Ravi Shenoy, Asst Vice President (Mid-cap Research), Motilal Oswal Securities talks to Puneet Wadhwa on the outlook for the mid-cap space and the stocks that one can buy at the current levels. Edited excerpts:
Mid-cap space has seen a lot of unwinding since the past few sessions. What do you attribute this to? Do you expect this trend to continue?
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As small companies, mid-caps have been facing working capital pressure from larger clients given tight money situation. Given that the liquidity situation is likely to be tight one may not expect any near-term breather on this front for mid-cap companies. This could continue until the end of the financial year end with pressure in the form of planned government disinvestment, delayed and reduced GOI spending and advanced tax outgo.
Further, earnings have not been enthusing given the negative IIP (index of industrial production) and low growth in other segments of the economy. Performance in the mid-caps space will continue to remain stock specific until the risk-taking appetite of investors comes back.
Do you find value in any of the mid-cap public sector (PSU) banks at the current levels?
We believe that valuations of mid-cap banks will recover from the 0.6-sub1x book levels currently to 1.5-2x book over the next two – three years. Over the past two years, PSU banks have underperformed significantly, led by sharp increase in slippages / restructured assets and deterioration in operating performance led by fall in margins.
With expectation of economic recovery and monetary easing in FY14, we expect stress in balance sheet to peak out in 1HCY13. Banks' SLR portfolio is at a multi-year high which will benefit in a falling interest rate regime.
Valuations have seen some recovery and PSU banks now trade around Long Period Averages. Improvement in asset quality trend would be a key catalyst. Our preference amongst smaller PSU banks is for Andhra Bank, Dena Bank and Corporation Bank.
As a strategy, is it a good time to shift to the defensives – FMCG and Pharmaceuticals? Are there any stocks in these two spaces that you can recommend from a medium-term perspective?
We recommend some amount of exposures to FMCG and Pharmaceuticals in the portfolio at any point of time. In the consumer space, we like Bata India and Bajaj Corp and would recommend these stocks for investors.
In the mid-cap Pharma space we are recommending exposures to FDC and Unichem to benefit from increase in exports. FDC, also, has an ongoing buyback which will support valuations and boost ROE. Amongst slightly larger companies, we like IPCA and Torrent Pharma.
How has the December quarter results season panned out thus far for the companies in the mid-cap space, according to your analysis? Are there any key observations / trends that you can share with us?
The quarter has been a mixed bag with its set of positive and negative surprises. Consumer facing companies continue to do well, but companies with capital intensive models continue to lag. Cement and Auto-ancillaries have had muted performance in our coverage companies. NBFCs continue to grow at a strong pace, but valuations have been more influenced by and now factoring in potential banking license.
A lot of mid-cap media and entertainment, cement generated a lot of investor interest recently. Do you like any stocks in these spaces given the valuations and the outlook?
Though we do not formally cover companies in the mid-cap broadcasting space, we have a positive bias towards them. We like companies in the mid-cap newsprint space such as DB Corp and Jagran Prakashan.
In the cement space, we estimate EPS growth of around 42% CAGR (FY13-15E) for MOSL mid-cap Universe, translating into around 550 bps RoE improvement as against around 180 bps RoE improvement for the large-caps. Narrowing of the operating performance gap will drive re-rating. We recommend a Buy on Birla Corp, Dalmia Bharat, JK Cement, JK Laxmi Cement, Orient Paper Industries, Madras Cement and India Cement.
