Midcap Stock Ideas

Mid-cap stocks, which are trading at cheaper valuations compared with large-caps, can be rewarding investments.

Year 2007 is likely to be remembered for providing great returns in the stock market. The BSE Sensex has gained 43 per cent so far this year, and the recent rally, where the Sensex made a new milestone crossing 20,000 levels, has added a lot of wealth to those who are invested in large-cap stocks.

However, many analysts describe the current market rally as one driven by momentum, powered by heavy net foreign inflows into equities, most of it in large-cap stocks.

There is an increasing belief among market experts that valuations of many large-cap stocks appear stretched today – the BSE Sensex trades at a twelve-month forward earnings of 20 times as compared with about 17.7 times a month back.

While most of the gains have been captured by the large-cap stocks, many mid-cap companies have remained out of investors’ focus. Though the mid-cap indices have gained more than the Sensex since the beginning of 2007, their valuations are still low at about 15 times forward earnings.

“The recent rally has created a significant divergence between the valuations of large-cap stocks and the mid- and small-cap stocks. The divergence should shrink as many of the mid-cap stocks are trading at attractive levels,” says Ajay Bodke, senior fund manager - equity, Standard Chartered Mutual Fund. Fund managers believe there is significant value left in select mid-cap stocks.

“Over the last few months we have seen a significant rally in the large cap stocks and most of these stocks are expensive in terms of valuations. This is the right time to enter into some select mid cap stocks,” says, Satish Ramanathan, head-equities, Sundaram BNP Paribas Mutual Fund.

What is a mid-cap? There is no clear definition for this, but Sundaram Mutual Fund calls a stock a mid-cap if it is not among the top 50 shares listed on NSE in terms of market capitalisation.

For DSP Merrill Lynch, it begins from the 101st company. On November 17, the 51st company had a market cap of Rs 25,000 crore and the 101st company Rs 9,538 crore.

Here, we have a list of some select small- and mid-cap companies that have a strong business model and operate in an emerging or growing industry. We have looked at companies with a market capitalisation of around Rs 5,000 crore with just one exception (Indian Overseas Bank).

These companies are expected to grow at a faster rate over a longer period due to the inherent advantages. Also, along with the long-term earnings visibility, these companies are trading at attractive valuations.

3i Infotech IT stocks are not doing well due to the appreciating rupee against the dollar. But 3i Infotech, which has only 25 per cent exposure to the US and about 5 per cent net dollar earnings, is an exception. 3i Infotech is a mid-sized software company focussing mainly on the BFSI (banking, financial services and insurance) vertical.

The company has a mix of 50:50 between products and services. 3i Infotech offers products catering to segments such as core banking, treasury, investment management, risk management, lending, mutual funds and anti-money laundering.

The company also focuses on services such as systems integration and e-governance. The company has been growing inorganically to offer different services.

“Going forward, we expect the company to grow at over 54 per cent during FY07-09,” says Rajiv Mehta, analyst, India Infoline. At current market price the stock is trading at 9 times its FY09 earnings.

Bartronics India Within the small-cap segment, Bartronics could emerge as one of the best investments.

The company is a leading automatic identification and data capture solutions player and is now moving up the value chain by diversifying into smart cards. Smart cards are used in mobile Sim-cards, government projects, magnetic banking transaction cards, and so on.

The company sold 4 million smart cards in Q2 FY08 and achieved a capacity utilisation of 20 per cent, which is expected to reach 50 per cent by the end of FY08. In FY09, it will be 80 per cent on its enhanced capacity of 80 million units.

“Revenues from smart card business is expected to increase from Rs 99 crore (FY08) to Rs 216 crore (FY09) primarily due to increased demand from telecom, banking and other varied business,” says Harendra Kumar, research head, ICICIDirect.com.

Besides, the company is also expanding its presence in neighbouring markets like Malaysia. Considering that the company is operating in a high-growth emerging business and has a first-mover advantage, its current P/E of 9.3 times FY09 estimated earnings is attractive.

Bharati Shipyard Stocks of shipbuilding companies have outperformed the market helped by hefty order books. Bharati Shipyard has an order book of Rs 4,430 crore, which is 12 times its FY07 revenue.

Bharati designs and builds sea-going, coastal, harbour, inland crafts and other support vessels for the offshore industry. The company has more than 12 clients including well-known global companies.

Considering the growing order book, Bharati is expanding its present capacity. This will also facilitate in turnaround of more ships for booking higher revenues and operating leverage.

The faster execution of the current order book and better industry outlook makes it an attractive stock for the long term. The company is expected to grow at 50 per cent over the next two-three years and trades at 12 times its estimated FY09 earnings.

Everest Kanto Record crude oil prices have once again highlighted the importance of alternative fuels. Everest Kanto Cylinder (EKC) is one player that can benefit from higher crude oil prices as it makes high-pressure cylinders for CNG automobile and industrial applications.

Over the past few years, the number of CNG-fitted vehicles has grown at 80 per cent a year due to better economics and efficiency, and is expected to grow at 31 per cent a year till 2010.

Most of the CNG supply is limited to Mumbai and Delhi, but there is a proposal to extend it to 28 more cities, which will be a big push for EKC.

Analysts estimate the company to grow at about 50 per cent annually over the next few years led by its capacity expansion and higher industrial demand. At the current market price, the stock discounts its estimated FY08 and FY09 earnings at 32 times and 21.3 times respectively.

Indian Overseas Bank IOB is the only stock with a market cap of Rs 8,500 crore in this set, but in banks, the market cap is not large. IOB has a return on equity of 27 per cent and net interest margin of 3.5 per cent.

The Chennai-based bank has nearly 1,800 branches, almost half of them in the south. “We expect IOB’s business to grow at a 21 per cent a year till FY09. On return on assets front, the bank will continue to do well on the back of 19-20 per cent growth in assets coupled with profitability growth of 22-23 per cent,” says ICICIDirect.com’s Kumar.

At the current price the stock trades at 1.4 times its FY09 estimated book value.

Opto Circuits Medical equipment player Opto Circuits has been growing at a rapid clip through the organic and inorganic route and expanding its products offerings.

The company enjoys technical expertise for making optical sensors, critical electronic equipment used in the healthcare industry and security systems. It has acquired a coronary stent manufacturer and a balloon catheter manufacturer.

The increasing demand for its products in the domestic and international markets coupled with the acceptance of its products in international markets will drive the future growth for the company.

Opto Circuits is expected to grow at about 55 per cent for the next two years. The stock is trading at 33 times and 23 times estimated FY08 and FY09 earnings respectively.

Patel Engineering Construction, real estate and power are considered to be the most favoured sectors. Patel Engineering operates in each one of these segments. It is a leading player in hydropower plant construction with a market share of 22 per cent.

Also, the company is building its own power generation plants which are expected to come during 2011-12.

In the near term, its growth will come from core businesses of construction, irrigation, transportation and micro-tunnelling, which are growing at a fast pace.

Given the strong order book position of Rs 5,000 crore (3.8x FY07 revenue), PEL is expected to grow at about 33-35 per cent annually till FY09. Also, the development of its land bank could unlock value. PEL has a land bank of 1,183 acres in Hyderabad, Mumbai, Bangalore, Chennai and Panvel.

PVR Cinemas A pioneer of the multiplex culture in India, PVR has a significant market share in northern region. It is an established film distributor and has also ventured into film production recently. Two of its co-productions with Aamir Khan are slated to be released in the current year.

In the wake of the company’s strong financial performance in Q2 FY08 in the exhibition business, its venture into movie co-production along with domestic distribution rights could rake in significant profits if the movies fare well at the box-office.

“Considering the company’s future expansion plans, it is expected to register a 54 per cent and 95 per cent growth in net sales and net profit over the next two years,” says Lalit Thakkar, director research, Angel Broking. At the current market price, the stock is trading at 11 times its FY09 estimated earnings.

Sanghvi Movers Sanghvi Movers is a good play on India’s increasing industrial and infrastructure capex.

Sanghvi Movers provides cranes on a hiring basis to various industries like power, refineries, steel and cement. It is the largest organised player in this sector with a fleet of 254 hydraulic and crawler cranes ranging 20-800 tonne of capacity.

Considering that most of its fleet is booked for the next 18-24 month, Sanghvi is expanding its fleet size and investing about Rs 200 crore a year in FY08 and FY09.

The company will grow faster in the future, driven by expansion, higher demand from user industries and pricing power. The stock is currently trading at 12.9 times estimated FY09 earnings.

Sintex Industries Plastics and textiles player Sintex Industries is another stock that should do well. The company has been moving up the value chain in plastic products providing technology intensive products. It has acquired a leadership position in pre-fabricated structures, custom moulding and other businesses with high entry barriers.

Also, it acquired the US-based Wausaukee Composites, an established player catering to the high-end industries such as medical imaging, mass transit, wind energy, recreation and corrosion-resistant materials handling. The company also made its second acquisition of Bright Brothers’ automotive products business.

Sintex will continue to benefit through its product innovation, higher plastic penetration in the domestic market and increasing capex across industries. The stock is trading at 21 times its FY09 estimated earnings.