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The recent fall in mid-cap stocks left many investors saddled with huge losses, as share prices dropped drastically due to selling pressure across many counters. However, some mid-caps have fared well, outperforming the broader indices consistently in the past three months. These include Piramal Enterprises, Godrej Consumer, Kansai Nerolac, Sanofi India and GMR Infra.
Experts believe a selective approach towards mid-caps could work well in the coming months, even as markets might face headwinds. “Companies with bad management and poor balance sheets are getting hurt. However, there are quite a few companies that are holding (ground). I think at this point, one should be stock-specific and look for quality companies,” says Raamdeo Agrawal, joint managing director of Motilal Oswal Securities.
Apart from fundamental issues, analysts feel concern also stems from a possible increase in supply, especially in counters in which the level of pledged shares is high. “A large part of the problems in the mid-cap space comes from the selling of pledged shares of promoters and investors, leading to erosion in the market capitalisation of many companies. But I think a large part of the pain is over,” says Deven Choksey, managing director of KR Choksey Securities.
Among the key factors investors should keep in mind while investing in mid-caps are growth visibility, low debt, dividend track record and a low proportion of pledged shares.
Choksey favours two stocks in the mid-cap space — Jain Irrigation and Sterlite Technologies. He believes for Jain Irrigation, the sharp correction provides an opportunity to buy, with a target of Rs 90 a share. The changing revenue mix, efficient working capital management in FY14 and rupee appreciation are likely to have a positive impact on the company’s financial health, he says. Also, the concern on receivable days is likely to be resolved in a few quarters.
Choksey says in the case of Sterlite Technologies, capacity expansion in the power conductor and telecom products segments would lead to strong revenue growth in the near future. Currently, the stock is available at eight times the price-to-earnings ratio, based on FY14 estimated earnings.
Though there is potential for gain in the mid-cap space, there are risks as well. Therefore, there is a need for extreme caution. Harendra Kumar, head (institutional equities and global research) at Elara Securities, says selling pledged shares has been a major factor behind the fall in prices across mid-cap counters. He says there are worries about earnings visibility, too. “If the economy contracts, mid-cap companies would be impacted the most. For example, if Maruti has a lower revenue visibility, it would have a cascading impact on auto ancillaries. Likewise, if Tata Steel is ready to sell steel at lower prices, smaller steel producers would see erosion in margins and earnings,” he says.
Experts believe through the next two to three quarters, mid-cap companies could face significant growth challenges if the economic environment doesn’t improve. To deal with the situation, Harendra Kumar suggests investors could look at companies whose fundamentals and business prospects are less vulnerable, dividend yield is high and leverage is low. Such stocks include Jammu and Kashmir Bank, Navneet Publications and Entertainment Networks, which are debt-free companies and have good business prospects. Currently, these are offering good dividend yield. Companies such as Pidilite Industries, Wyeth and Monsanto are expected to outperform.
Vishal Jajoo, who tracks mid-cap companies at Nirmal Bang Securities, believes 80 per cent of the hurdles in the mid-cap space have been crossed. He says investors need to be cautious and focus on the stocks of companies in which promoters have high stakes (unpledged). His favourite stock, he says, is VST Tillers. The company has inherent value, in terms of land bank and solid business, and is virtually debt-free, he says, adding it is expanding capacity 130 per cent through internal accruals.
