR of 15 per cent. By virtue of strong long-term financial performance and positive industry outlook, we recommend our reader-investors to BUY the stock.

Hindustan Oil Exploration Company

BSE CODE 500186 Face Value Rs.10
Market Cap F F (Cr.) 817.83
CMP Rs. 118.25 


Here is why
Strong revenue growth 
Debt free balance sheet 
Growing operational 
cash flows




Hindustan Oil Exploration Company Limited (HOECL) is engaged in the development and production of hydrocarbons such as crude oil and natural gas. It enjoys a diverse geographical footprint with presence in 4 out of the 7 producing basins in India.

The standalone unaudited quarterly financials show a dramatic improvement in the performance of the company. Its revenue from operations stood at Rs.35.06 crore in Q1FY19 as against Rs.3.71 crore in Q1FY18. The EBITDA rose to Rs.25.58 crore in Q1FY19 from Rs.1.40 crore in Q1FY18. The net profit climbed to Rs.23.34 crore in Q1FY19 from Rs.2.93 crore in Q1FY18.


On a QoQ basis, revenue from operations posted a growth of 50.92 per cent and stood at Rs.35.06 crore in Q1FY19 in comparison to Rs.23.23 crore in Q4FY18. Consequently, net profit surged 41.88 per cent to Rs.23.34 crore in Q1FY19 from Rs.16.45 crore in Q4FY18. The earnings per share (EPS) increased to Rs.1.79 in Q1FY19 from Rs.1.26 in Q4FY18. The operating profit margin (OPM) increased to 80.38 per cent in Q1FY19 in comparison to 63.53 per cent in Q4FY18. However, the net profit margin (NPM) fell to 66.57 per cent in Q1FY19 from 70.81 per cent in Q4FY18. 

The company's annual consolidated financial performance is quite impressive. Its revenue from operations demonstrated a steep climb of 90.53 per cent to Rs.48.71 crore in FY18 from Rs.25.56 crore in FY17. The EBITDA marked a tremendous improvement as it rose to Rs.30.69 crore in FY18 from Rs.1.34 crore in FY17. The net profit surged 4.03 per cent to Rs.37.52 crore in FY18 from Rs.36.06 crore in FY17. 

On an annual basis, the EPS increased to Rs.2.90 in FY18 from Rs.2.78 in FY17. The OPM fell to 94.81 per cent in FY18 from 198.81 per cent in FY17 and the NPM dropped to 77.67 per cent in FY18 from 145.40 per cent in FY17.  

Although the company did not declare dividend during the FY2017-18, it has invested its earnings in pursuing exploration opportunities and towards developing discoveries in its existing portfolio. During FY2017-2018, the company achieved a debt-free balance sheet with the option of self-funding growth commitments by means of its growing cash flow from operations. It has a strong liquidity position with cash and cash equivalents of Rs.118.13 crore. It has a successful track record of raising cash when required to fund growth opportunities. In comparison to the performance of the previous fiscal, the company has done remarkably well in FY2017-18. Its gross operated production has multiplied five-fold and its revenue from operations has doubled. Owing to these factors, we recommend our reader-investors to BUY the stock.

Parag Milk Foods

BSE CODE 539889 Face Value Rs.10
Market Cap F F (Cr.) 995.67
CMP Rs. 232.10 


Here is why
Positive quarterly financial 
performance 
Bullish outlook on future 
prospects 
Competitive edge


Parag Milk Foods (PMF) is engaged in manufacturing, processing, branding and distributing a range of dairy products. It has seven brands namely – Avvatar, Gowardhan, Go, Topp Up, Milkrich, Slurp and Pride of Cows. The company offers a diverse portfolio of products including cheese, ghee, fresh milk, whey protein, paneer, curd, yogurt, milk powder, and dairy based beverages. The company claims to be the only company in India to derive all its products from 100 per cent cow’s milk. 





PMF exports its products to a number of countries such as UAE, Singapore, Oman, Kuwait and Australia, to name a few. In FY18, the company reported an export turnover of Rs.59.64 crore as against Rs.56.82 crore in FY17, registering an increase of 4.96 per cent. 

The company's consolidated quarterly financials present a positive picture. The company's net sales rose 6.10 per cent to Rs.549.42 crore in Q1FY19 from Rs.517.83 crore in Q4FY18. Its EBITDA was reported at Rs.59.74 crore in Q1FY19 in comparison to Rs.55.10 crore in Q4FY18, registering a climb of 8.42 per cent. The net profit went up by 8.06 per cent to Rs.28.26 crore in Q1FY19 from Rs.26.15 crore in Q4FY18.

On a consolidated annual basis, the company's net sales increased 12.92 per cent to Rs.1,954.50 crore in FY18 as against Rs.1,730.73 crore in FY17. The increase in Positive quarterly financial performance Bullish outlook on future prospects Competitive edge Here is why revenue is attributed to growth in value-added products and product mix to remain in sync with evolving consumer preferences. The EBITDA demonstrated a staggering increase of 78.71 per cent to Rs.193.28 crore in FY18 from Rs.108.15 crore in FY17. The net profit increased a whopping 408.46 per cent to Rs.87.05 crore in FY18 in comparison to Rs.17.12 crore in FY17. 

With farmers readily available in the vicinity of its operations, PMF is adept at procuring raw milk at competitive prices. Its key area of focus is on assisting milk producing farmers boost their productivity and reduce cost of production, thereby making it inexpensive for the masses. The company has a bullish outlook on its future prospects as it enjoys strong partnerships with major institutional buyers across the country. 

During FY2017-2018, the company strengthened its relationship with farmers, expanded production capacities and launched new products. Two-third of its portfolio is composed of valueadded products. With renewed focus on enhancing value addition, increasing distribution reach and great R&D resources, the company is on the path of growing profitability. Its business strategy involves growing its consumer business to become a major FMCG player. By virtue of these factors, we recommend our reader-investors to BUY the stock

Repco Home Finance Ltd

BSE CODE 535322 Face Value Rs.10
Market Cap F F (Cr.) 1,450.62
CMP Rs. 368.05 


Here is why
Attractive valuation
Good financial performance
Growth opportunities in housing
finance sector


Repco Home Finance Ltd. (RHFL) is a registered housing finance company with the National Housing Bank (NHB). With 131 branches and 29 satellite centres, it offers institutional credit support tailored to meet the specific requirements of individuals.



Looking at the quarterly financial performance, we observe that the revenue was reported at Rs.286.93 crore in Q1FY19 versus Rs.283.25 crore in Q4FY18, registering a growth of 1.29 per cent. The EBITDA climbed 5.27 per cent to Rs.261.41 crore in Q1FY19 versus Rs.248.32 crore in Q4FY18. Its net profit went up 7.55 per cent to Rs.60.90 in Q1FY19 as against Rs.56.62 in Q4FY18.

The revenue from operations climbed 4.77 per cent to Rs.286.93 crore in Q1FY19 from Rs.273.86 crore in Q1FY18. Its EBITDA rose 4.96 per cent to Rs.261.41 crore in Q1FY19 from Rs.249.05 crore in Q1FY18. The net profit increased 8.82 per cent to Rs.60.90 crore in Q1FY19 from Rs.55.96 crore in Q1FY18.

The revenue from operations stood at Rs.1105.43 crore in FY18 versus Rs.1044.18 crore in FY17, posting a rise of 5.86 per cent. Net profit surged 14.74 per cent to Rs.215.31 crore in FY18 from Rs.187.65 crore in FY17. The net interest margin was 4.6 per cent in FY18 versus 4.4 per cent in FY17. While the return on assets remained constant at 2.2 per cent from FY16 to FY18, the return on equity decreased to 17.6 per cent in FY18 from 18.2 per cent in FY17. The capital-to-risk weighted assets ratio (CRAR) lowers the risk of insolvency by ensuring that banks have sufficient cushion to absorb losses without losing depositors’ funds. In the event of liquidation, the depositors’ funds have priority over the bank’s capital. The only way depositors will lose their savings is if the bank registers losses greater than the amount of capital it possesses. Thus, the higher the CRAR, the greater the degree of protection of depositors’ assets. The CRAR reported by RHFL stood at 23.04 per cent in FY18 versus 21.30 per cent in FY17. Additionally, the net NPA figure has declined to 1.3 per cent in FY18 from 1.4 per cent in FY17.

 The housing finance sector as a whole is flourishing due to burgeoning population (growth at 1.3 per cent p.a.) and rapid urbanisation. However, it would be prudent to consider the ramifications of economic slowdown and rising interest rates on the demand for housing and housing finance. RHFL boasts a proven track record of containing loan losses at minimal levels and has garnered insights in underwriting the risks associated with lending in underpenetrated markets such as the non-salaried class. Owing to these factors, we recommend our readerinvestors to BUY this stock. (Closing price as of Oct 09, 2018)

Methodology

Mid-cap 250 Ranking Methodology


It is again that time of the year when we bring on plate the top 250 mid-caps. We have ranked companies with market cap between Rs 1000–Rs 5000 crore. The ranking considers the highest market cap, sales and net profit. While arriving at the ranking, the financial performance is the first criteria and, therefore, we consider two primary factors – sales and net profit. So, the companies with highest sales and net profit tend to be ranked higher than the other companies. As the share price is the main market factor, we have considered market capitalization as the third factor for ranking. Along with share price, investors are also keen to know the dividend they can expect from the mid-cap companies. Hence, we rebase the dividend on Face Value (FV) of 10 to provide a common platform to measure the returns. Assigning equal weights to these parameters, we assign a cumulative rank. Please note that we have evaluated the companies during the last week of September. Also, these are rankings of companies based on the above listed parameters and should not be considered as recommendations. We hope it provides our readers information to make good investment decisions.

Click Here to Download 250 Mid-Caps Databank

 

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