Softening commodities and and better earnings visibility drove an uptick in indices from the lows of June last year. The Nifty Midcap index outperformed the benchmark Nifty, rising 25% from June lows as against a 9% rise in Nifty50. Overall last year in 2022, the midcaps underperformed the benchmarks, rising a little over 1% as against an over 4% jump in Nifty.
Brokerage firm Jefferies sees an earnings revival in mid-cap firms in FY2024 as commodity prices turn favourable and also expects the operating margins of midcaps to rise around 90 basis points (bps) y-o-y. Jefferies also recommends a bottom-up approach in the mid-cap space and advises investors to stay selective. It prefers themes like capex revival, housing, and PLI (production-linked incentive).
PVC prices have seen an uptick of 9% m-o-m in December 2022 to $850/MT which could improve near-term operating margins (OPM) of mid-cap firms like Supreme Industries, Finolex Industries, and Astral led by waning inventory losses. Also, LME copper has risen by 13% in Q3FY23, which would likely bode well for OPM in cables & wires, especially for Polycab, Finolex Cables, and V-Guard Industries, it pointed out. Further, the correction in crude oil by 23% in H2CY22 will likely soften natural gas prices in 2023, which augers well for Kajaria Ceramics, Jefferies noted.
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In H1FY23, midcaps posted stronger sales, up 30% y-o-y but weaker Ebitda margin, noted Jefferies. But now, many sectors like durables, tiles, electrodes are alluding to softer offtake, leading the brokerage to pencil in lower sales growth in FY24E at 16% y-o-y. Even so, select demand pockets could stay healthy, for example, private capex revival and PLI upside will be positive for Dixon Tech and Amber Enterprises, noted the brokerage. With most input commodities turning favourable, Jefferies expects average OPM for its mid-cap coverage universe to rise by +90 bps y-o-y in FY24E vs -180bps y-o-y in FY23E.
Jefferies further pointed out that with the economy resuming post Covid, uptick in capex (B2B) and housing appears to be gaining pace. As government’s budgetary allocation for infra/capex has risen notably in 2022, private capex is also on an upward trajectory, it noted. Key beneficiaries could be Polycab, Havells, and Supreme Industries.
PLI tailwind: Indian electronic manufacturing services (EMS) industry is forecasted to reach $135bn by FY26, as cited by Dixon, implying a 30% CAGR over $36 bn in FY21. Indian labour cost is one third that of China. PLIs provide opportunities for exports and backward integration, it said.
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Jefferies prefers strong brand franchises that demonstrate good margin resilience. It likes Supreme Ind as its margin uptick is likely from FY24e with PVC stabilising; 40% value-added mix. It is also bullish on Polycab on the back of solid execution despite softening copper; focus to improve FMEG. Kajaria Ceramics is another of its top picks amid its focus on exports by Morbi to aid domestic demand and pricing stability. And finally, it prefers Crompton Greaves Consumer Electricals due to its healthy margins in core business and potential synergies from Butterfly integration.
Meanwhile, the brokerage maintained its hold calls on Astral, Havells and Whirlpool. Demand slowdown and raw material volatility are key risks for the midcap space, it added.