How to become a crorepati? These midcap stocks can be your best bet; this is what CLSA says

In a year, the benchmark indices on Dalal Street have seen a tremendous shift with many giving away their glory days and in fact, being hit by hefty price corrections. For instance Midcap stocks which had soared to an all-time high of 18321.37 on 09 January 2018 is now trading in trouble. On Monday, S&P BSE Midcap closed at 15,102.15 which was again lower by 74.88 points or 0.49% from its previous close, which was 15,177.03. Even as this is going on, CLSA has stepped in to suggest targeting the midcap sector - the company expects midcaps to face bouts of volatility in 2019 given macro uncertainties and spread in headline earnings growth for Nifty midcaps vis-a-vis Nifty narrowing in FY20.

Here are 6 power points that show this sector is set to see a full-fledged big bull moment going forward:

1. Large dispersion in stock performance: In our Midcaps strategy note, Multiples normalisation vs growth, we argued that stocks with higher earnings growth visibility would be better placed to offset inevitable multiples normalisation. While the headline index has corrected 15% in CY18, there has been a very stark diversion in stock performance with bottom quartile stocks correcting 49%, while the top quartile still delivering 25% stock returns. Meanwhile, only 3 of the 12 CLSA Midcap coverage universe stocks have declined by more than 15%.

2. Valuations more reasonable, but tailwinds lacking: The Indian national elections during 1HCY19 could lead to market volatility in 1HCY19. Midcaps though have outperformed post-election outcomes in the last three cycles. Considering that the spread over Nifty earnings growth is also likely to narrow in FY20, we believe tailwinds are lacking for Midcaps in general, though good bottom-up opportunities are emerging post the correction.

3. SEBI categorisation, domestic flows: Domestic mutual funds had a large portfolio churn in 1HCY18 on the back of new SEBI categorisation and strong inflows. Incremental flows into mutual funds have come off from their highs of US$3bn per month in FY18 to US$1.6bn per month in FY19 so far. Our analysis of SEBI categorisation of ‘Midcaps’ and Nifty Midcap index suggest that there is only ~58% overlap, offering a large window of ~68 stocks that could move Midcap focused fund performance. Fig 17 shortlists some of these stocks that offer faster earnings growth.

4. Key themes: Our screens across a large universe of Midcaps suggest that Property, Branded Apparels, Flexi Staffing and QSR companies are reporting strong growth momentum over the last few quarters. Developer funding issue is a near-term growth headwind for building material companies, but we continue to prefer Housing as a structural theme. Listed residential property developers are also seeing strong traction given the undergoing consolidation in the residential real estate sector triggered by the Real Estate Regulatory Act (RERA) reform in 2017 and accentuated by the NBFC liquidity crunch. We like Hotels as a cyclical play; slower new supply since FY15 and continuing demand bode well for occupancy and room rates over the next 3-4 years.

5. Govt welfare spending: Going into national elections, we expect govt spending on welfare schemes to be positive for select stocks. Consumption, Affordable Housing, and Healthcare are possible beneficiaries of acceleration in govt spending on welfare programmes, in our view. Govt’s key schemes like ‘Ujjwala’ (LPG roll-out), ‘Saubhagya’ (LED bulbs), Rural Housing & Electrification could generate incremental consumption demand for companies like TTK Prestige, Supreme Industries, and Crompton Consumer.

6. Key rating and earnings changes: We raise FY19/20CL estimates for Crompton Consumer by 4-8% to build in impact of lower ESOP expenses going ahead. Also, we increase Pidilite FY20CL estimates by 4% given the sharp fall in crude prices (its key raw materials are linked to crude). Increase PVR and Inox estimates by 3-8% with concern around F&B uncertainty easing and deal with online aggregators.

For investors, CLSA recommends ABFRL, Apollo Hospitals, Godrej Properties, Lemon Tree, Supreme Industries, TTK Prestige and Westlife Development preferred picks. Whereas Pidilite and Voltas are our key SELLs given expensive valuations.