Cherry-picking midcaps in the earnings season…

Historically, it’s been witnessed that whenever a market rally in the frontline indices sustains and money continues to flow in, interest in the midcap segment skyrockets. A similar phenomenon can be witnessed even at present. As markets rose like phoenix from the ashes over the last 4 months, BSE 150 Midcap Index outshone BSE Sensex on a Year-to-Date (YTD) basis.

It’s absolutely fine to play the momentum if you understand associated risks. However, you must be ultra-careful when the earnings season is around the corner and stocks are going into corporate results with a roaring price performance on bourses.

Midcaps running neck and neck with largecaps…

Evaluating the Q1 performance

Comparing quarterly results on Year-on-Year (Y-o-Y) basis is a customary practice among investors and stock market professionals. However, Q1FY20 results would prove an exception. As India observed (perhaps) the world’s strictest lockdown during April and May, Q1FY21 earnings won’t be comparable with those of Q1FY20. Company guidances on the potential recovery in their respective businesses post pandemic will be the only yard-stick available to investors this time for building any future case.

Besides, you should also look at the earnings momentum of companies in the pre-COVID times—Q4FY20 numbers would serve the purpose. Companies that reported a substantial drop in revenues and profits, with just one week under lockdowns, will be vulnerable to bigger shocks in Q1FY21 and beyond—irrespective of what concerned companies have said in their respective COVID-related exchange filings.

Are any bright spots in sight?

We analyzed BSE 150 Midcap companies to gauge the earnings momentum and filter out laggards based on their Q4FY20 performance. Only 38 out of 150 companies reported a double-digit growth in the revenue and net profit.

Q4FY20 report card of BSE 150 Midcap

We applied one more parameter to narrow down further—Net-debt-to-EBITDA ratio (Earnings Before Interest-Tax-Depreciation-and-Amortization). We considered companies having a Net-debt-to-EBIDTA ratio of less than 2.

Torch-bearers?

COVID disclosures filed with exchanges serve as a great heads up to how the Q1 and Q2 might be for the business of various companies. Given below are a few samples:

Trent
Even as the lockdown measures are eased, we envisage restrictions being prescribed/ warranted with respect movement of people and this may lead to the consumer sentiment taking a few months to adjust/ fully recover. The Company has visibility to adequate resources to sustain the Covid-19 related impact in the interim period and we do not foresee any continued adverse impact over the medium to long term.

Gujarat Gas
Subsequent to the outbreak of Coronavirus (COVID-19) followed by countrywide lockdown, the Company continued its uninterrupted supply of Natural Gas to its customers based on their requirement. However, the lockdown had an impact in the immediate natural gas demand, mainly from Industrial and CNG customers. As restrictions are being lifted gradually in many of the Company’s operating areas, demand has started showing up an increasing trend both in industrial and CNG segments. The company also invoked the provision of Force Majeure under the gas purchase agreement with its suppliers to secure itself from any liability.

IRCTC
The impact of COVID-19 on the financials of FY20 will be minimal. Due to the lockdown, the revenues and profitability of the Company are likely to be adversely impacted for the April-June quarter of 2020. As the situation is very dynamic, the Company is closely monitoring it. The Company expects that the business situation could normalize during 3rd and 4th quarter.

If you have shortlisted any midcap company that you want to buy post earnings, you might want to read its COVID-related exchange filings first.

Markets will start building a hypothesis on how long a company might take to go back to pre-COVID levels based on: 

  • Q1FY21 earnings
  • Momentum in earnings witnessed in Q4FY20 and full-year (FY20) numbers
  • Sectoral outlook
  • Post-result management commentary on the impact of COVID (vis-à-vis) that in the exchange disclosures

Price performance of stocks post-earnings will tell you how close the results were to the market expectations. Unless companies that witnessed an impressive growth in Q4FY20 perform miserably and give a negative outlook, markets might prefer to look beyond Q2 and Q3 in their case.

Usually, well-performing largecap companies have a better financial muscle and other firepower required to sail through tough times. Unless midcap companies manage to beat them on growth or valuations, sharp pre-earnings rallies in midcaps—that accord them large-cap befitting valuations—can quickly fizzle out post earnings.

Be cautiously optimistic!

 

Please Note (read as a disclaimer): None of the stocks discussed in the article is the recommendation to buy, hold or sell. This could just be the starting point for deeper analysis that you might want to carry out on your own. You may also take professional help as you feel appropriate.

 

You may also like to read: 20 Potential split and bonus candidates…

 

Disclaimer: 

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

Leave a Reply