Three quality mid caps trading at attractive valuations

We take a look at three mid-cap companies with high growth and reasonable valuations.

Bargain picks: 3 mid-cap companies at attractive valuations

dhanak हिंदी में भी पढ़ें read-in-hindi

The march of Dalal Street bulls has been unwavering. The blue-chip Sensex index leaped 22 per cent in the past year while its mid cap counterpart vaulted a handsome 65 per cent!

Stocks are obviously much pricier following the rally, making it tough to find attractive opportunities. This is when it's crucial to remember that fundamentally strong companies lead to solid returns only when bought at reasonable prices.

Hence, we looked for such companies using our 'top value mid-caps'> stock screen that filters mid caps (Rs 11,000-63,000 crore market cap) with a quality score of more than 5 and valuation score of more than 6.

From there, we picked three non-BFSI companies that have grown their annual revenue by over 20 per cent in the last five years. Let's find out their prospects:

Chambal Fertilisers & Chemicals

About 12 per cent of India's urea output is produced by Chambal Fertilisers (FY23). The company earns nearly 60 per cent of its revenue from urea fertilisers. It also markets non-urea fertilisers (DAP, MOP, NPK), specialty plant nutrients and crop protection chemicals.

Chambal has been quick to capitalise on the demand-supply gap of urea that is among the most widely used in India. It invested Rs 5,700 crore to set up its Gadepan III plant, raising its urea production capacity to 3.4 metric tonnes in FY23 from 2.1 metric tonnes in FY18.

The company's revenue and net profit grew a robust 30 and 16 per cent per annum between FY18-23, aided by its diversification into non-urea segments like specialty plant nutrients and crop protection chemicals.

That said, government-mandated pricing in the highly regulated fertiliser industry leaves companies with close to zero bargaining power. Their revenue, thus, largely depends on subsidies that the government provides based on how energy efficient they are.

Hence, Chambal has been improving its energy efficiency. The Gadepan III plant has an ammonia purifier, CO2 removal process and urea synthesis. This helps the company avail higher government subsidies, and protect its profitability and margins.

The dearth of urea output in India and the government's priority towards improving agriculture remain the biggest opportunity areas for Chambal. On top of this, it plans to establish a technical ammonium nitrate plant at an estimated cost of Rs 1,170 crore that has applications in other growing businesses like coal mining, cement production, iron ore and infrastructure projects.

However, its high dependence on subsidies, where there is ample risk of delays or reduction, makes the business volatile and working capital intensive. Note that its trade receivables as a percentage of current assets had touched 76 per cent in FY20 due to delayed subsidy disbursements. The cyclical nature of the industry and weather-related uncertainty are other worrying factors.

Indraprastha Gas and Mahanagar Gas

Gas distributors Indraprastha Gas (IGL) and Mahanagar Gas (MGL) have long benefitted from the government's favourable policies on reducing diesel consumption and mandating piped natural gas (PNG) usage in industries.

The duo was thus able to establish dominant positions in their respective markets. IGL primarily offers compressed natural gas (CNG) in the Delhi-NCR region, while MGL is the only CNG and PNG distributor in Mumbai, Urban Thane, its adjoining areas and Raidgad.

CNG makes a good auto fuel due to its low price and PNG is liked for its feasibility as a cooking gas, making both of them high-demand in nature.

The two companies were able to cater to this demand by steadily enhancing their infrastructure network (CNG stations and piped connections for PNG). As a result, IGL and MGL's topline grew 26 and 23 per cent per annum, respectively, between FY18-23.

Moreover, exclusive agreements for setting the infrastructure and the industry's high-regulatory, high-capex nature puts the two giants at an advantage by making it difficult for others to enter.

However, the Delhi Government's recent electric vehicle (EV) policy that mandates cab aggregators to have a 5 per cent EV fleet and a complete transition by 2030 is a significant risk, especially to IGL.

With 60-65 per cent of its CNG volumes coming from Delhi, the move can impact around 20 per cent of IGL's volumes. The government's growing focus on EVs is an overhang on Mahanagar Gas too.

Is the EV threat real?

As much as the threat from EVs is undeniable, we still believe it is not enough to weed out the two giants.

The impact of EVs will be first felt on the demand for petrol and diesel, as CNG still remains the most preferred choice for its low price and high mileage combination. Besides, a fully electric infrastructure is still years away.

The two companies have begun diversifying their operations into battery swapping and charging segments at their well-established and widely present CNG stations.

The other business segment of PNG continues to have high room for growth backed by the government's aim to connect every household via the piped network. In industries, usage of any other gas except PNG is already prohibited.

IGL and MGL's growing focus on the liquefied natural gas (LNG) segment for long-haul vehicles will also contribute to growth as the heavy weight of such vehicles makes them unsuitable for batteries and using hydrogen as a fuel will take many more years.

Owing to this, IGL is readying a small plant (first such pilot in the country) that will be used to convert CNG into LNG.

Hence, we believe the growth prospects for the two companies are still intact given their diversification plans.

Disclaimer: These are not stock recommendations. Please do the due diligence before investing.

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