Vinod Nair of Geojit said the selloff in the mid and smallcap space can provide a value buying opportunity when the market turns around
The continuous fall in mid and smallcaps may not sustain for the long term. This can provide a value buying opportunity, which will reward investors, when the turnaround happens.
Mid and smallcaps underperformed by 13 percent and 20 percent from their respective 52-week highs till June 15. Weakening of domestic macro, outflow by foreign funds and selling by mutual funds resulted in increased volatility in the mid and smallcap space.
Premium valuation, rising interest rates and falling rupee-dollar impacted. On the valuation front, the gap between mid and largecaps narrowed. On a 1-year forward basis, midcaps are trading at a price-to-earnings of 20.8 times versus 17.5 times for largecaps. Smallcaps are trading at a discount of 22 percent at 13.7 times.
Though mid and smallcaps are risky as compared to largecaps, they are rewarding too (especially high-quality stocks) given their flexibility and scale of the opportunity. Any correction should be used as an opportunity to buy and accumulate these stocks.
2018 had started on a positive note in expectation of a pick-up in earnings, led by the easing of concerns around Goods & Service Tax and demonetisation. But the actual performance was below expectation.
India started to underperform compared to other emerging markets (EMs), which were falling given the increase in global risk. A pick-up in economic activity and a normal monsoon is providing reasons to accumulate midcap stocks.
Historically, we have seen many scenarios that have resulted in a correction in mid and smallcaps. When one looks at last year specifically, if demonetisation was a bolt from the blue, then GST was a planned action. All these had an initial negative impact on mid and smallcaps, resulting in investors losing their faith in the sector.
But it was viewed as a positive development as it made strong financial sense, leading to an upgrade in valuation. The set of stocks and sectors that were anticipated to be positively impacted were rewarded as the turnaround happened.
Recently, we are seeing some respite in the market led by positive economic data (Q4 FY18 GDP, April IIP) and proactive rate hike decision by the Monetary Policy Committee.
The carnage in mid and smallcaps is likely to ebb as a large portion of a kneejerk downgrade in earnings is over. Domestic political risk is now being factored in and there are hopes of a revival in the business outlook going forward.
The consumption story is getting better led by GDP growth, improvement in rural market and a positive start to the monsoon. We anticipate a bounce in the market given the attractive pricing and ease in valuation.
Midcaps continue to trade at premium valuations, but the gap between largecaps has narrowed. Smallcaps are trading at a discount compared to the Nifty due to the recent underperformance in pricing and earnings.
Here is a list of top 3 stocks that could return 10-15 percent in the medium term:
Bata India Ltd: Buy| CMP: Rs 824| Target: Rs900| Return 9.2 percent
Bata India Ltd (BIL) is the largest footwear retailer in India having 1,290 stores as of 31st March 2018. To accelerate growth by tapping opportunities in small cities, BIL is planning to add 300-350 stores via franchise route in the next 3 years and has identified 435 small cities in India.
BIL’s plan to increase its advertisement spending to 2.5 percent of sales in FY19 will drive an increase in footfalls. The franchise route expansion strategy will reduce fixed costs.
We expect revenue growth will be boosted by a revival in rural demand aided by good monsoon, government focus on rural, store additions, new launches, and higher advertisement spending.
TVS Motor Company Ltd: Buy| CMP: Rs 591| Target: Rs 691| Return 15 percent
TVS Motors (TVS) is the third largest two-wheeler manufacturer in India with a market share of 14 percent in FY18. During Q4FY18 TVS registered a revenue growth of 40 percent on a YoY basis largely led by 32 percent volume growth and superior product mix. PAT grew by 31 percent YoY.
Increased penetration in the high margin premium motorcycle is becoming a game changer for the company. The company registered a 31 percent YoY growth in its premium flagship brand Apache 150 during FY18 and also the executive segments remained robust at 19 percent YoY due to lower base and strong rural demand.
We factor 19 percent/33 percent CAGR in Revenue/PAT over FY18-20E driven by improvement in export, revival in rural demand and growth in the urbanisation for high margin premium motorcycles.
Vinati Organics Ltd: Buy| CMP: Rs 985| Target: Rs 1,106| Return 12 percent
Vinati Organics Ltd (VOL) is a global leader in two speciality chemicals IBB & ATBS. In Q4FY18 VOL witnessed strong traction in its ATBS business driven by the exit of Lubrizol from the market.
Whereas, the off-take in IBB segment was impacted by prolonged shut down of plants due to de-bottlenecking of VOL’s client capacity.
Going forward, with higher off-take led by demand uptick from IBB in FY19E and pass through of higher cost, we expect EBITDA margin to improve.
Further, ATBS will continue to drive overall revenue growth & profitability led by strong demand, capacity expansion and incremental volumes led by the exit of the competitor from the business.
Given healthy earnings outlook of 21 percent CAGR over FY18-FY20E, we remain constructive on the stock.
Disclaimer: The author is Head-Fundamental Research at Geojit Financial Services Ltd. The views and investment tips expressed by investment experts on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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