Midcap stocks hit by lower earnings growth, FII exits

Midcap and smallcap stocks, despite the recent spike in the stock market, are continuing to languish. Since November 20, the Bombay Stock Exchange (BSE) midcap index has lost 23 per cent. In comparison, the BSE-30 has fallen much lesser at 12 per cent.

Over a three-year period, since January 9, 2008, the midcap index has lost 36 per cent. And they might continue to do badly in the near term as well.

Among the top 750 companies by market capitalisation, the top 10-15 per cent companies are large cap and the rest 80-85 fall under the mid- and small-cap companies. The market capitalisation data is a three-month average market capitalisation and liquidity. Over the next six months, high inflation will deflate margins further due to higher raw material, employee and interest costs and continue to hurt them. The midcap companies posted a moderate growth in earnings in the first nine months of FY11, so the short-term outlook has weakened further.

While the concerns — inflation, rising crude prices, the rising fiscal burden, and a spate of scams — that are hurting the large-cap stock continue to be same, these stocks have also suffered because of less interest shown by the foreign institutional investors (FII).

The FIIs holding in midcap companies rose gradually from around 5.13 per cent in December 2004 to over 10.8 per cent in December 2006 and peaked at around 13 per cent in December 2007. The holding declined thereafter has stagnated at 10-11 per cent, as it was December 2008 and 2009.

The fall in the midcap segment was led by the FIIs exit in several midcap stocks. The FIIs holding in 20 midcap companies fell more than 10 per cent while in another 100 plus firms it decline between 1 and 10 per cent. The value erosion in these stocks was over 50 per cent.

In some stocks, FIIs entered as well, in about 28 per cent stocks, leading to an outperformance. For example, Manappuram General Finance gained seven fold in three years as the FIIs holding rose from miniscule 4 per cent in March 2008 to 30.3 per cent in December 2010. Emami appreciated 120 per cent as the FIIs stepped holding by 13 per cent to 14.8 per cent while McLeod Russell up 196 per cent on account of 12 per cent rise in the FIIs holding.

The strong earnings growth also helped some midcap companies to appreciate handsomely in the last three years. For example, the market value of Zydus Wellness, Whirlpool India, Coromandel International, Rallis India and Glodyne Technologies up more than 200 per cent each.

Fundamentally the 257 stocks, part of the BSE midcap Index, have been reporting a moderate performance during the past two financial years. They performed well in 2008 posting a 33 per cent growth in net profit, but in the following year there was a 23 per cent decline in net profit on account of global crisis. In 2010, net profit rose by 22 per cent and in the first nine month of the current financial year the net profit growth rate slipped to 13 per cent.

Among midcap stocks, underperformance was clearly evidence in sectors such as oil exploration, realty, infrastructure, construction, air services, power, ship building, steel and several others. Smaller steel companies really struggled to sell. Logistic bottleneck due to strict enforcement of rules and poor end demand affected their margins.