Time to bet on these 6 mid-cap market leaders

The Covid-induced lockdown is being relaxed in India, even as the number of cases is rising. Easing of restrictions has helped large companies restart production, with most working at 80% capacity utilisation levels. However, small and medium enterprises are still dogged by problems. While this is bad news at the broader economic level, it has resulted in market share gain by leaders in all industries. Smart investors can make money betting on the winners. This trend of strong companies becoming stronger is not new. It started with demonitisation and the resultant disturbances. Since GST made tax arbitrage by smaller firms difficult, the trend continued.Experts say this trend will only become stronger in coming quarters. “The trend of the big and strong becoming bigger and stronger may get amplified this time, amid the extended business dislocations. Companies with a strong balance sheet will gain market share and become bigger,” says Pankaj Pandey, Head of Research, ICICI Direct. Amar Ambani, President and Head of Research, Yes Securities, concurs with this view. “Working capital requirement of most companies are up due to Covid-related disturbances and therefore, companies with weak balance sheets will not be able to survive,” he says.Most of the big and strong players are in the large-cap space. However, the largecap sector leaders are already known to everyone in the market and therefore, most of them are already fully priced in. On the other hand several mid-cap companies sector leaders from relatively smaller industries—are still quoting at reasonable prices and therefore, offer good investment opportunities.While the trend of strong companies gaining more in strength is visible across all sectors, it is happening at a faster clip in some sectors. “This strong becoming stronger trend is happening across nations and industries, but its impact will be stronger in sectors where capex intensity will be high or innovation is happening at higher speed,” says Deepak Jasani, Head of Retail Research, HDFC Securities.The changing legal and regulatory landscape is another reason for this consolidation. “The strong becoming stronger theme is still working in industries that are going through major legal and regulatory changes. For example, real estate consolidation is amplified due to Rera regulations. Similarly, high taxation demand has forced out most small players from the telecom sector,” says Ambani. For instance, the number of telecom operators are already down to four (three private companies and one PSU) and threatening to go down further because of the precarious financial positions of some players. “While Reliance Jio has mobilised enough funds, other players are still struggling. Both Airtel and Vodafone have tied up with Huawei for 5G and they may get into trouble if the India-China border skirmishes escalate,” says K. Subramanyam, Co-Head - Equity Advisory, Altamont Capital.Strong balance sheet is needed to survive in industries mauled by the pandemic. For example, the aviation industry is going through such a phase. Since aviation is a critical industry, it has to survive this crisis. However, there is no guarantee that all players will make it. Players that can sustain during this crisis will come out as winners.Large and strong players also benefit in industries with large unorganised markets. The present situation gives them additional opportunities. “Bigger and strong players will keep on growing in sectors with large number of unorganised players like hospitality, hospitals and testing labs, jewellery, etc,” says Pandey. Storage battery, hotels, lubricants, etc are other sectors with large unorganised players.After considering expert views, we have shortlisted a few mid-cap stocks for you. However, the stock market has already bounced back from the March lows and therefore, the risk is higher in the mid-cap space. Investors should buy these quality mid-cap companies only in a staggered manner.1. APOLLO HOSPITALS 76658080While the pharmaceutical segment of the healthcare sector is already organised, the healthcare providing segment— hospitals, pathological testing labs, etc— still remain mostly unorganised. Since large and listed players in this space are few, they should be able to grow at the cost of unorganised players. For instance, Apollo Hospitals, India’s largest private hospital player with more than 10,000 bed capacity, is expected to be the main beneficiary of this change. Since its hospitals are concentrating on superior technologies, it also commands premium like that of other centre of excellences. Since high speed of hospital addition in the past had stretched its profitability, the management now is focussing more on consolidation of the existing hospitals and making recently launched hospitals profitable. Its capex will moderate due to lower new hospital additions and this in turn should help Apollo Hospitals to report better free cash flows (FCF) and also return ratios like return on capital employed (RoCE).2. CASTROL 76658115Castrol is the strongest lubricant player in the domestic market. However, it will be negatively impacted in the short term due to the ongoing disturbances. Since domestic manufacturing operations are expected to be 80-90% of capacity in the near future, industrial lubricant demand is also expected to remain tepid in 2020 and may recover only in 2021. “Factoring the Covid impact on volumes, we have built-in volume decline of 20% in 2020 to 163 million litres and normalization in volumes at 196 m litres in 2021,” says a Motilal Oswal report. However, demand for personal mobility, which accounts for 40% of Castrol’s revenues, is expected to increase because people are now shifting away from public transport to personal vehicles. To overcome the ongoing tough period, Castrol is focussing on cost cutting and improving product mix . It has also completed launching BS-6 ready products in all categories. Castrol is already a high dividend paying company and its management’s decision to continue with their dividend policy in 2020 shows confidence about the future.3. INDIAN HOTELS 76658125Hospitality is one sector that is reeling under the impact of Covid-19 induced disturbances. However Indian Hotels, the market leader in the hotel industry with more than 200 hotels and 25,000 rooms, is expected to come out of this crisis without much damage. While most segments of the hospitality industry are expected to be under pressure throughout 2020-21, the hotel industry is getting a bit of a reprieve in the form of medical occupation. For instance, around 50% of the hotels owned by Indian Hotels are currently operational and are being primarily used to host medical staff. Strict action taken by the management during the crisis may also help Indian Hotels in the medium term to long term. “While stringent cost cutting measures will help Indian Hotels to sail through the crisis, new initiatives to increase occupancies from leisure and business travellers should support sales growth in the coming years,” says a recent IDBI Capital Report. For example, Indian Hotels plans to reduce its domestic and international operations costs by 40% and 65% respectively in this year.Indian Hotels also has plans to defer capital expenditures and to monetise non-core assets it owns. These measures should help it to preserve capital and also provide adequate liquidity during this crisis.4. EXIDE INDUSTRIES 76658131With two companies owning 30% of the market share each, the Indian battery industry is already in a duopoly situation. Though the leaders—Exide and Amara Raja—continue to eat into the market share of smaller players, they won’t be able to get out of the short term pain in the industry. For instance, the lockdown and related disturbances have obliterated Exide’s UPS battery demand, which usually peaks in summer. The fall in new vehicle sales is expected to dent battery sales through the OEM route in 2020-21. However, it is expected to improve in 2021-22. “Due to the replacement nature of the business, Exide’s 2021-22 volume is expected to surge beyond the 2019-20 peak,” says a recent Edelweiss report. Exide’s margin is also expected to remain stable in the coming quarters due to the prevailing low lead prices. Since Exide has two lead smelting facilities owned by its subsidiaries, which contributes a major portion of its requirement, it will be able to manage the lead price volatility better. Exide is also a 100% holding company of Exide Life Insurance and any value unlocking there in the form of listing can be a good trigger for the counter.5. UPL 76658138While other companies mentioned are expected to grab market share from their Indian counterparts, UPL is expected to do at the global level. For example, UPL was able to generate positive volume growth from all geographic regions —India, Latin America, US, etc —during the fourth quarter of 2019-20. While UPL’s revenue grew by 22% in this period, revenue of global peers grew only at 7%, helping UPL to improve its market share further. Global companies were trying to diversify out of China for last few years and this move got accelerated after the Covid crisis and companies like UPL will be able to grab the space vacated by Chinese agrochemical companies. Increasing dividend per share to Rs 6 for 2019-20 also shows management’s confidence about a prosperous 2020-21.6. INTERGLOBE (INDIGO) 76658146Aviation is another sector that is being devastated by the impact of Covid. As mentioned earlier, aviation is a critical industry and therefore, the players that can sustain during this crisis will come out as winners. “Since Indigo can sustain for the next 6-9 months, its situation is not as challenging as that of other players,” says Ambani.IndiGo’s market share was around 40% in 2019 and this is expected to improve further in the coming quarters. The main reason is IndiGo’s balance sheet strength. “With a robust balance sheet (gross debt of Rs 2,430 crore, free cash of Rs 8,930 crore as on March2020) and competitive cost structure, IndiGo is best placed amongst Indian carriers to withstand the current disruption and also be in a position to capitalise on growth recovery,” says a recent Centrum report. IndiGo is also taking cost reduction and liquidity improving measures like pay cuts, cut in discretionary expenses, deferring capex plans, replacement of fleets with high operating costs, deferring dividend payouts, etc.Index values normalised to a base of 100. Compiled by ETIG Database. Source: Bloomberg(Graphics by Abdul Shafiq/ET Prime)

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