India Strategy

Top 10 Mid-cap Ideas

The valuation discount (Midcap discount to largecaps) at which midcaps Sensex: 20,709 tradedbetweenAugustandOctober2013haslargelyevaporatedintherecent market rally. The BSE Midcaps Index now trades at a 17% discount to the SensexandtheCNXMidcapsIndextradesata7%discounttotheNifty.Theseareamongthelowestdiscounts seenhistorically.Hence,bottomupstockpickingassumesevengreatersignificance. We favour stocks with good fundamentals and reasonable valuations. We expect Amara Raja, Bajaj Finance, SCUF, MindTree, Info Edge, Havells, and Torrent Pharma to show continued good growth over the medium term, while their valuations remain reasonable. We expect Crompton, Biocon and Sobha to show improved earningstractionincomingquartersastheoutlookforgrowthandmarginsimproves. Findbelowourtopmidcapbuysandtherationaleforthesame:
Amara Raja (CMP Rs329)

Nifty:

6,161

AMRJ is gaining market share from the market leader Exide across the Auto replacement and OEM segments.Weexpectindustryvolumestogrow1012%inFY15FY16andAMRJtogrowfaster. AMRJs industrial segment growth was impacted in FY14 by weak industry and capacity constraints. AMRJsnewcapacitywillcomeonlineinearly2014anditshouldresultinmarketsharegains.Thiscoupled withanimprovementintheeconomywilldrivegrowthinboththeUPSandTelecomsegments. AMRJ boasts of a superior cost structure, higher margins, better capital efficiency, and greater growth potentialcomparedwithmarketleaderExide.
Crompton Greaves (CMP Rs122)

Steady improvement in standalone power systems margins indicates that the business is on a recovery path.INRdepreciationledexportgrowthwouldsupportdomesticpowersystemsrevenuetrajectory. Healthytractioninconsumerproductssegment(22%ofconsolidatedrevenues)andsteadymargins. 1HFY14 results provide first signs of turnaround in overseas subs. Despite lower revenues, subsidiaries posted positive Ebitda after four quarters. While problems persist in the US and Canada, management is confidentofreportingprofitforthefullyearforoverseassubs. The overseas business trajectory provides confidence to look beyond the losses in these subs in the near termandvaluethecompanyonstandalonebasis.
Havells India (CMP Rs750)

Havells strategy of growing through new product launches, expanding into new geographies, and wideningdistributionchannels,hasresultedinstrong14%revenueCagrand21%earningsCagrinthepast five years for its domestic operations. We expect revenue and earnings growth to remain robust going forward. Sylvanias (Havells 100% European subsidiary) profitability dipped in FY13 due to a sharp fall in the prices of a key raw material resulting in destocking by dealers; we believe that the margins have bottomed out, sinceafewproducersarealreadyfacinglosses. At16xFY15earningsestimates,thestockisvaluedreasonablyfromamediumtermperspective.
December 05,2013
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Bajaj Finance (CMP Rs1,459)

Top 10 Mid-cap Ideas

BAF has successfully evolved a growth strategy based on product diversification, geographic penetration, and crossselling. This is supplemented by topnotch execution in establishing a strong origination infrastructureandlayingdownstrictprocessesofduediligenceandloanrecovery. BAFs ability to defend product pricing, its strong brand recall and parentage, and efficient operations will aidingeneratinga22%earningsCagrthroughFY1316ii.AsastandaloneNBFC,BAFwillbeabletodeliver +3.5%ROAand20%ROE It is a strong contender to receive abank license and is best placed to transition smoothly into one. Some of BAFs loans already classify for priority sector and BAF has an existing branch infrastructure and strong brandrecall.
Shriram City Union(CMP Rs1,060)

SCUF promises to deliver sustained 23% AUM Cagr driven by increasing penetration, niche product focus and small market share. Retail loans and loans to small businesses will remain key drivers. Warrant conversionhasaddedtothealreadyhealthycapitalisation. Despite marginal increase in NPAs, we expect 17% earnings Cagr, driven by improving loan growth and stablemargins. The stock currently trades at 1.9x FY15ii BV. Given reasonable visibility of 2.7% ROA, 1820% ROE, and strongcapitalisation,webelievethestockshouldtradeatapremium.
MindTree (CMP Rs1,396)

Strongaccountminingandrobustgrowthininfrawouldcontinuetoresultinrevenuegrowthbeingoneof thebestinthesector.Dealwinsandmanagementcommentarycontinuetobehealthy. Performance at the hitech business unit has also improved as the company is seeing success in cross sellingITservicestoitshitechcustomers. Mindtreeslowemployeeutilisation(~65%lowestinfouryears)isakeymargintailwindinthenearterm. Although furloughs and wage increases are not likely to result in margin expansion in 3QFY14, we see marginsexpandingfromthereon.
Info Edge (India) (CMP Rs437)

While the hiring conditions remain tight, management indicated that hiring in its largest segment, IT services, is showing signs of improvement. Naukris traffic share among job portals remains high and the newproductpipelineisamongthebestever. MgmtofportfoliocompanieslikeZomatoandPolicybazaarhasindicatedthatfocusonprofitabilityishigh. Forinstance,whilePolicybazaarsrevenuewilllikelygrowmorethan80%inFY14,itsemployeeheadcount hasnotincreased.Zomatohasalreadybecomeprofitableincertaingeographies. Given a wide portfolio of internetrelated business, InfoEdge is the most diversified company to benefit fromtheincreasinginternetpenetrationinIndia.At27xtwoyearforwardPER,itsvaluationsarecheap.


Biocon (CMP Rs387)

Top 10 Mid-cap Ideas

Legacy biopharma business will be driven by immunosuppressants and insulins geographical penetration. Domestic pharma business (now contributing 14% to top line) is growing at 30%+ Cagr; new launch of trastuzumabaddstovisibility. Syngene(contractresearchsubsidiary)isgrowingatmidtohighteenCagr;listingcouldunlockvalue. Bioconis oneofthefrontrunnerstotheregulatedbiosimilarsmarketintheUSandEurope.Globalphase III trials have been initiated for Herceptin and are completed for rhInsulin. The stock is trading at 15.5x FY15ii core earnings, without pricing in any significant option value for biosimilar products. We expect valuationtobuildinbiosimilarupsideasvisibilityimprovesovernext1224months.
Torrent Pharma (CMP Rs483)

Torrent has a strong business portfolio with longest growth potential; >60% revenue comes from the emerging markets and more than 70% of domestic revenue comes from specialties; Torrent has a fast rampingUSbusiness. A low base and high number of product launches will keep growth in the US above 30% for the next 3 l years.PickupindomesticgrowthandrampupinMexicowouldenhancegrowthrates. The stock is trading at 11.6x FY15ii core earnings, at 2050% discount to largecap pharma. A growing revenue base, improving growth outlook, high contribution from branded markets and steady and high freecashflowsmakemediumtermreratingastrongpossibility
Sobha Developers (CMP Rs335)

Strong improvement in operating cash flows ahead. Cash collections were up 30% YoY in 1HFY14, well aheadofthe18%YoYgrowthinrevenue.Weexpectdoublingofoperatingcashflowsand2.5xincreasein profitoverFY1216asthecompanyrecogniseshighermarginnewsales. ROE should improve 400bps to 14% by FY15. Free cash flow to interest will turn increasingly favourable, allowingthecompanytoploughbackmoremoneyintothebusiness/paydividends.Thecompanydoubled itsdividendpayoutto37%ofPATinFY13. Valuationremainscheap.Stocktradesata30%discounttoouroneyearforwardNAVofRs440/share.

Recommendationparametersforfundamentalreports: BuyAbsolutereturnofover+10% MarketPerformerAbsolutereturnbetween10%to+10% SellAbsolutereturnbelow10%

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