Quality midcaps not cheap

The pause in interest rate cut by the RBI may not be good news for mid-cap companies that typically tend to have high interest payouts. But quite a few companies in this universe run their business on low debt and thus face no debt servicing problems.

Almost a third of the BSE Midcap companies have an interest coverage ratio of five times or more. That means their operating profits cover their borrowing costs by at least 5 times. MNCs such as Kansai Nerolac, Alstom or BASF, which are regularly funded by their parents as well locals with rich cash or low debt, such as Marico, Lakshmi Machine Works or Mahindra Holidays all have high interest coverage.

Besides, 15 per cent of the 170 companies (for which balance sheet data is available) in the midcap index have nil debt. As the market currently favours companies that are cash rich or have a sound balance sheet, do these mid-cap companies make for good buying opportunities?

No, because of their rich valuations. Having delivered supernormal returns in a short period, many of these stocks now look expensive. For example, companies such as 3M India, Britannia Industries or Berger Paints have all delivered good results besides possessing the defensive qualities mentioned above.

The above stocks therefore delivered returns anywhere in the 40-235 per cent range in the last six months and look steeply valued now in terms of their price earnings ratio.

The valuations they demand will require them to grow their earnings by 30-50 per cent annually in future. A task that is not easy, if you go by their past performance, in much better times. That simply means that opportunities that were available in the mid-cap space have been amply tapped in the last six months to a year.

Large-cap scene

But contrast this with the equation for large-cap companies. The stock of BHEL is trading at 7.6 times its trailing earnings in contrast to the 12-16 times valuations enjoyed by other capital goods players in the power space. This, after the company delivered a 17-per cent earnings growth, in sharp contrast to the marginal increase or even decline in earnings by quite a few companies in the space.

BHEL was an underperformer in the market in the last six months on account of slower order flows, linked to lack of activity in the power generation space.

Then there are large-cap players such as UltraTech Cement or ACC that rallied over 25 per cent year to date and yet are cheaper compared with mid-cap plays such as Shree Cement. The large-caps space also showcases dividend yield plays that can provide you with hefty returns in the form of dividends even when their stock action remains mute.

With rich cash, these options are more abundant in the large-cap space. Hero MotoCorp, refiners such as IOCL, BPCL, HPCL and even power plays such as REC all offer dividend yield of anywhere between 3.6 per cent and 5.1 per cent. Buying a stock at depressed prices obviously hikes your dividend yield too.

READ ALSO: Time to buy large caps

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