India Strategy: Top 10 Mid-cap Ideas

We expect Amara Raja, Bajaj Finance, SCUF, MindTree, Info Edge, Havells, and Torrent Pharma to show continued good growth over the medium term, while their valuations remain reasonable.

January 01, 1970 5:30 IST | India Infoline News Service

The valuation discount (Mid-cap discount to large-caps) at which mid-caps traded between August and October 2013 has largely evaporated in the recent market rally. The BSE Midcaps Index now trades at a 17% discount to the Sensex and the CNX Midcaps Index trades at a 7% discount to the Nifty. These are among the lowest discounts seen historically. Hence, bottom-up stock picking assumes even greater significance.

We favour stocks with good fundamentals and reasonable valuations. We expect Amara Raja, Bajaj Finance, SCUF, MindTree, Info Edge, Havells, and Torrent Pharma to show continued good growth over the medium term, while their valuations remain reasonable. We expect Crompton, Biocon and Sobha to show improved earnings traction in coming quarters as the outlook for growth and margins improves.

Find below our top mid-cap buys and the rationale for the same:

Amara Raja (CMP Rs329)
  • AMRJ is gaining market share from the market leader Exide across the Auto replacement and OEM segments. We expect industry volumes to grow 10-12% in FY15-FY16 and AMRJ to grow faster.

  • AMRJ’s industrial segment growth was impacted in FY14 by weak industry and capacity constraints. AMRJ’s new capacity will come online in early 2014 and it should result in market share gains. This coupled with an improvement in the economy will drive growth in both the UPS and Telecom segments.

  • AMRJ boasts of a superior cost structure, higher margins, better capital efficiency, and greater growth potential compared with market leader Exide.

Crompton Greaves (CMP Rs122)
  • Steady improvement in standalone power systems margins indicates that the business is on a recovery path. INR-depreciation-led export growth would support domestic power systems revenue trajectory.

  • Healthy traction in consumer products segment (22% of consolidated revenues) and steady margins.

  • 1HFY14 results provide first signs of turnaround in overseas subs. Despite lower revenues, subsidiaries posted positive Ebitda after four quarters. While problems persist in the US and Canada, management is confident of reporting profit for the full year for overseas subs.

  • The overseas business trajectory provides confidence to look beyond the losses in these subs in the near term and value the company on standalone basis.

Havells India (CMP Rs750)
  • Havells’ strategy of growing through new product launches, expanding into new geographies, and widening distribution channels, has resulted in strong 14% revenue Cagr and 21% earnings Cagr in the past five years for its domestic operations. We expect revenue and earnings growth to remain robust going forward.

  • Sylvania’s (Havells 100% European subsidiary) profitability dipped in FY13 due to a sharp fall in the prices of a key raw material resulting in de-stocking by dealers; we believe that the margins have bottomed out, since a few producers are already facing losses.

  • At 16x FY15 earnings estimates, the stock is valued reasonably from a medium term perspective.

Bajaj Finance (CMP Rs1,459)
  • BAF has successfully evolved a growth strategy based on product diversification, geographic penetration, and cross-selling. This is supplemented by top-notch execution in establishing a strong origination infrastructure and laying down strict processes of due diligence and loan recovery.

  • BAF’s ability to defend product pricing, its strong brand recall and parentage, and efficient operations will aid in generating a 22% earnings Cagr through FY13-16ii. As a standalone NBFC, BAF will be able to deliver +3.5% ROA and 20% ROE

  • It is a strong contender to receive a bank license and is best placed to transition smoothly into one. Some of BAF’s loans already classify for priority sector and BAF has an existing branch infrastructure and strong brand recall.

Shriram City Union(CMP Rs1,060)
  • SCUF promises to deliver sustained 23% AUM Cagr driven by increasing penetration, niche product focus and small market share. Retail loans and loans to small businesses will remain key drivers. Warrant conversion has added to the already healthy capitalisation.

  • Despite marginal increase in NPAs, we expect 17% earnings Cagr, driven by improving loan growth and stable margins.

  • The stock currently trades at 1.9x FY15ii BV. Given reasonable visibility of 2.7% ROA, 18-20% ROE, and strong capitalisation, we believe the stock should trade at a premium.

MindTree (CMP Rs1,396)
  • Strong account mining and robust growth in infra would continue to result in revenue growth being one of the best in the sector. Deal wins and management commentary continue to be healthy.

  • Performance at the hi-tech business unit has also improved as the company is seeing success in cross-selling IT services to its hi-tech customers.

  • Mindtree’s low employee utilisation (~65% - lowest in four years) is a key margin tailwind in the near term. Although furloughs and wage increases are not likely to result in margin expansion in 3QFY14, we see margins expanding from there on.

Info Edge (India) (CMP Rs437)
  • While the hiring conditions remain tight, management indicated that hiring in its largest segment, IT services, is showing signs of improvement. Naukri’s traffic share among job portals remains high and the new product pipeline is among the best ever.

  • Mgmt of portfolio companies like Zomato and Policybazaar has indicated that focus on profitability is high. For instance, while Policybazaar’s revenue will likely grow more than 80% in FY14, its employee headcount has not increased. Zomato has already become profitable in certain geographies.

  • Given a wide portfolio of internet-related business, InfoEdge is the most diversified company to benefit from the increasing internet penetration in India. At 27x two-year forward PER, its valuations are cheap.

Biocon (CMP Rs387)
  • Legacy biopharma business will be driven by immunosuppressants and insulin’s geographical penetration. Domestic pharma business (now contributing 14% to top line) is growing at 30%+ Cagr; new launch of trastuzumab adds to visibility.

  • Syngene (contract research subsidiary) is growing at mid-to-high teen Cagr; listing could unlock value.

  • Biocon is one of the front-runners to the regulated biosimilars market in the US and Europe. Global phase III trials have been initiated for Herceptin and are completed for rh-Insulin. The stock is trading at 15.5x FY15ii core earnings, without pricing in any significant option value for biosimilar products. We expect valuation to build in biosimilar upside as visibility improves over next 12-24 months.

Torrent Pharma (CMP Rs483)
  • Torrent has a strong business portfolio with longest growth potential; >60% revenue comes from the emerging markets and more than 70% of domestic revenue comes from specialties; Torrent has a fast ramping US business.

  • A low base and high number of product launches will keep growth in the US above 30% for the next 3 l years. Pickup in domestic growth and ramp up in Mexico would enhance growth rates.

  • The stock is trading at 11.6x FY15ii core earnings, at 20‐50% discount to large‐cap pharma. A growing revenue base, improving growth outlook, high contribution from branded markets and steady and high free cash flows make medium‐term re‐rating a strong possibility

Sobha Developers (CMP Rs335)
  • Strong improvement in operating cash flows ahead. Cash collections were up 30% YoY in 1HFY14, well ahead of the 18% YoY growth in revenue. We expect doubling of operating cash flows and 2.5x increase in profit over FY12-16 as the company recognises higher-margin new sales.

  • ROE should improve 400bps to 14% by FY15. Free cash flow to interest will turn increasingly favourable, allowing the company to plough back more money into the business/pay dividends. The company doubled its dividend payout to 37% of PAT in FY13.

  • Valuation remains cheap. Stock trades at a 30% discount to our one-year forward NAV of Rs440/share.

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