scorecardresearchMicrocap space is the last bastion of relatively cheap valuations, says
The brokerage has assumed the microcap universe to be consisting of stocks with a market cap rank from 501 to 1,000.

Microcap space is the last bastion of relatively cheap valuations, says ICICI Securities; lists top stocks

Updated: 17 Jul 2023, 03:32 PM IST
TL;DR.

ICICI Securities believes the microcap space is the last bastion of relatively cheap valuations in a rising bull market environment. However, it added that liquidity remains a key risk.

At a time when the Indian markets are trading at their peaks and valuations of major bluechips as well as broader market stocks have become expensive, brokerage house ICICI Securities believes the microcap space is the last bastion of relatively cheap valuations. However, it added that liquidity remains a key risk.

Valuations

Microcaps offer relatively cheap valuations vs large, mid and small caps, it said. As per the brokerage, the current microcap universe valuation in terms of trailing earnings yield excluding loss pools is 6 percent (trailing P/E of 16x-17x) as compared to 4 percent for large caps (trailing P/E of 24x), thereby, offering reasonably cheap valuations in terms of risk spread in a bull market environment.

On the other hand, mid and small-cap valuations in terms of earnings yield spread over largecaps have diminished significantly with their average trailing earnings yield at 4.7 percent (marginally above that for largecaps at 4.3 percent), it noted.

The brokerage has assumed the microcap universe to be consisting of stocks with a market cap rank from 501 to 1,000.

Past trends

Going by the past trends, the brokerage highlighted that the ‘risk tolerance’ towards microcaps has room for expansion if the current bull market continues.

"Earlier instances of bull markets in broader equities have seen microcap earnings yield spread over large caps drop to near zero vs current spread of 150-200 bps. Assuming that current bull market continues, driven by a broad-based investment cycle, the probability of a repeat of past behavior cannot be ruled out. Mid and small caps, on the other hand, have marginal earnings yield spread over large caps although they too have not reached extreme bull market valuations wherein they trade at a premium to large caps," it said.

Strategy

The brokerage further pointed out that the Nifty Microcap 250 index has a significantly high weight of 68 percent in the broader industrial sector and discretionary consumption, which could benefit from the current demand environment in the economy.

Post-pandemic recovery, GDP is being driven by growth in ‘gross fixed capital formation’ (GFCF) and higher-end discretionary consumption, it added.

"GFCF growth has been augmented by the ‘real estate upcycle’ and central government capex while corporates have started showing robust growth FY23 onwards. Empirical evidence suggests industrials related to manufacturing activity benefit in the aforementioned environment, which is getting further support from the government in terms of policymaking (PLI schemes and overall boost towards manufacturing in India). NIFTY Microcap 250 index has a large weight in the broader industrial sector (50 percent) and discretionary consumption-related manufacturing (18 percent) as compared to NIFTY50, and given the current trend of economic growth, such stocks are favourably placed in the economic upcycle," it stated.

Risks

Apart from being largely cyclical in nature, microcaps have another major risk which is liquidity with the bulk of stocks having an average daily turnover of below 10 crore, cautioned ICICI Securities. Hence, in an economic downturn-driven bear market, the ‘beta’ factor works against microcaps along with liquidity risk, thereby, resulting in sharp corrections, it noted.

The brokerage also mentioned that microcaps are the wider universe of stocks with minimum quality standards (RoE over 10 percent) available at a cheap price. Currently, in microcap universe (market cap rank from 501 to 1,000) there are around 80 stocks with RoE > 10 percent and earnings yield > 10-year government bond yield which allows screening within a wider universe of stocks available at cheap valuations with minimum quality standards, it noted.

Microcap top picks from ICICI Securities' coverage universe: Wonderla Holidays, Somany Ceramics, Greenpanel, Sansera Engineering, ISGEC, Fusion Micro Finance, Repco Home Finance, Nazara Tech, Tatva Chintan, Astra Microwave, and Gokaldas Exports.

Wonderla Holidays: The brokerage has a ‘buy’ call on the stock with a target price of 738, indicating a 30 percent upside. After a washout in FY21 and FY22 owing to Covid, Wonderla Holidays (Wonderla) staged a stellar bounce back in FY23 with revenue of 4.3 billion which was up 58 percent vs FY20 while EBITDA grew 102 percent over FY20 to 210 crore. “While we estimate 12 percent EBITDA CAGR over FY23-25E from the three existing parks leading to FY25E EBITDA of 260 crore, the company is also entering a new phase of growth with its Chennai and Odisha parks set to become operational in FY26E,” it said.

Somany Ceramics: The brokerage has a ‘buy’ call on the stock with a target price of 896, indicating an over 21 percent upside. The company's operational performance in Q4 was largely in line with expectations and has near-term demand and margin tailwinds due to a pick-up in the domestic housing market and increased exports from Morbi (thus possibly lower domestic competition and pricing pressure) along with lower gas prices. We, thus, continue to like the company and maintain ‘buy’, it said.

Greenpanel: The brokerage has a ‘buy’ call on the stock with a target price of 505, indicating a massive 43 percent upside. While the brokerage cut its FY24/FY25E PAT estimates by 9 percent/5 percent due to near-term demand headwinds from high imports and increased raw material prices, it continued to like the company for its leadership in the MDF segment which has strong growth prospects, increased focus on A&P which will enable long-term growth for the segment and strong net-cash balance sheet.

Sansera Engineering: The brokerage has a ‘buy’ call on the stock with a target price of 1,033, indicating an upside of 12 percent. The brokerage is positive on the stock as: a) SEL is aiming towards 3500 crore revenue by FY25 vs 2300 crore in FY23 with growth being driven by domestic 2W demand revival, return of growth in export markets and expansion of the aerospace segment; b) Bidadi plant, after clocking 240 crore revenue in FY23, is targeting to double the figure by FY25; and c) post reaching 90 crore revenue in aerospace in FY23, SEL is aiming to take it up to 250 crore by FY25 driven by its newly constructed facility.

ISGEC: The brokerage has a ‘buy’ call on the stock with a target price of 698, indicating an upside of just 2 percent. With improving order inflow and better margins led by a better job mix, ICICI Securities expects execution to pick up along with a gradual improvement in profitability. Management guidance of double-digit revenue growth has also been factored into estimates, it added.

Fusion Micro Finance: The brokerage has a ‘buy’ call on the stock with a target price of 650, indicating an upside of 7 percent. Fusion Micro Finance (Fusion) continues to lead the industry in terms of profitability and growth – as reflected in its RoA and RoE sustained at >4 percent and >20 percent, respectively, in each of the 4 quarters of FY23 despite the creation of a provisioning buffer of 30 lakh in Q4FY23. AUM grew by a strong 7 percent QoQ, taking full-year FY23 growth to 37 percent YoY. Incremental growth was driven by new customer acquisitions. The company continued to invest towards distribution expansion which would ensure the sustainability of high growth in the near term, it said.

Repco Home Finance: The brokerage has a ‘buy’ call on the stock with a target price of 360, indicating an upside of 14 percent. The brokerage is bullish on the stock on the back of strong financial performance, NII growth, rise in AUM, NIM expansion and improving asset quality. It also believes that the company’s business franchise is currently undervalued.

Nazara Tech: The brokerage has a ‘buy’ call on the stock with a target price of 700, indicating an upside of 5 percent, given its strong revenue growth trajectory in the eSports business and gradual profitability improvement in gamified early learning (GEL). It estimates a 35 percent YoY revenue growth in FY24E led by 45 percent YoY growth in eSports and 25 percent YoY growth in GEL.

Tatva Chintan: The brokerage has a ‘buy’ call on the stock with a target price of 2,110, indicating an upside of 23 percent. Tatva Chintan has guided an EBITDA margin of 20-22 percent and 20-30 percent revenue growth to sustain in FY25 but ICICI Securities believes that near-term weakness in margin has weighed on guidance for FY25. It sees the potential for higher margins in FY25 due to the commissioning of a continuous flow plant which has higher margins and capacity ramp-up in Dahej-2. Notwithstanding the near-term weakness, the brokerage likes Tatva Chintan due to its unique product portfolio, and strong pipeline which can drive faster growth on macro situation turnaround.

Astra Microwave: The brokerage has a ‘buy’ call on the stock with a target price of 425, indicating an upside of 16.5 percent. As per the brokerage, AMW’s order potential is robust and the solution-oriented approach being built on twin planks of collaboration with external parties and internal competencies – is likely to result in better margins.

Gokaldas Exports: The brokerage has a ‘buy’ call on the stock with a target price of 560, indicating an upside of 5.5 percent. A sharp fall in key input costs might have excited the street; however, the benefit of the same shall only be visible in upcoming months as clients place larger orders. There is no change in the long-term story for GEXP; however, a few blips may result in minor stock price correction and hence, provide a fresh entry opportunity, it said.

 

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First Published: 17 Jul 2023, 03:32 PM IST