The silver lining in the mid-cap space

The stock market is gripped by bouts of panic, with many investors looking to sell. Over the last three months, the BSE Mid-Cap Index has fallen by more than nine per cent, while foreign institutional investors ( FIIs) have sold shares worth more than Rs 7,500 crore. But as an investor, should you really worry about the situation?

Veteran investor Warren Buffet once said, "Be fearful when others are greedy and greedy when others are fearful." However, most of us hardly follow this rule. Investors in panic look to sell their holdings in a hurry and exit the market. Going by Buffett's words, this is the time to hold your patience and find good quality picks for gains in the future.

Going with the lesson Buffett teaches us, we filtered out two companies wherein FIIs have increased their stake over the last three months. Since foreign investors are high-risk investors, there is a possibility for them to buy companies with weak fundamentals. However, to weed out this possibility, we have applied some fundamental filters related to pledging, profitability and return on equity. We ended up with two companies. One bets on the consumption story, while the other, on the digital future.

Filters

• FII stake increase of more than three per cent in the last three months
• The company should not have any pledging
• Profit growth of more than 20 per cent in the last three years
• ROE of more than 15 per cent in all three preceding years

Astral Poly (increase in FII stake by 3.6 per cent)
The initial entrepreneurial journey of Sandeep Engineer, founder of Astral Poly was bumpy, with the failure of his two early ventures. However, it could not dent the entrepreneurial dream of this former employee of Cadila Healthcare. Taking lessons from his failure and moving ahead with his never-give-up attitude, he started Astral Poly Technik after spotting an opportunity in the CPVC (Chlorinated polyvinyl chloride pipes, which are superior to traditional PVC pipes and can carry both hot and cold water) space.

The company initially catered to the industrial segment only and almost went into bankruptcy in 2001 before entering into the retail segment, which acted as a game-changer for the company. Today, it is one of the leading players in the Indian piping industry with a reputed brand name and sizeable market share. It primarily derives its revenue from two segments: PVC and CPVC pipes (74 per cent as of March, 2019) and adhesives (26 per cent). Its recent acquisition of Rex Polyextrusion will provide it with an entry into manufacturing corrugated pipes (pipes used in sewer, drainage and telecommunication cable), which will further diversify its revenues.

Astral is a story of transformation right from traditional (PVC) to premium products (CPVC) and now shifting from traditional metallic or concrete pipes to corrugated pipes, which are made up of plastic and offer superior quality. Earlier, till 2011, it focused mainly on PVC and CPVC pipes but later, to de-risk its business model, it diversified into adhesives.

Backed by a host of successful acquisitions and promotional campaigns, it has also made its name in adhesives used for consumer, water leakage, tiles and glass. The company is also expanding its pipe capacity from 1.5 lakh metric tonnes to 2.3 lakh metric tonnes without any requirement of major capital expenditure. While its backward integration in CPVC gives it an edge in the market, its increasing product portfolio in adhesives and additional revenue from the newly acquired corrugated business are likely to provide a boost to its revenues. Falling crude oil prices and an increasing share of organised players are other positives. Nevertheless, it faces huge competition from organised players like Supreme, Finolex and Pidilite in various segments, which may make it difficult to attract additional market share.

When it comes to the company's financials, its sales and profits have risen by 13 per cent and 23 per cent, respectively, over the last three years on the back of increasing operating margins (11 to 16 per cent). Its average three-year return on equity stood at around 19 per cent as of FY19. On the other hand, its stock continues to trade at a very high price to earnings of 73 times, which is well above its five-year median price to earnings of 63 times.

L&T Technology Services (increase in FII stake by 3.4)
Listed in 2016, L&T Technology Services- a subsidiary of the infrastructure major Larsen & Toubro (L&T) - specialises in engineering research and development (ER&D). It primarily helps its clients design products/software and technologies related to 5G, robots, 3D printing, autonomous vehicles, artificial intelligence, plant energy efficiency, blockchain, just to name a few. It is a major beneficiary of outsourced engineering-based research and development expenditure on future technologies, catering to around 50 per cent of the top 100 global ER&D spenders. As of the quarter ending June 30, 2019, it derived its revenue from five segments; transportation (35 per cent), industrial products (20), telecom (22), plant engineering(15) and medical devices (8).

The company has created a niche for itself in technological research and development, focusing on innovation and digitisation. It enjoys strong parentage and brand name of its parent, L&T. It works on T3: A3 model, which focuses on the top 30 clients of the company (T30). This leads to long-term engagements and increased client confidence, enabling the company to cross-sell its other offerings, thereby leading to adjacent service diversification (A30). This clever strategy has translated into 90 per cent repeat business for the company. However, it is highly dependent on the business from North America, which accounted for more than 60 per cent of its revenues, while Europe accounted for another 16 per cent as of June 30, 2019. It is also exposed to slowdown in global growth, primarily the auto sector, which can lead to a potential cut in the research and development expenditure of its clients. Its robust free cash flows and debt-free status cushion it from a potential slowdown.

Its revenues and profitability have increased by 19 and 21 per cent, respectively, over the last three years. Its average three-year return on equity stood at around 38 per cent as of FY19. Currently, its stock trades at a price to earnings of 20 times.