Midcap mania: Forget valuation worry, look for earnings visibility; 10 stocks to look at

NEW DELHI: The debate is on. Everyone wants to be in midcaps. That’s the way to go, they say. But which stocks should one pick? Is the risk-reward ratio favourable?

These are some of the questions haunting investors on Dalal Street for some time now.

At a time when there has been near-consensus among analysts about midcap valuations nearing the ‘rich’ one, it is wise to hunt for midcap stocks with earnings visibility. This is what CLSA and some other brokerages have been advocating actively.

Many midcap stocks are now trading at valuations above those of their largecap peers. The Nifty Midcap100 index’s valuation premium over the Nifty50 is close to an all-time high.

Brokerages such as JM Financial have cut their exposure to midcaps, while others such as Kotak Institutional Equities have dumped the entire midcap portfolio, citing excessively rich valuations.

“Most bull markets have been a function of PE re-rating rather than earnings, except in 2003 and 2008. This is what studies indicate,” Lalit Nambiar, Senior Vice President & Fund Manager (Equities), Head – Research, UTI Mutual Fund told ET Now.

“We are pretty well placed and I would not be too worried. It is a great opportunity to buy stocks that are more domestic economy-facing, maybe to some extent even the midcap names which are fundamentally sound. Because, midcap companies typically have better space around them to grow and they are more inward-looking, they are more India-focused,” Nambiar said.

Foreign brokerage CLSA believes midcap valuation premium has risen on the back of a 54 per cent consensus earnings growth projection for FY17.

“However, our analysis suggests such high growth is driven largely by a rebound in the materials/energy segments and PSU banks (NPA recognition peaking), where sustainability of such high growth could be an issue. Hence, we advise a cautious approach with preference for quality and growth visibility,” the brokerage said.

CLSA is banking on the midcaps such as Crompton Consumer, Dr Lal Pathlabs, Arvind, IndiGo, Sobha and IDFC Bank.

Prabhudas Lilladher sees value in Sadbhav Engineering, Hexaware Technologies, SpiceJet, VRL Logistics, NIIT Technologies, Navneet Education

Here a list of stocks that CLSA and Prabhudas Lilladher have picked as potential performers going forward:

CLSA

Dr Lal Pathlabs: The brokerage believes strong expansion potential with a scope to expand market share is positive for Dr Lal PathLabs. An asset-light operation model is likely to improve the overall profitability of the company, the brokerage said. The stock has risen 27 per cent in the past one month.

Sobha: This stock has fallen 3 per cent in the past one month. Over the last 12 months, office take-up in Bangalore has improved, which is positive for South-India focused Sobha. “Smaller developers are seeing the borrowing rate from banks move up - for Sobha it has edged lower. Focus on balance sheet consolidation is a positive,” CLSA said.

Arvind: The stock has surged 300 per cent in the past three years but has turned rangebound of late. CLSA believes Arvind is a play on India’s fast-growing branded-apparel market, given its stable of top foreign names, strong product lines and retail management capabilities.

IndiGo: The September quarter numbers for the company were not that good, CLSA is banking on IndiGo saying the company has proven business model and strong management team. IndiGo is best positioned to profitably leverage on India’s aviation growth, it said.

IDFC Bank: The scale-up of the banking franchise led by Casa and fees will drive profitability for the lender, the brokerage believes. In the research note, CLSA noted that “IDFC Bank has launched almost all products, beefed up teams with lateral hiring from banks/NBFCs and is now looking at scaling up the franchise.” The stock is up 28 per cent in the past one month.

Crompton Consumer: Crompton Greaves Consumer Electrical (CGCEL) was de-merged from Crompton Greaves in May 2016. CLSA said that the strategy of Crompton Consumer to build on its brand and distribution network along with new product introductions should help create a successful consumer durables franchise with industry-leading growth.

Prabhudas Lilladher

Sadbhav Engineering: The brokerage believes that the engineering company will be the key beneficiary of strong outlook in road sector and improving outlook in mining and irrigation sector.

“Healthy balance sheet and strong management gives us additional comfort. We expect company to deliver 26 per cent earning CAGR over FY16-18E,” it said. The stock is trading at core PE of 12.5 times FY18E earnings.

VRL Logistics: Strong management pedigree with proven track record, high visibility on operating cash-flows and superior returns ratios with ROE in excess of above 23 per cent is seen positive for the stock. Besides, steady margins on account of lower fuel prices and efficient use of Biodiesel are seen as other favourable factors. At present VRL trades at 17.6 times FY18E PER and 8.2 times EV/Ebitda FY18E, the brokerage said.

Navneet Education: PL pointed out that Navneet has been a value stock over the years with a payout ratio of 48 per cent. In the research note it said, “Considering RoE of 23 per cent and consistent earnings over FY16-FY18E period, Navneet is well-positioned to deliver superior returns.”

NIIT Technologies: The brokerage has a target price of Rs 605 based on 12x FY18 EPS. The stock is inexpensive, the brokerage said citing its valuations at 10.2x/9.3x FY17/FY18 EPS.

“We expect a revenue recovery in the second half of FY17 will drive stock performance,” it said.