Reving up on green growth: companies like Gujarat Gas will reap benefits from the increased usage of CNG

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The recent mid cap rally has taken analysts big and small by surprise. Companies that have a middle-range market capitalisation (defined as the market value of all shares added up) have been doing remarkably well on the bourses. Over the last three months, the NSE Mid Cap Index has shot up from 1,647 to 2,005 (a gain of 358 points or 22 per cent). Compare this to the 224-point-14 per cent-gain in the overall NSE Nifty over the same period.

There's more. While the main market indices are still dreaming of hitting their all-time peak, the Mid Cap Index has already pierced it. Mid cap stocks are on a roll like never before, and much money has been made. If you're tempted to jump right into the game, stop. Your question should be whether it still makes sense to get in at this stage.

So, does it?

First, consider the basics. Mid cap stocks are typified by higher risk and lower liquidity, which means that investors have always paid less for every rupee's worth of earnings on them than for big cap stocks. They trade at a discount. Well, no longer. "With the tremendous rally in the last three months, the valuations gap between mid cap and large cap has vanished," observes Sharad Shukla, Head of Investment Advisory Services at IL&Fs Investmart. This could mean that mid caps do not have much further to go.

But that still doesn't mean you avoid mid cap stocks altogether. "Though the across-the-board mid cap rally is over," says Chandan Desai, Director, TAIB Securities (India), "there are several mid cap stocks that are still cheap." These stocks can be broadly classified into two. First, the ones that have already rallied but have potential for further rise. These are stocks that could display a sustained strengthening of financials on the back of an improvement in economic conditions overall. These mid-sized companies could easily turn large, thereby gaining economies of scale too, but the market may not yet have priced the future in. The second category is that of stocks that are going cheap because they have escaped the attention of big time investors. These, of course, are slightly riskier too, which may be partly why they've escaped attention so far.

That said, you need a mid cap strategy before getting into the game. Our suggestion: take the top-down approach. This involves no more than a good look at the big picture, and having understood it, taking the logic down systematically to the smallest unit. So if the reformed economy is going strong, work out the sectors that stand to gain the most, and then look closely at different players and how they're placed to make money. Clothing and textiles, for example, are expected to gain from the end of the quota regime in 2005. Shipping is witnessing high demand and rising rates. Construction is set to gain from the big infrastructure push.

Another way would be to identify standapart firms that are doing well regardless of other conditions. This is the bottom-up approach. Either way, here are some mid cap stocks that could do your portfolio good.

Gujarat Gas

A mid cap stock, by the way, need not be a small player in the industry. This subsidiary of British Gas is India's largest private sector natural gas distribution company. It boasts a pipeline network of over 1,600 km in the three most important industrial cities of Gujarat, and also of a customer base exceeding 1,50,000 spanning a wide range of gas usage segments (be it industrial, commercial or domestic). Most excitingly, demand for gas is growing very fast. "The proposed phasing out of polluting vehicles (or its compulsory conversion to compressed natural gas or CNG) will benefit this company," predicts Rajeev Thakkar, Head (Research), Parag Parikh Financial Advisory Services.

Hikal

In terms of industries, Hikal has interests in both agrochemicals as well as pharmaceuticals. Moreover, it has shown steady growth in both, despite the presence of domineering companies. Its global approach helps. Thanks to a fresh outsourcing contract from the us, its generic pharmaceutical business is likely to give a big fillip to its growth momentum. "Over time," says Nischal Maheswari, Head (Private Clients), Edelweiss Capital, "its contract manufacturing model has the potential to scale up rapidly in both agrochemicals and pharmaceuticals." Further, if the company is able to reduce its raw material costs-which is quite likely-it could see a nice improvement in operating margins.

Maharashtra Seamless

This is a niche player in the seamless industry. It has just commissioned a new facility, which should deliver volume growth over the next couple of years. It also has ambitious plans to venture into steel making, after which it will become a completely integrated player. "For the next two years, Maharashtra Seamless has the potential to grow its revenues and net profit at a compound annual growth rate (CAGR) of 34 and 24 per cent, respectively, and generate a huge cash flow that will help it integrate vertically," says Dilip Bhat, Head (Research), Prabhudas Leeladhar. Not just that, Mahasrashtra Seamless is also the cheapest available stock in its peer group.

Nagarjuna Construction

This is a mid cap company that will benefit vastly from the ongoing infrastructure boom. During the last three decades, it has executed several prestigious projects across the country, and that explains why it is sitting pretty with a huge order book position that will cover sales for the next two years. Further, it has a relatively de-risked business model, thanks, in large part, to the spread of activities across several states and covering the entire gamut of infrastructure construction. "We believe the stock is attractive at the current price," says Bhat, "considering the robust order book, which translates into high revenue visibility and strong earnings growth potential."

Oriental Hotels

Any fast growing economy attracts large numbers of business travellers, and India is no exception. This, coupled with the renewed tourist inflow in recent months, has helped Indian hotel stocks look up. Hotel occupancy rates have been zooming (especially in southern cities such as Bangalore, Hyderabad and Chennai), and tariffs are looking robust after quite some time. All these conditions point to this mid cap company from the Taj group, which has quite a reputation for hospitality excellence. "Its huge real estate also offers inherent value to this stock," says Nilesh Shah, Senior VP and Head (Portfolio Management), Kotak Securities (Private Client Group). Oriental Hotels' aggressive plans to upgrade and modernise all its hotels should help capitalise on the sector's buoyancy in the years ahead.