Despite crash, analysts upbeat on mid-and small-caps

In May alone, the S&P BSE Mid-cap index has surged 20.2%, while the S&P BSE Small-cap index has moved up 23.87%

Usually, a market rally is considered to be in its last phase when it spreads to mid-cap and the small-cap segment. The recent market frenzy, too, has seen mid-and small-cap stocks hit multi–year highs. While the S&P BSE Mid-cap index is now trading at its highest level since November 2010, the S&P BSE Small-cap index has hit its highest level since July 2011.

In May alone, the S&P BSE Mid-cap index has surged 20.2%, while the S&P BSE Small-cap index has moved up 23.87% till date. In contrast, the benchmark indices – the S&P BSE Sensex and the CNX Nifty have gained 11.6% and 11.4%, respectively.

On Monday, however, the rally came to an abrupt halt as investors decided to cash–in gains ahead of the swearing-in ceremony of Narendra Modi as the country’s 15th Prime Minister.

Both the mid-and small-cap indices closed over 2% lower on Monday. On an intra-day basis, both the indices saw a sharp decline of nearly 6%.

Despite the fall, analysts say, the positive sentiment in this market segment is here to stay. Monday’s fall is a mere correction given the sharp rally, they suggest.

“The fall in the mid-and small cap segments seen on Monday is purely profit booking. These stocks had run up sharply over the past few sessions. I feel that the overall positive sentiment is still intact but one has to be careful while stock selection,” said Ravi Shenoy, assistant vice president (mid-cap research), Motilal Oswal Securities.

But why are the analysts so upbeat about this space?

First, the rally in select small caps has been backed by an improvement in financial performance in the recently concluded quarter. The aggregate net profit of 196 small–cap companies which have so far declared their March quarter results has risen an average 34% over a year to Rs 2,932 crore, data suggests.

Second, analysts believe that the worst may be over for the economy and a turnaround in the macros will also help companies in the mid–and the small–cap sectors gain financial muscle.

“We expect GDP (gross domestic product) growth to accelerate from 4.6% in FY14 to 6.5% in FY16, driven by an improvement in investment demand and stronger exports. We expect investment demand to recover mainly due to a favourable base, removal of election-related uncertainty, project clearances being fast-tracked, and a revival in animal spirits on the back of rising equity prices and improving liquidity conditions,” points out Tushar Poddar, chief India economist at Goldman Sachs.

Third, with the election outcome uncertainty over, analysts expect reforms to pick up pace that will help revive capex cycle, which, in turn, will benefit the companies in the mid-and small-cap segment. Moreover, most industries that comprise the mid-cap are feeders to the large caps. An improvement in the economy can see a turnaround in their fortunes as well.

“As evident in its election manifesto, the BJP-led NDA government intends to put its emphasis on addressing economic issues. This means key reforms crucial to business are more likely to be pushed through. Modi’s immediate objectives are likely to be to restore macroeconomic stability and revive investment, especially in infrastructure,” says Sukumar Rajah, MD & CIO, Franklin Templeton Local Asset Management, Asian Equity.

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So where should you invest now? Since most of the stocks from these segments have suffered in the last five years due to a combination of domestic slow down and mid cap value contraction, and have now run up sharply, analysts suggest that investors need to be cautious.

“Given the volatility in the market, it is possible that the market will have bouts of ups and downs and we advise investors to buy into every correction in the market as we believe that the resurgent structural story is yet to begin, suggests R Sreesankar, head – institutional equities, Prabhudas Lilladher.

 
“JK Lakshmi Cement, Texmaco Rail, Titagarh Wagons, AIA Engineering, Dewan Housing Finance, Astra Microwave, Elecon Engineering, Gati, Finolex Cables and Bajaj Electricals are some of the companies which we believe have great potential to give handsome returns,” he adds.

Says Shenoy of Motilal Oswal: “There is more steam left in a lot of stocks in the mid-cap space. Stocks from the automobile sector have seen some run-up but there is still some scope there. We like WABCO India and Suprajit Engineering. Selectively, there is some scope for re-rating in the engineering space. We like Finolex Cables, Lakshmi Machine Works (LMW) and AIA Engineering here. Consumer and IT stocks have been beaten down. I feel there is value in that space as well. V-Mart Retail, Berger Paints and Bajaj Corp are a few stocks we like in the consumer pack.”