Size Does Matter: Midcaps Can Bring That Fortune For You In 2016

Wisdom whispers that midcaps conventionally imitate the directional movement of the big brother large- caps. However, they exaggerate the movement in either direction. Therefore, when large cap index, which is generally represented by the frontline indices such as BSE Sensex or Nifty 50, goes up, midcaps too move up but at a faster pace.

Similarly, when they fall, midcaps fall faster than large cap companies. That stays as a rule of this game and we need to stay exposed to it as irrespective of markets’ movements, this rule remains constant, never changed or challenged.

But then, we are oflate experiencing a different story in terms of their directional movement. This year till date (December 18), the frontline index Sensex are lower by seven per cent compared to BSE midcap, which is up by five per cent during the same period. Although, midcap tend to outperform large cap in long run, in shorter run the direction remains the same. But there is even a direction divergence between them in the last three months, six months and even in one year. While in all these days, Sensex has given negative return, midcaps have given positive returns thus ensuring some bit of smile on the face of the investors.

This anomaly is explained by the heavy under-performance of midcap segment, years prior to 2014. For instance, during calendar year 2013, while Sensex was up by good 8.5 per cent, BSE midcap index was down by almost six per cent, an outperformance by almost 15 per cent by the Sensex. Nevertheless, in longer run, midcap companies have always outperformed the larger ones. For example, between 2005 and 2015, the CNX Midcap basket of 100 stocks has delivered annual returns of 11 per cent compared to 9 per cent by Nifty in the same period.

Hence Midcap stocks remain a perfect basket for all those investors who are looking for the multi-bagger idea. The reason why midcap stocks give better returns in longer run is due to their unique positioning. They have already passed the phase of being small and all the vagaries associated with small cap companies. Moreover, in most of the cases they are in the process of scaling up of their business and take hold of larger opportunities. Besides this, lower base also helps them to clock higher growth numbers.

As India remains one of the fastest growing major economies in the world, it is well positioned to nurture midcap companies. As our economy grows, it opens up new business opportunities and sectors which introduce new midcap companies. And as these sectors mature, midcap companies in these sectors grow into mature large cap stocks. Befitting examples of this is Indian IT sector during ‘90s and telecom sector during early 2000, which saw companies like Infosys and Bharti Airtel emerging as large cap companies and in their transition from midcap to large cap made many of their shareholders rich. Therefore, investors should have confidence in midcaps that are aspiring leaders in their respective sectors.

What is also good for investors is the breadth and depth of midcap companies that can be found across the sectors and you can create a well-diversified midcap portfolio. Although any individual midcap stocks may get impressed by the sector or company specific issue, it is quite possible to build a portfolio of mid cap stocks that will thrive irrespective of market movements.  Our recommendations at the fag-end of 2012 on midcap (we did not carry any special issue on Midcap in year 2013&14) reveals the fact.

[PAGE BREAK]

However, this does not mean that all mid-cap stocks would do well, going forward. This is especially true in current scenario when the midcap stocks have outperformed the large cap stocks by such a huge margin and trading at a higher valuation. If we look at the valuation of midcap index, they are trading at premium to the large cap index. For example, trailing price to earnings (PE) ratio of S&P BSE Midcap is currently at around 26 compared to PE of 21 times of S&P BSE SENSEX. It is highest in last 10 years. Most of the times we have seen that the midcap stocks or their indices have traded at a discount to the large cap stocks.

However, as market expected the change of guard at the Centre, they moved ahead of the earnings. From December 2013, when BJP led NDA won three states’ elections and there were indications that the performance will be repeated in the general elections, midcap stocks moved ahead of their earnings. Since December 2013, BSE midcap index has gone up by 73 per cent while their earnings are yet to show the similar rise and hence there was expansion of trailing twelve month PE ratio from 14.4 to 26 times.

Therefore, before investing in midcap stocks at current juncture, you should be more cautious and check all the boxes of prudent investment. You should not be carried away by the recent outperformance and should check for quality of management, scalability of business, financials including sustainability of earnings growth and valuation before committing your fund.  With a relatively large universe of stocks to choose from, stock-selections play a very important part in midcap investing.

Hence in this issue we are giving list of 250 midcap companies that are not our recommendations but you can definitely start this list as first filter.  Along with this list we are also making 10 recommendations of midcaps that are likely to give you superior returns over next 1-3 year time horizon. Depending upon your risk profile, you may have exposure of between 10-15 per cent of the entire portfolio in mid cap stocks.

Our earlier story on midcap done in the month of December 2012 has surpassed our expectation. Since then all our recommendations have outperformed the midcap indices returns by huge margin in the same period.

• A leading EPC and turnkey service provider for power T&D, BSL (previously BS Transcomm) is currently executing more than 2000 kilometres of transmission line, 43 substation projects and electrifying more than 10,000,0 homes across India.

• The company has forayed into Build–Own–Operate–Maintain (BOOM) project with Patel Engineering and Simplex Infrastructure and operational since June 2014 with constant annuity revenues for a period of 35 years.

• BSL has plans to acquire businesses from Agarwal Steels Structures India, Durafast Automotive, NHS Metals and Rajesh Sandhi Infras & Metals for a total investment of Rs 937 crore. With the new acquisitions, the company aims to achieve revenues of Rs 10,000 crore in the next 2-3 years.

• On financial front too, BSL reported a revenue growth of 64 per cent in H1FY16 to Rs 1993 crore and a profit growth of almost 28 per cent to Rs 44 crore in H1Fy16 on yearly basis.

• On valuation front, the stock is trading at PE ratio of 16.53x and its trailing twelve months EPS and attractive with its peers.

• Rupa is the unquestioned numero uno knitwear brand in India, covering the entire range of knitted garments from innerwear to casual wear. Rupa has evolved to become the frontrunner in India and a leading player in global markets with far-reaching footprints and millions of satisfied customers.

• Rupa’s Q2FY16 revenues increased 4.5 per cent to Rs. 268.7 crore and PAT grew by 75 per cent to Rs 29.1 crore on yearly basis over one time exceptional income due to dividend received from the subsidiary to the tune of Rs 12.3 crore.

• Rupa has more than 18 brands and has a strong brand recall. Rupa has been consistently involved in robust advertisement and brand promotion activities and spending around 7 to 8 per cent of total revenues on marketing expenses.

• As the country approaches the winter season, the new TV Commercial (TVC) of Rupa Torrido has launched to encourage Indians to choose Torrido Premium to stay warm and comfortable. Torrido is a premium range of thermals from the House of Rupa.

• On valuation front, the company’s stock is trading at a PE ratio of 31.67x its trailing twelve month EPS.

[PAGE BREAK]

• Kwality offers a new range of innovative products and enjoys a large presence in northern India. The company has various milk processing plants: four in UP and one each in Haryana and Rajasthan and has a capacity to handle around 3 million litres of milk per day.

• Kwality's revenue increased by 10.49 per cent to Rs 1433 crore in Q2FY16 on a yearly basis. Its operating profit boosted by 20.58 per cent to Rs 95.25 crore in Q2FY16 on yearly basis. The company's bottom line also rose by 3.64 per cent in Q2FY16 as compared to same period in previous fiscal year.

• Kwality is going to establish 12 to 16 outlets by current financial year. Recently, the company roped in Akshay Kumar as a brand ambassador for entire range of dairy products. It also planning to launch value added products such as flavoured milk, variants of cheese, tetra pack milk in next 3 to 12 months times period.

• Kwality’s share is available at trailing twelve month PE multiple of 16.34x which is cheaper as compared to industry PE of 32.18x.

• Repco Home Finance (RHFL) provides long term loan financing for residential purposes. The company has presence in 11 states and 1 Union Territory with 108 branches and 38 satellite centres.

• RHFL's net sales increased by 27.45 per cent to Rs 402 crore in H1FY16 on yearly basis. The housing finance company reported net profit of Rs 69.28 crore in H1FY16 with a growth of 20.42 per cent on yearly basis.

• The housing finance company's net interest margin stood at 4.4 per cent in H1FY16 with marginal reduction of one basis point as compared to same period in the previous financial year.

• RHFL has a healthy position across asset quality front as net NPA stood at 0.92 per cent amounting to Rs 62.37 crore in H1FY16 with increment of 11 basis points on yearly basis.

• Reserve Bank of India (RBI) reduced the risk weight for individual housing loans of up to Rs 75 lakh to boost demand for low cost housing. The RBI's move will enhance government's 'housing for all' campaign. The reducing interest rate will raise demand among home buyers.

[PAGE BREAK]

• V-Guard Industries, a leading consumer electrical and electronics company, manufactures wide range of products. The majority of the products include voltage stabilizers, polyvinyl chloride (PVC), cables, pumps and motors, electric water heaters, digital uninterruptible power supply (UPS).

• V-Guard Industries revenue increased by 0.5 per cent to Rs 433 crore and PAT rose by 20.33 per cent to Rs 23.06 crore in Q2FY16 on yearly basis. On segmental revenue front, company earns 65.64 per cent from electrical and remaining 34.36 per cent from electronics segment.

• V-Guard Industries total debt to equity ratio stood at 0.18 as of FY15. The company witnessed ROE and ROCE of 20.47 per cent and 27.99 per cent respectively.

• V-Guard Industries has set up a manufacturing unit of voltage stabilizers in Sikkim, in order to cater growing demand of stabilisers in the non-south markets. The company is also exploring inorganic expansion opportunities which will drive company's success in future.

• Vinati Organics (VOL) is manufactures specialty organic intermediaries and Monomers. The company's plant located at Mahad and Lote-Ratnagiri. Its product range includes speciality monomers, aromatics and other speciality products.

• VOL's top line declined by 24.43 per cent to Rs 294 crore in H1FY16 as compared to same period in previous financial year. However, company's net profit increased by 18.21 per cent to Rs 62 crore in H1FY16 on yearly basis.

• VOL's ROE and ROCE stood at 31.12 per cent and 37.75 per cent respectively. It is very low debt company with debt equity ratio of 0.15 as of FY15.

• The company export its products 40 per cent to US, 40 per cent to the European Union and 20 per cent to Middle East and North Africa (MENA) market.

• Promoters filled trading plan to SEBI to buyback of 9 lakh shares at Rs 500 per share. After buyback promoter holdings would increase 300 basis points to 75 per cent.

[PAGE BREAK]

Kitex Garments.

• Kitex Garments (KGL) is engaged in the manufacturing of fabric and readymade garments. The readymade garments which are manufactured are exported. The company operates through two business segments: garments and fabric.

• Recently the company tied up with Lamaze International, USA for manufacture, supply of infants’ garments and for marketing of baby toys. The company is also planning to launch their own brand by October – November 2016 in the US and Canada.

• Kitex's revenue increased by 4.88 per cent to Rs 134 crore in Q2FY16 on yearly basis. Its operating profit boosted by 37.67 per cent to Rs 46 crore in Q2FY16 on yearly basis. The company's bottom line also rose by 40.57 per cent in Q2FY16 as compared to same period in previous fiscal year.

• With substantially improved financials, the recent tie-ups and expansion plans, KGL is poised to further grow in coming days.

Navneet Education

• Navneet is an educational content provider in print & digital medium, manufacturer of Paper stationery, publisher of general books has a wide range of scholastic non-paper stationary products.

• In August this year, Navneet launched TOPScorer range of product which promises to teach better with its digital dose stapled together with artificial intelligence. The objective is to make learning more scientific and interactive.

• The operating revenue of the company increased by 11 per cent in FY15 from Rs 882 crores it become Rs 979 crores. The EBITDA margin for FY15 is at 24.45 per cent compare to 23.97 per cent in FY14. Net profit increased by 13.13 per cent to Rs 200 crores in FY15.

• The company's trailing twelve month(TTM) PE ratio of 15 times compare to industry PE of 14.04 times.

• The company enjoys no debt burden. Its operating revenue is increasing at 12.30 CAGR for last 5 years. The new TOPScores will help the company to increase revenue further.

[PAGE BREAK]

• Zensar is backed by a strong track-record of innovation and a technology partner of choice for global organizations looking to strategically transform and lead in challenging business environment. Zensar operates in the US, Europe, Africa, Middle East, Singapore and Australia.

• Zensar's revenue increased by 15.66 per cent to Rs 759 crore in Q2FY16 on yealry basis. Its operating profit boosted by 25.24 per cent to Rs 129 crore in Q2FY16 on yearly basis. Company's bottom line also rose by 35.68 per cent in Q2FY16 as compared to same period in previous fiscal year.

• The EBITDA margin of the company stands at 12.86 per cent in Q2FY16 compare to 12.20 per cent same period last year. The net profit margin stands at 12 per cent compared to 10.26 per cent in Q2FY15. The Return on Equity (ROE) of the company stands at 25.19.

• On valuation front the company's trailing twelve month (TTM) PE multiple of 15.76 times a little undervalued compared to industry PE of 19.27 times.

Credit Analysis & Research

• CARE provides credit rating that helps the corporate to raise capital for their requirements and assists the investors to form an informed investment decision based on the credit risk and their own expectations.CARE's revenue increased by 5.40 per cent to Rs 78 crore in Q2FY16 on yearly basis. Its operating profit decreased by 21.91 per cent to Rs 57 crore in Q2FY16 on yearly basis. The company's bottom line also decreased by 27.78 per cent in Q2FY16 as compared to same period in previous fiscal year.

• Company enjoys good margin levels as EBITDA margin stands at 68.76 per cent in Q2FY16 compare to 66 per cent same period last year. The net profit margin stands at 48.38 per cent compared to 70.58 per cent in Q2FY15 (on the back of substantial profit from other income). The Return on Equity (ROE) of the company stands at 38.39

• The stake of DII increased to 46.39 percent in September 2015 from 44.69 percent in June 2014.

• On valuation front the company's trailing twelve month (TTM) PE multiple of 32.32 times, undervalued compared to industry PE of 57 times.