There are reasons for the midcaps for expanding their valuations and continue to trade at the all-time high. During the last 2-3 years, midcaps started to outperform as the domestic economy reached some stabilisation along with benefit from the reduction in cost due to price corrections in international market. Since then midcaps were catching up to the high valuation of large caps which had reached to extreme level.
For example valuation for sectors like FMCG, pharmaceutical and consumer discretionary were beyond long-term averages for a long time due to the defensive nature of the equity market. But in the last 2 years we started to experience strong improvement in domestic inflow from mutual funds which increased exposure to midcaps. Now in terms of earnings outlook the expectation for midcaps companies have expanded further led by 7th Pay Commission, good monsoon, strong government spending in rail and road and avenues from the new reforms being undertaken by the government like ‘Make in India’.
Looking at the expectation for Nifty Midcap Index, the market expects CAGR (compounded annual growth rate) earnings growth of more than 20 per cent over the next 2 years. The one year forward price-to-earnings (P/E) is about 18.5 times which is above the last 3 year average of 16 times. Hence the valuation is not sober but cannot be considered as high since the expectation is good. Additionally, the focus is on stocks which are likely to benefit from the GST Bill, as per which it will provide additional pressure on valuation in vice-versa. We provide some stock ideas which are likely to accrue with perpetual advantage.
Some midcap stocks which can give good returns are:
1) Amara Raja Batteries
Investment Rationale: The company is the second largest lead-acid battery manufacturer in India and is likely to benefit from the demand uptick in automotive segment supported by better monsoon and the Seventh Pay Commission. At present, shares of the company are trading at 21.7 times on FY18E and the earnings are expected to grow at a CAGR of 18 per cent over FY16-18E further supported by its new capacity addition and newer verticals (Home UPS, Solar).
2) Bharat Electronics
Investment Rationale: Bharat Electronics has 37 per cent market share in Indian Defence Electronics with core capabilities in radar and weapons systems, defence communication and electronic warfare. The company will be a key beneficiary of ‘Make in India’ in defence. Earnings expected to grow by 15 per cent CAGR for the next 3 years. Shares of Bharat Electronics are currently trading at a P/E of 18x on FY18E.
3) Havells India
Investment Rationale: Havells India, a leader in electrical consumer goods in India with last 5 years earnings growth of 14 per cent CAGR, is expected to grow by 19 per cent CAGR over FY16-FY18E. At present, shares are trading at P/E of 31 times on FY18E, the stock is likely to maintain its premium valuation given its brand visibility, diversified product profile & wider distribution network.
4) Bata India
Investment Rationale: Bata India is the largest retailer and leading manufacturer of footwear in India with around 1,254 retail stores across tier1, tier2 and tier3 cities. It has a healthy balance sheet with zero debt and adequate cash surplus. Earnings are expected to grow by robust 29 per cent CAGR over FY16-18E and is trading at P/E of 31x on FY18E.
5) Apollo Hospital Enterprise
Investment Rationale: Apollo Hospitals is India’s largest private healthcare services provider. Earnings of the hospital may grow by 32.3 per cent CAGR over FY16-18E and is in a sweet spot given its leadership position, strong brand equity and underpenetrated nature of the healthcare sector. It currently trades at EV/EBITDA of 18 times on FY18E and has been trading in the range of 21-23 times (1Yr Fwd).
(The author is head of research at Geojit BNP Paribas Financial Services)