As prices of mid-cap stocks have also run up along with the broader market, investors need to be careful while picking the winners of tomorrow.

Mid-cap stocks have been in the limelight recently, following the foot-steps of their larger peers. Mid-cap stocks from the metals, IT, banking and auto components space have been among those which have seen increased activity. Experts attribute this to the re-rating of smaller companies, as the valuation gap between the large caps and mid caps has widened considerably (see chart, A wide gap). The rally is also partly due to the fact that mid-cap stocks were shunned earlier due to concerns over their ability to sustain during the worst ever downturns the markets have seen in decades.

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The flip side, however, is that the share price of many mid-cap stocks have run up significantly in the recent past, thus experts also advise to tread cautiously, as any significant correction in the market could have a larger impact on stocks of smaller companies.

The Smart Investor spoke to a host of experts for their views on the mid-cap space and arrived at a list of investment-worthy stocks. The final list of stocks was arrived at after considering qualitative factors like growth prospects of a company, its position in the business and quantitative factors like low debt-equity ratio and dividend track-record among others. Such characteristics would also act as a cushion during any downturn, and thus lower the risk element. While a select few companies have a market capitalisation of over Rs 5,000 crore, which is typically considered as the upper-range for mid-caps, such companies were included as they are also a part of the popular mid-cap indices. To know more on the individual stocks, read on.

Apollo Tyres
The Indian auto component manufacturers, which were among laggards till some time, are again back on the growth path. This is due to the revival seen in the automobile sector, especially the CV sales---these had declined by 45 per cent during Q3FY09, but although too small, they have grown by about 6 per cent in July 2009. The revival should also augur well for companies like Apollo Tyres, which has about 28 per cent market share in the domestic truck and bus market. The comfort also comes from the fact that its share price, which was beaten down to Rs 15 in March this year has now recovered to Rs 47, indicates that there is value in the company. Apollo Tyres is expected to report an EPS of Rs 6.6 in 2009-10 and Rs 8 per share in 2010-11. This discounts the share prices by 7 times and 5.8 times, respectively.

Besides, led by the revival, the ramp up in Nano production and stable demand in the replacement markets should help company post better growth in revenues. The company generates about 80 per cent of its revenue from the replacement market, where the demand is relatively stable compared to demand from the automobile manufacturers. Further, the company is expanding its capacities from 850 tonne per day to 1,000 tonne per day, which should help increase its domestic market-share further. Analysts also believe that its recent overseas acquisition of Vredestein Banden BV, a passenger car tyre manufacturer based in Netherlands, should help in improving its global presence. Besides, the recent correction in raw material prices such as rubber and crude oil derivatives like carbon black and synthetic rubber will benefit the company substantially, leading to significant improvement in net profit.

Bartronics India
Bartronics India is among the promising midcap companies given that it operates in a sunrise sector where growth opportunities are immense. It generates about 70 per cent of its revenues from products and solutions based on the AIDC and RFID technology, which find strong demand in industries like manufacturing and retail in the areas of distribution and supply chain management. This segment saw revenues jump 133 per cent to Rs 411.3 crore in 2008-09 and by 55 per cent to Rs 122.9 crore in Q1FY10. Going forward as well considering its order book of Rs 650 crore, which is 1.1 times its 2008-09 revenues, expect revenue growth in this business to be strong.

Besides, the company’s smart card segment is growing equally fast and is considered to be an emerging business. This segment could see robust long-term growth considering that the investment in unique identification programme, implementation of e-governance and demand for the banking cards has just started and has a long way to go. The company currently has a capacity of 8 crore cards per annum and is operating at 75 per cent of its capacity. However, benefits of higher utilisation and improved realisations would drive profit growth. “We are currently supplying our cards to telecom, but that will change as we move to government and banking sector by 2011 where the average realisations are higher at Rs 70-100 per card compared to current realisation of Rs 35 per card,” says Sudhir Rao, managing director, Bartronics India. The company is eyeing more projects from the government. It has already won orders for about Rs 5,000 crore, which will be executed over the next nine years, for the “Aapke Dwar” project of the Municipal Corporation of Delhi.

Bharat Electronics
Bharat Electronics, which supplies strategic electronics and equipment to all the defence establishments including the army, navy, air force and paramilitary forces, is 75.86 per cent owned by the Indian government. This is also a reason that the company has an edge over others for defence supplies. Although 70 per cent of defence requirements are procured from the international markets, but within the rest of 30 per cent which is sourced domestically, the company enjoys a market share of about 57 per cent. The company would continue to benefit on account of higher spending on defence equipment, which is pegged at Rs 54,820 crore for 2009-10 (higher by 34 per cent) besides, another $40 billion (about Rs 200,000 crore) to be spent over the next five years. This increasing focus on indigenous technologies in the defence sector and Bharat Electronics' efforts to identify newer opportunities and get into technological tie-ups with established players in the domestic and international markets should enable the company to grow faster.

The company is debt-free, incurs less capex and its working capital needs are limited, which is why the company has been generating positive cash flows. Its cash and cash equivalent as on March 2009 are valued at Rs 330 per share, which is almost 25 per cent of its current market price. Adjusted for this cash, the stock is currently trading at 9 times 2009-10 and 7.5 times 2010-11 estimated earnings.

EMCO
The increasing capex towards new power generation capacity would mean new opportunities for companies like EMCO, which is a leading player in the domestic transmission and distribution space. The company has an installed capacity of 20,000 mva and the widest range of transformers. The revenue visibility for EMCO is good given its order book of Rs 1,505 crore, which is almost 1.42 times its 2008-09 revenue. Besides, analysts estimate that the order inflows and its order book should improve further considering that the country’s T&D expenditure is on the rise, which till some time back was on a slow-track.

About a few months ago, the company was in the limelight for its high debt of Rs 356 crore and resultant higher interest costs; the latter was up by 72.9 per cent in 2008-09 and 56.8 per cent in Q1FY10. However, these are expected to ease out and have a positive impact on the earnings because of the recent deal involving the sale of EMCO Energy (EMCO’s 100 per cent subsidiary), which was in the process of building a 300 mw power plant, to GMR Energy. Analysts expect this deal to generate about Rs 350-400 crore, and thus, help in partly reducing the company’s debt burden.

EMCO’s revenues are expected to grow at about 18 per cent and net profits by about 20 per cent annually during FY 2009-11. The company is expected to report an EPS of Rs 11 per share in 2009-10 and Rs 14 per share in 2010-11, translating into a PE of 8.7 and 6.6 times, respectively.

IDBI Bank
IDBI Bank could be a good mid-cap investment considering the changes that are happening at the bank, which should lead to better performance in the times to come. Among the key ones, the bank is taking measures that should help improve its net interest margins (NIMs), a key ratio measuring profitability. Thanks to lower rates and re-pricing of some of its old deposits, the bank's NIMs, which were 0.8 per cent in 2006-07 has moved up to 1.06 per cent in 2008-09 and expected to move further to 1.2 per cent in 2009-10. Although lower than industry standards, expect the same to move higher in the coming years.

Besides, the bank is now targeting more retail business, where the margins are typically higher. In this direction, the bank is also investing in more branches and ATMs. The bank has currently about 578 branches, which it will increase to 750 by March 2010. Additionally, the World Bank has approved a loan to the government of India so that the latter can infuse more capital in PSU banks, if the government further infuses capital in IDBI Bank it will help in funding the bank’s growth plans.

On the efficiency side as well, the bank's net NPA ratio has seen improvement at 0.92 per cent in 2008-09 as compared to 1.12 per cent in 2006-07. Considering the developments happening in the bank, its stock at Rs 116 is considered to be trading at attractive valuations. The stock discounts its estimated 2009-10 earnings by 8.5 times and 2010-11 earnings by 7 times. For the same period, even on a price to book value basis it is available at 0.8 times and 0.72 times, respectively. Besides lower valuations, analysts also like the stock given that there is potential to unlock value from the bank’s investments in different subsidiaries and companies, even as there is no certainty on the timing of such a move.

IVRCL Infrastructure
Within infrastructure, the allocation for irrigation projects was raised by almost 100 per cent to $57 billion for the Eleventh Five Year Plan ending 2012. The spending on such projects is expected to grow at about 30 per cent annually over the next three years. IVRCL Infrastructure, which generates about 65 per cent of its revenues from projects relating to the irrigation and water, remains a major beneficiary given its execution capability and leading position in this segment. The company has good visibility in terms of revenues given its strong order book of Rs 15,000 crore, which is almost three times its 2008-09 standalone revenue. The order book is reasonably diversified as irrigation accounts for 44 per cent, followed by water at 21.8 per cent and the power sector at 8.8 per cent.

Besides, the company is also present in the high growth road segment (4.8 per cent of order book) and currently has four BOT projects, which will be operational by December 2009 and hence, will start contributing to revenues to the tune of Rs 360 crore per year. Considering its strong order book, analysts expect the company’s revenue to grow between 28-30 per cent annually during FY2009-2011.

Analysts value the company at Rs 430-450 per share on a sum-of-parts valuation basis, given its different businesses and investments in subsidiaries like Hindustan Dorr Oliver (53 per cent stake) and IVR Prime Urban Development (79.9 per cent stake). IVR Prime has 3,241 acre of land with saleable area of 80 million square feet. Jyoti Structures
The investment in the T&D space should augur well for Jyoti Structures, which is among the leading players in the domestic transmission EPC space. Over 85 per cent of its contracts have escalation clause, which insulates the company from volatile commodity prices.
 

Its capabilities and execution track record have been good, which is also a reason that the company’s revenue and profits have been growing constantly along with the opportunities in the power sector. Consistent growth in profits and cash flow have also helped the company to reward share holders with high dividends.

The company’s order book is currently at Rs 3,953 crore, which is 2.3 times its 2008-09 revenue. Going forward, over the next 2-3 years the order book and inflows are expected to be strong given the robust pipeline of domestic orders from Power Grid for grid expansion and rural electrification programme coupled with increased orders from the international markets (exports account for five per cent). Further, the company will leverage its capabilities by tapping emerging opportunities in the form of BOT projects in the transmission and distribution space.

Analysts expect the company to maintain sales and net profit growth of about 20 per cent annually over the next two years. The stock is currently trading at 12.5 times its estimated FY10 EPS and 9.8 times FY11 EPS.

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