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Smallcap, midcap stocks find takers as global commodity prices soften

With commodity prices easing and rural sentiment turning positive, the Nifty Midcap and Nifty Smallcap indices have seen a rally. The indices have risen nearly 7 percent and 4 percent, respectively, in July 2022.

July 18, 2022 / 12:53 PM IST
 
 
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So far this month, the Nifty Midcap 100 index has risen 6.8 percent and the Nifty Smallcap 100 rose 4.2 percent while the benchmark Sensex and Nifty have advanced 2.3 percent each. Since June 20 till date, the Nifty midcap and smallcap indices have climbed nearly 11 percent each, while the Sensex and the Nifty have risen 5.3 percent each.

In May, the midcap and smallcap indices were down 5 percent and 10 percent, respectively, while in June (till 20), they declined 11 percent and 8.5 percent, respectively.  Year-to-date, the Nifty midcap has shed 7.3 percent, while the Nifty smallcap has lost 22 percent, and the Sensex and the Nifty have fallen 7 percent each.

The gainers

Among the MidCap firms, Hindustan Zinc, Adani Total Gas, Oberoi Realty, Dalmia Bharat, Indian Bank, Crompton Greaves Consumer, Canara Bank, IDBI Bank, United Breweries, Escorts Kubota, Apollo Tyres, Trent, Maindra & Mahindra Financial Services, Godrej Properties, MRF have risen 13-18 percent.

Among the SmallCap companies, Brightcom Group, HFCL, Anupam Rasayan India, KEC International, Can Fin Homes, Chambal Fertilisers and Chemicals, City Union Bank, Bajaj Electricals, Edelweiss Financial Services, Granules India, Jindal Stainless, Poonawala Fincorp advanced 11-46 percent.

Better days ahead

"Small-cap and mid-cap companies have higher sensitivity to increasing commodity costs on their margins and profitability. Therefore, these indices corrected sharply, post the sudden jump in commodity prices amidst the Russia-Ukraine crisis in the last 4-5 months,” said Mitul Shah, Head of Research, Reliance Securities.

“Recently, commodity prices have started softening, crude oil prices have started falling and rural sentiment has become stable, post a favourable monsoon. All these have turned investor sentiment positive. The valuations of these companies are compelling, after a sizable stock price correction,” he said.

Narendra Solanki, analyst at Anand Rathi, said both the Nifty midcap100 and Nifty smallcap100 are trading at about 12x and 17xm respectively, in the last twelve months (LTM) while their-five year average is at 36x and 34x, respectively, on an LTM basis.

Analysts expect the June quarter earnings for midcap and smallcap companies to remain strong, YoY, due to the lower base effect after the second wave of COVID-19. Hence, one must not extrapolate the growth rates with this quarter, they said.

Double-digit growth to sustain

However, they see a trend of double-digit and mid-teen growth, adjusted for seasonality, sustaining for midcap and smallcap companies, on a quarter-on-quarter (QoQ) basis,

“I think earnings would be fairly on expected lines. The markets are expecting sustained growth in top line for most companies and pressure on margins to persist this quarter," Solanki says.

Nearly 85 percent companies from the Nifty MidCap segment and 78 percent from the Nifty SmallCap universe have risen so far this month.

There were also multiple other macro challenges like increase in freight, power and fuel costs for some companies. For some export-oriented companies, logistics costs too had gone up due to container shortage issues. Analysts see a reversal in most of them and that too at a rapid pace.

That is expected to boost the earnings of midcap and smallcap companies, starting the second quarter, and they will have a full impact in the third quarter. Markets, being forward-looking, have already started to price in some of the benefits ahead and hence some gains of late, analysts added.

"Lower commodity prices also lead to some price correction, which is healthy. We have been seeing demand destruction in many categories due to price hikes by companies. With the cycle reversing, some of the demand, in terms of volume growth, is likely to come back. This augurs well for midcap and smallcap companies, making a case for operating leverage to play out, going forward," Niket Shah, Fund Manager, Motilal Oswal AMC, added.

Global markets are already under pressure amid concerns of inflation and fears of a recession looming. India's CPI inflation stayed above 7 percent in June, while the US recorded a 41-year-high inflation, at 9.1 percent.

Central banks around the world are likely to consider a steep hike in interest rates in order to tackle elevated inflation levels. India's depreciating rupee, widening trade deficit, continuous outflow from FIIs and volatility in global crude prices are adding concerns.

Ravindra Sonavane