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S. Vaidya Nathan

THERE is usually wealth creation beyond belief when a company makes the transition from mid- to large-cap status, crossing a milestone in its history. The process usually stretches over decades, and the number of stocks that make the grade is small. Many a stock remains in the mid- or the small-cap category.

The current bull market — running now for 18 months — has centred on a large number of mid-cap stocks, several of which have made such a transition, adding wealth of a magnitude never managed in the past.

An expansion in large-cap stocks also augurs well as it makes the Indian market more attractive for foreign institutional investors in terms of investment opportunities and greater depth.

Adding strength to the process is the expansion in the mid-cap ranks, even as several of them moved into the large-cap league. There have been occasions of companies appearing to have arrived on the large-cap stage, only to remain there briefly.

Such cases are a consequence of speculative excesses, as happened with IT/media/telecom stocks in 1999-2000.

The quality of the ones that have now made the cut is of more attractive in terms of business fundamentals and valuation levels.

As the curtains come down on 2004, we present two sets of stocks that could make this quantum leap over the next few years:

One, a dozen that have moved into a different league in terms of market capitalisation, and

Two, an equal number of potential candidates. The lists also comprises stocks on which our outlook is still bullish and on which we have either `buy' or `hold' recommendations.

In each set, the focus is on companies that have a growth story largely independent of price trends of the end products. This is why the list is short on commodity stocks, especially from sectors such as steel and oil. Most companies that have made good in a bullish period in the price cycle could slide rapidly if the latter hits the inevitable speed-breaker.

But stocks from this space, too, are likely to expand the list of large-caps, especially if the upward trend in commodity prices lasts a further a year or two. Chennai Petroleum, Essar Steel, Nava Bharat Ferro Alloys, Sesa Goa and Balrampur Chini would top the likely candidates in this category.

Nascent large-caps

The UTI Bank Chairman, Mr P. J. Nayak ... Mature businesses now in the fast lane.

Companies that have an over Rs 3,500-crore market cap have been considered in the shortlist. Mid-cap funds launched a couple of years ago had used the Rs 1,500-crore level as the dividing line.

Of the Nifty portfolio of 50 stocks, half of them were below the Rs 3,500-crore level before the bullish phase altered the profile of the Nifty. Now there are just five Nifty stocks with a lower market capitalisation.

Most stocks in the Nifty Junior, too, have either breached, or are close to beating, that level. As most of these stocks may retain valuation gains, this seems an acceptable threshold for large-cap status now.

Matrix Laboratories CEO, Mr N. Prasad ... Leapfrogging into the big league in double quick time.

Our preferred stocks from those that swept past this mark are: Bharti Tele-Ventures, Bharat Electronics, Bharat Forge, Container Corporation of India, Great Eastern Shipping, MICO, Nicholas Piramal, Siemens (India), UTI Bank, Matrix Labs, Corporation Bank and i-flex solutions.

The Bharat Forge Chairman, Mr Baba Kalyani

Healthy scaling up of revenues, tight check on costs, expansion of operating margins, impressive earnings growth, leaner and meaner balance-sheet, ability to compete effectively in domestic and export markets, and business plans that hold promise of delivering high growth rates are the shared attributes.

Nicholas Piramal Chairman, Mr Ajay Piramal .... Setting store by acquisitions to grow.

Companies such as Bharat Forge, Bharti Tele-Ventures and Nicholas Piramal have also effectively used acquisitions to grow their businesses.

The Executive Chairman, Great Eastern Shipping Company, Mr K. M .Sheth

A portfolio of these stocks has risen four-fold over the past two years. A share in each of these companies bought in January 2000 would have meant an outlay of Rs 2,375. This portfolio would be worth Rs 10,920 now.

The biggest story has undoubtedly been Bharti Tele-Ventures, which has vaulted into the top ten in the market cap-based rankings (ranks sixth, ahead of Hindustan Lever, ITC and State Bank of India).

The Bharti group Chairman, Mr Sunil Mittal

As mobile connections are expected to more than double and touch 100 million over the next couple of years, it is a growth theme that would be coveted by investors.

What transition means

Going forward, returns may be tempered as compared to the manifold rise over the past two years.

In the early stages of a stock's presence on the large-cap stage, there would still be ample room for expansion in valuation levels as investors would be inclined to buy and remain invested at higher price earnings multiples; only later do their returns touch double digits.

A few may make the quantum jump that Bharti has, and perhaps over a far longer period.

Even considering Nifty returns over a fifteen-year period as a benchmark, annual returns of about 15 per cent would be a conservative estimate of likely returns. In each of these companies, the growth story that could scale up their revenues and earnings is still unfolding.

If the equity market moves into a lacklustre phase, these stocks may now provide a better cushion on the downside. This is likely to make them attractive for long-term investors such foreign pension funds that have started to take exposures in Indian equities over the past year.

They are also likely to be subject to greater scrutiny, which should work in favour of investors. The quality of management practices in the rest provides an important comfort level.

The emerging large-caps

The stocks that could gravitate to large-cap status over a three-to-five-year period also share most of these attributes.

In drawing up this list, we were spoilt for choice, as there are a large number of credible companies that have a market cap of less than Rs 3,500 crore.

Raymond, Hughes Software, Indian Hotels, Aventis Pharma, Lupin Labs, Apollo Hospitals, Cummins, Kotak Mahindra Bank, Goodlass Nerolac, Madras Cements, Thermax, and Pantaloon Retail are the ones that we have zeroed in on. Apart from market capitilisation and performance parameters, subjective judgment on growth prospects has played a key role in drawing up this shortlist. You could have picked up this portfolio at Rs 1,964 in January 2003 and would be sitting on Rs 7,292 now. The two phases of upward trends in mid-cap stocks this year have seen across-the-board growth.

Going forward, a higher degree of selectivity may be in evidence in this space. This could mean quality mid-cap stocks getting higher valuations than others in the same sector.

The emerging dozen have the credentials to benefit from such a trend. These companies have, however, a long way to go before their operations are scaled up to a level that could push them towards a large-cap status.

Stocks such as Goodlass Nerolac, Sundaram Clayton, Aventis, Raymond and Lupin Labs have risen manifold in the ongoing bullish phase to get to where they are now. Prospective gains are bound to accrue in a more staggered manner with a few knocks likely on the way up. But the magnitude of wealth accretion could make the holding period valuable.

Riding the theme

To capitalise on such investment themes, investors have options that can be considered, apart from direct investing. A spate of new mutual funds have also been launched this year to capitalise on trends in the market. But funds such as HDFC Long Term Advantage (known earlier as HDFC TaxPlan 2000), Franklin Prima and HDFC TaxSaver have an impressive track record over a longer period. Sundaram Select Mid-Cap, too, has delivered value over a two-year period.

The rest either have shorter positive track records or an indifferent track record despite favourable market trends. Our preferred choice would be HDFC Long Term Advantage as it has a small asset base that enables flexibility in fund management. It has also consistently exhibited the ability to pick up investment themes before they acquire a wider market fancy and reaped rich gains.

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