Web Exclusive: Should you invest in mid-and-small caps?

While the large-cap stocks found it difficult to find their feet amid volatility and the uncertain market conditions in calendar year (CY) 2013, mid-and-small cap counters have taken it on their chin.

The S&P BSE Mid-cap index has lost nearly 19 per cent in CY2013, while the fall in the S&P BSE Small-cap index has been steeper at 24.2 per cent year-till-date (YTD). This is as compared to 2.4 per cent drop in the S&P BSE Sensex and 0.4 per cent YTD fall in the CNX Nifty.

Among individual stocks, Gitanjali Gems, Financial Technologies, MCX, Future Retail, Wockhardt, HDIL, Pipavav Defence and Offshore, Jet Airways have slipped between 33 – 90 per cent YTD. Mid-cap banking stocks like Indian Bank, Dena Bank, Oriental Bank of Commerce (OBC), Andhra Bank, Allahabad Bank, Karnataka Bank, Federal Bank and Corporation Bank have lost between 46 – 64 per cent in this period.

In the small-cap space, stocks like Core Education, Educomp Solutions, Simplex Infra, IVRCL, Kingfisher Airlines, D B Realty, Opto Circuits, MTNL and Raymond have seen their prices slip between 46 – 95 per cent in 2013.

“Tight liquidity and higher interest rate outgo has been a drag on the financial performance. Moreover, the demand has also seen a slowdown and all this is getting reflected in the index of industrial production (IIP) figures and the GDP (gross domestic product) numbers. Gross margins have also been under pressure given the rise in raw material prices. All put together, this has either resulted in reduced cash flow or negative cash flow for the companies in this space. As a result, shareholder wealth got eroded. While in the short-term festive demand can change this scenario, easing liquidity condition and improving cash flows will not happen in a hurry,” points out Ravi Shenoy, assistant vice-president (mid-cap research), Motilal Oswal Securities.

“From a market perspective, investors typically take refuge in the large-cap stocks in uncertain times. As a result, the mid-and-small caps get beaten down and even a slight hint of optimism sees these stocks gain considerable ground,” he adds.

Outlook

Analysts suggest that if the markets consolidate from here-on, one can get a good return from stocks in the mid-cap pack. However, if they were to correct again and the rupee depreciates on any concerns regarding how the US economy is shaping up, the rally (if any) in the mid-caps will be short-lived.

“We recommend being very selective in this space while investing. One needs to have one-year plus horizon. We are positive on AIA Engineering, Triveni Turbines and Swaraj Engines. Realty sector is going through a tough phase right now. However, one way of playing this space is through the housing finance companies (HFCs) that will stand to benefit from an increase in liquidity from a long-term perspective. Gruh Finance and Repco Home Finance are investment-worthy stocks in this space,” suggests Shenoy.

As regards the mid-cap information technology pack, Nick Paulson-Ellis, India Country Head, Espirito Santo Securities expects increasing pricing pressure and a narrowing valuation discount versus larger peers.

“Polaris Financial Technology is our preferred mid-cap pick at present, given the possible acquisition of its services business by Tech Mahindra or NEC, and even if that doesn’t play out in the near term, we should see an improvement in margins in the services business in Q2 versus a decline last quarter on the back of a weak INR. We think it is also inexpensive at 5x FY15E,” he says.

As regards the banking pack, analysts advise investing in these stocks only if one has a two–three years perspective. “It doesn’t make sense taking a short-term call here. On the consumer side, the stocks have run-up. However, there are selective pockets like Bajaj Corp, Supreme Industries and Berger Paints where one can invest from a 12 – 18 month perspective,” Shenoy of Motilal Oswal Securities suggests.

Arun Baid, an analyst with IDBI Capital maintains a ‘buy’ call on Gujarat Pipavav Port, Symphony, Talwalkars Better Value Fitness and a ‘hold’ rating on Everest Kanto Cylinder and Havells India.

Karvy Institutional Research maintains a 'buy' recommendation on Arvind, Kewal Kiran Clothing, Maxwell, Page Industries, Raymond, Siyaram Silk Mills and Vardhman Textiles among the mid-and-small cap stocks in the textiles segment. In the real estate segment, Oberoi Realty, Sobha Developers, Puravankara Projects and Kolte Patil are their preferred picks.