Nuvama sees pocket of opportunities in small, midcaps, lists its top picks
3 min read 18 Sep 2023, 03:08 PM ISTMarket leaders in the Small & Midcap sector (SMIDs) have consistently provided higher investor returns, says domestic brokerage Nuvama Equities. Nuvama's top SMID picks include Polycab, Blue Dart, Coforge, Escorts Kubota, Prince Pipes, PI Industries, BHEL, APL Apollo Tubes, and Sterling & Wilson.
PremiumIn its analysis, domestic brokerage Nuvama Institutional Equities stated that the majority of market leaders in the Small & Midcap sector (SMIDs) have consistently provided higher investor returns.
While challengers have continued to be in their respective categories as challenges, their sizes have increased over time, making them considerably more relevant in their ecosystems.
In some SMID sectors, the brokerage thinks that the leadership definition may be expanding right now, and over time, the challenger's valuation discount to its market leader may be reducing. According to Nuvama, it will initially consider a short list of a few of these potential candidates.
Polycab, Blue Dart, Coforge, Escorts Kubota, Prince Pipes, PI Industries, BHEL, APL Apollo Tubes, and Sterling & Wilson are among the best SMID picks overall, according to Nuvama.
“On SMID outlook, our markers show mixed indications. Midcaps warrant caution (valuations are above mean), but we do not see this as a bubble. We also highlight pockets of potential upside (value stocks awaiting triggers; some others with high earnings growth certainty)," said the brokerage.
Also Read: Is there a bubble in mid, small-cap space? Kotak and Nuvama slug it out
Preference for leaders have kept challengers cheaper
According to the brokerage's analysis, it has been a significant supporter of market leadership among Indian SMIDs. And it is clear that over time, leaders have generated outstanding returns, resulting in significant rating increases. While investors may benefit from earnings compounding, large outsized returns from leaders are unlikely in several categories because valuation multiples for leaders have re-rated 2–5 times over the past decade.
"Market’s preference for leaders has meant that the challengers have remained relatively cheap in many categories, and we believe this is where the next set of outsized returns may potentially emerge," explained Nuvama.
Challengers still challengers, but now much more relevant
Leaders typically gain on three fronts as a result of their size: more growth, stronger margins (because to better pricing power), and better RoCEs (due to better financing terms, etc.). Brokerage Nuvama believes that while challengers (players no. 2/3/4) may continue to be in this position, their larger size today (compared to 8–10 years ago) may enable them to close the business metrics gap, particularly in terms of price and credit conditions.
“We are very clear that this would not be in all categories, and hence our preliminary list includes a few candidates after assessing this likelihood. Some stocks (rated/unrated both) that feature thereof: Prince Pipes, Finolex Cables, Nippon AMC, Stylam, Gulf Oil, Rolex Rings, etc," explained Nuvama.
But, in some cases, backing leaders may still work better
In its analysis, the brokerage stated that it also examined categories where the leaders have only become stronger and the challengers have been unable to compete, either in terms of market share or any other operating parameter (margins, RoCE, OCF generation, etc).
“In these cases, we believe that sticking to market leaders may well continue to deliver superior returns. Some of the categories/market leaders (rated/unrated) that we showcase are: Kajaria Ceramics, CRISIL, InfoEdge, APL Apollo, Century Ply and Interglobe (Indigo)," said the brokerage.
Nuvama's views on SMIDs - Great outperformance unlikely; not a bubble though
In its analysis, the brokerage stated that it relies on a number of markers to determine if SMIDs can outperform or underperform large-cap stocks. Nuvama observes that the share of companies inside SMIDs that display downgrades has decreased since Q4FY23, but the SMID rise from Jun-23 partially catches that. Next, let's look at trends in earnings upgrades/downgrades (pre- and post-quarter). SMID valuation premiums (to large-caps) have grown, although not, in Nuvama's opinion, to bubble-like levels.
“We believe while a meaningful SMID outperformance is unlikely, we do not anticipate a huge under-performance, at least for midcaps," added Nuvama.
Further, the brokerage also developed a list of stocks that have so far been missing triggers and have not joined the rise YTD. The firm has filtered out stocks that are expected to have triggers in the next two to three quarters.
"Some stocks that make the cut are: Crompton Consumer, Blue Dart, PI Industries, Mahanagar Gas, UPL, Sterling & Wilson, Teamlease Services and Prince Pipes. We also put out a list of stocks that have done well this year, but their earnings growth and certainty is both high. Some stocks that filter out here are Polycab, KEI Industries, APL Apollo Tubes, Escorts Kubota, Coforge and Syrma SGS," the brokerage said.
"Exciting news! Mint is now on WhatsApp Channels 🚀 Subscribe today by clicking the link and stay updated with the latest financial insights!" Click here!
