Short Call | Street looks for 'next best ideas' as focus shifts to MCX, Colgate, Dr Lal Path Labs

Small-caps and micro-caps continue to be in a parallel universe.

Only novel 'soft-shelled' ideas produce extraordinary returns, because the obvious ideas are already reflected in a stock's price. - Charles Ellis

One of the signs of trouble that market veterans keep an eye out for in a bull market, is of ignored stocks regaining favour with investors. That is an indication that the market may have run out of good ideas and is now willing to give a benefit of doubt to the stories it was not convinced about till a few months back. And that is now beginning to happen, they say. The good part is that such stories too have their day in the sun, before investors conclude that there are not enough stories available at a sensible price, even after accounting for a hefty growth premium.

Foreign funds were net sellers for the second successive day on Friday. Thursday’s huge negative figure was attributed to reversal of cash-futures arbitrage positions on expiry day. The street is unfazed by Friday’s net sales figure as well. The view is that mutual funds are sitting on enough cash, having sold shares when FIIs were on a buying spree since May. Should FIIs keep up with their selling, domestic funds would step in, say market players. Fundamentals, anyone?

What’s cooking?

Multi Commodity Exchange (MCX) on Saturday reported a weak set of first quarter earnings. The numbers did not come as a surprise, given the hefty licence and maintenance charges it has been paying 63 Moons Technologies for extension of the contract for the trading platform. Net profit fell 52.7 percent even as the revenue for the quarter jumped around 34 percent year-on-year.

The net profit numbers are expected to worsen in the next couple of quarters, as MCX will be shelling out Rs 125 crore each quarter to 63 Moons,

compared to the Rs 87 crore it had paid for the June quarter. Licence and maintenance fees alone will work out to Rs 337 crore for this financial year, compared to the net profit of Rs 149 crore for the whole of last year.

Interestingly, the MCX stock has been resilient in the face of this massive a blow to its bottomline. The stock had corrected sharply in the trading session following the extension of the contract with 63 Moons. Since then, it has not just recouped the losses, but is trading higher than the levels pre-announcement of the deal. What could explain market enthusiasm for a stock that is not expected to report any meaningful profits for this year, and perhaps even a loss. There is chatter that MCX is in talks for a possible buyout by either NSE or BSE.

Market players say a deal with the NSE is highly unlikely because the bourse would then have a dominant position in both equities and commodities, something that won’t sit well with the Competition Commission of India (CCI). When asked for their comments, NSE denied that it was in talks with MCX, BSE declined to comment on market speculation and PS Reddy, CEO, MCX messaged: “It is not our policy to keep reacting to every rumour floated in the market. We will mind our business.”

A more straightforward explanation of the strength in MCX shares could be that investors are willing to look beyond the next few quarters of weak earnings, and instead focussing on the big picture story—that of MCX’s dominant market position in the commodity trading space, which does not appear to be under threat in the foreseeable future.
Benefits of under ownership

In December 2022, the Colgate India management met up with analysts and presented its game plan. Most of the analysts returned unenthused, terming the targets as too aggressive for a segment that was not growing fast enough. The stock drifted lower for a while, but since then has been climbing steadily, going on hit a record high on Friday. FMCG stocks, barring ITC, have not exactly been in the rage in 2023, but Colgate has quietly managed to tot up a 30 percent plus gain. The first quarter numbers announced last week were better than what most analysts had pencilled in. The company is slowing wresting back market share in the toothpaste segment, easing raw material prices have helped margins and there are signs of a recovery in the rural market as seen from the first quarter.

But analysts don’t seem convinced yet, and for two reasons. One, they are waiting to see if the first quarter number growth numbers can be sustained, and two, stock valuations are not exactly cheap. Citi has retained its 'sell' rating on the stock after the Q1 earnings, Motilal Oswal has a 'neutral' rating on the stock, Prabhudas Lilladher has a 'hold' while Sharekhan has upgraded its rating to 'hold'.

Most of the analysts raised earnings estimates for this year, but whether they want to hard sell the idea to fund managers is what will decide the rerating of the stock, which has been an underperformer for the last few years.

Analysts may be lukewarm to the stock, but the fact that most fund managers are underinvested in the stock appears to be working to Colgate’s advantage for now. The stock has rallied on heavy volumes despite cautious calls from analysts. As one of the market truisms go, the big profit from a stock call is not made by waiting till you see the proof of growth. And yet, it is hard to blame investors for not being adventurous enough, considering that growth has disappointed for the last many years. In a market where there are plenty of growth stories to choose from, investors can afford to be demanding in a few cases.

Street sees the red

Diagnostic stocks have been among the comeback stories of 2023, as concerns over the price war unleashed by recent entrants in the space appear to be fading. The worst seems to be behind for diagnostic stocks as investors appear to have made peace with the fact that the lusty growth numbers seen during the Covid phase were an aberration that could not have been sustained for long. Dr Lal Path shares have surged nearly 33 percent from the lows seen in February, raising hopes of a rerating. The price war may have abated, but pricing power is another matter.

Dr Lal Path Labs CEO Bharath Uppiliappan told CNBC-TV18 a few days back that competitive intensity remained high compared to pre-Covid levels, and that the company would hike prices only when input costs go up. He expects non-Covid volumes to pick up from the second half of this year. The outlook for the company is much better than what it was in 2022, but the question is if the market has already priced it in.

Kotak Institutional Equities analysts Alankar Garude, Samitinjoy Basak and Aniket Singh think so. “The increasing sanity in diagnostics pricing is well captured in the recovery built in our estimates,” the trio wrote in their earnings review note. “Despite recent moderation, pricing of incumbents such as Dr Lal Path Labs stays 2-3X higher than the cheapest organised alternative across cities, even for specialised and semi-specialised tests. While we have raised our margin assumptions post the 1QFY24 performance leading to a 4-6 percent raise in Dr Lal Path Labs FY2024-26E EPS, heightened marketing and tech investments could play spoilsport.”