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India's midcap stocks return to favor as risks fade

Profits to pick up, eclipsing growth pace at larger companies

MUMBAI (NewsRise) -- After a rough year, stocks of India's medium-sized companies are beginning to outperform their larger counterparts, driven by their improving earnings outlook and compelling valuations.

Although the looming general elections could heighten volatility and interrupt any rally, analysts agree that the economic backdrop could continue to favor this group of stocks in the months ahead.

Cost pressures have eased with softer crude oil prices and the Reserve Bank of India's recent rate cut. Meanwhile, risk aversion, which dominated after a suicide bombing attack inflamed tensions between India and Pakistan in February, has subsided. Prime Minister Narendra Modi's swift response to the incident could also strengthen his hand ahead of the polls in April-May, say observers.

The prospect of stability has helped midcaps, which are considered high growth but riskier investments. According to R.K. Gupta, director of Taurus Asset Management, strong demand from retail investors who prefer to invest in cheaper scrips gives midcaps a price-to-earnings valuation ratio which is at a premium to that of large caps.

The Nifty's midcap 100 index has gained 6.6% since the rate cut on February 6. By comparison, the benchmark Nifty index representing large-cap stocks has risen 1.9%.

Based on the Securities and Exchange Board of India's classification, midcap companies rank between 100 and 200 by market capitalization in the list of 5,000-odd listed companies. Some of the best-known midcap names include Tata Power, Adani Enterprises, backed by conglomerate Adani Group, and Future Retail, the largest department store operator in the country.

"Our analysis of fundamentals and valuations for midcaps and comparison of midcaps with large caps...suggest that the relative attractiveness of midcaps has gone up," brokerage Motilal Oswal said in a report.

That's partly due to the whopping 27% decline in the Nifty midcap index last year. Since many smaller state-owned banks belong to the midcap category, their losses and deteriorating asset quality weighed on the subindex.

The steep fall in share prices has also pulled down valuations. In March last year, the valuation premium of midcaps over large caps hit a high of 46%. The premium has since fallen to 10%, presenting a buying opportunity, say analysts.

Besides banks, whose outlook is improving following the central bank's efforts to curb bad loans, other groups such as non-bank finance companies are also expected to do better this year.

Motilal expects collective profit for the 120 mid- and small-cap stocks it tracks to rise 91% in the current fiscal year, a sharp reversal from the 43% plunge in the year ended March 2018.

In terms of sectors, Motilal tips earnings of retail companies to rise 67% and those of non-bank financial companies to increase 30%. As for metals companies, the rebound in metal prices is likely to lead to a near three-fold jump in earnings, it said. By contrast, the brokerage's large-cap universe is expected to report a profit increase of 7.4% in the current fiscal year, up from 5% last year.

Nevertheless, the recovery in the midcap index is unlikely to be even.

While valuations indicate there is some room for a further rise, it is likely to be driven by stocks that are seen to have value, brokerage CLSA said.

According to CLSA, consumer and technology companies are trading above their five-year average valuation, while capital-intensive sectors such as power and engineering are trading up to 56% below their average.

--Dhanya Ann Thoppil

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