Outperformance of mid and smallcaps versus frontliners will be contingent upon their earnings growth which will lead to valuation re-rating, Teena Virmani, Vice President – Research, Kotak Securities said in an interview to Moneycontrol’s Sunil Shankar Matkar.
Edited excerpt:
Q: After the underperformance in 2018, do you expect mid and smallcaps to outperform frontliners in 2019?
A: Midcap and small-cap stocks have underperformed significantly in 2018 due to range of factors including higher crude prices, cost inflation, higher interest rates, demand slowdown, liquidity crunch, etc. leading to earnings disappointment and valuation de-rating.
Teena Virmani
Vice President-PCG Research|Kotak Securities
Valuation multiple of midcap index has corrected significantly in last one year versus Nifty thereby taking away the froth which was there in 2018 and now a lot of mid-cap stocks are available at attractive valuations as compared to frontliners.
We believe that outperformance of mid and smallcaps versus frontliners will be contingent upon their earnings growth which will lead to valuation re-rating.
Q: What is your take on cement space and what should investors do with stocks in the year ahead?
A: Cement demand has registered a healthy growth during the year as reflected from the core industries output data as well as volume numbers of players. Cement price hikes didn’t match the cost hikes thereby resulting in margin pressure for players so far.
However, now costs have started coming down with fall in pet coke prices and diesel prices. The benefits of increase in auto axle limits is also likely to be reflected in the coming quarters.
Q: Do you expect construction and infrastructure sector to be a better bet in Lok Sabha elections year?
A: There is a general expectation that government may turn populist in the run-up to the elections and infrastructure spending may take a hit. Also, the sector has underperformed due to political uncertainty.
However, we believe that construction companies are comfortably placed with healthy order books, and strong execution is also reflected in their performance in past few quarters.
Order books are fairly diversified in terms of clients as well as geographies so execution growth is likely to be maintained post elections too. It is also reflected from the financial performance of the infrastructure sector after the election results are out — be it after 2004/2009/2014.
Concerns related to financial closure of HAM projects are also getting eased. Stocks are also trading at attractive valuations and we continue to remain positive on the sector even after taking into account next few months of underperformance.
Q: Are you still bullish on building material segment?
A: We are selective on building material segment as the sector has been reeling under weak demand, increased competition and cost pressure. Demand environment for tiles and plywood segment is still subdued as the real estate segment demand particularly from mid to high end segment has not kicked off meaningfully.
The individual housing segment demand mainly from Tier 2 and Tier 3 cities is driving the volumes. Also, due to lack of compliance towards GST/e-way bill, the shift of demand from unorganized towards organized segment is still a couple of quarters away.
However, we are witnessing some positives in terms of volume uptick, pricing improvement as well as peaking out of cost pressures. Thus, in the current scenario, we prefer the sector leaders like Kajaria Ceramics, Century Plyboards owing to their market leading positions, strong distribution channel, ability to grow volumes with products available in various price ranges and control over costs.
Q: What are you top five bets among sectors you track and midcap/smallcaps for 2019?
A: Phoenix Mills: Buy, Target Price: Rs 707
Company has a stable stream of rental generating assets with High Street Phoenix being the cash cow and other market cities following the similar pattern in terms of consumption and rental improvements. Revenue growth going forward is likely to be led by rental renewals and improvement in commercial and hospitality revenues. Next leg of expansion is likely to come from land acquisitions done during CY18 – in Bangalore, Ahmedabad, under construction retail assets in Lucknow and Indore which is in line with its growth strategy of increasing retail led mixed use development area going forward. Key risk to our rating and target would come from consumption slowdown and steep increase in debt.
Kajaria Ceramics: Buy, Target price: Rs 500
Kajaria Ceramics is the largest manufacturer of ceramic/vitrified tiles and is adequately positioned to benefit from pricing improvement and bottoming out of margins. Company has taken price hikes during Q3FY19 and is also likely to benefit from fall in the gas prices. Key risk to our rating and target would come from pricing pressure or imposition of anti-dumping duty by GCC nation on tiles imported from India.
NCC: Buy, Target price: Rs 135
NCC’s performance during Q2FY19 stood well ahead of our estimates. Its strong order book provides healthy revenue visibility while margins are also likely to remain strong. Balance sheet is also much cleaner with asset light business and leverage of around 0.38x. Key risk to our estimates and recommendation would come from adverse ruling on power project cases where arbitration is going on or delays in receivables.
Century Plyboards: Buy, Target price: Rs 232
Though performance of Century ply had come below our estimates during last quarter due to pressure on MDF utilization and realization and also forex losses, going ahead performance is likely to improve with volume improvement in plywood and laminate volumes. MDF realizations have not yet bottomed out but utilization levels have started improving since Q3FY19. Margins are also likely to improve in coming quarters led by price hikes as well as reduction in costs linked to crude oil.
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