Top 5 Undervalued Midcap Stocks to Watch Out for in 2024

Investing in the stock market may seem easy when the times are good. After all, even random portfolios are up 2x when a roaring bull run is in progress.

Even a blindfolded monkey can beat the market with his dart-throwing skills in a bull market.

But there's a lot of doom that comes into play when the direction of the market suddenly reverses.

Case in point is the current fall that has caused panic and distress among newbie investors.

Investors make the most common mistakes in the heat-of-the-moment. That's when they are most susceptible to the news.

But if you're looking to keep your cool and make the right investing decision in this volatile period, the news isn't of much use.

If you've read about Warren Buffett, you know that falling markets are not just times of decline, but great opportunities to buy cheap assets when others are fearful.

This simple strategy of identifying companies whose stock prices are trading below their intrinsic value could do wonders if you stick to it during good as well as bad times.

Last week, we wrote about the five most undervalued smallcap stocks that could do well in 2024. In this article, let's look at the top undervalued midcaps that could potentially do well in 2024.

The challenge is that good quality midcaps are seldom available at attractive valuations. But we've spent hours reading about these stocks and their current risk-reward set-up. The idea is to identify good businesses available at attractive valuations.

These stocks are filtered using Equitymaster's powerful stock screener.

#1 Indraprastha Gas

First on this list is Indraprastha Gas.

Established in 1998 as a joint venture between GAIL, BPCL, and government of National Capital Territory of Delhi (GNCTD) to implement CGD projects in Delhi, Indraprastha Gas enjoys an established position in the business of supplying CNG to the transport sector and PNG to industrial, domestic and commercial customers.

The company has the first mover advantage. Currently, the company dominates in Delhi-NCR, but it has received authorisation to set-up CGD networks in other geographies as well.

Indraprastha Gas makes it to the list of undervalued midcaps at the current valuation after it saw a steep fall last week owing to a policy announcement.

The Delhi government recently approved the electric vehicle (EV) policy for cab aggregators and delivery services.

What followed was a downgrade from a reputed brokerage suggesting volumes could take a hit after this approval. The final EV policy is aimed at accelerating the adoption of EVs for cab aggregators and delivery services. Delhi is currently at 10% EVs of all total vehicles and aims to go 100% by 2030.

NCR makes up 88% of volumes for Indraprastha Gas. This announcement of increasing EV push from the government led to a 11% decline in shares of the company.

Now, at the current price, the stock trades at a price to earnings (PE) multiple of 18.4x. This compares with its long term 5-year average PE of 27.3x.

Even if we compare it on a price to book value basis, the stock trades at a P/BV multiple of 3.2x. Its 5-year average PE stands at 5.5x.

The company is currently taking all necessary steps to diversify revenue and expanding gas agencies in Meerut, Muzaffarnagar, etc.

The largest city gas distribution company in India has played a stellar role in making the capital city switch to a clean and cost-efficient fuel like natural gas and help reduce pollution as well as provide a better quality of life to millions of citizens.

Having gone through the annual report of the company for the last 10 years, Indraprastha Gas stands has managed to grow, both its topline as well as bottomline, with superior quality of execution.

In an industry where you have a limited pricing power, the company has managed to grow its topline by 3x and bottomline by 4x between FY12 and FY22. And the growth for FY23 doesn't look all that bad.

In view of the several growth levers like potential in the home market, expansion beyond Delhi, backward integration into manufacturing of CNG tools and equipment, and foray into EV charging points, the medium-term potential of the stock does look good.

To know more about the company, check out the below video:

#2 Oracle Financial Services

Next on this list is Oracle Financial Services Software (OFSS).

When it comes to IT companies, the Big 4 have emerged as consistent wealth creators over the last few decades.

But when it comes to dividend payments, Oracle Financial Services Software (OFSS) stands above any other IT company.

Oracle is a data-driven tech company, which offers services to enhance customer experiences of its clients spread across industries.

It's one of the leading companies when it comes to cloud services, machine learning, and AI. Oracle is also known for its risk-management services around the world and manages 24 global SIFIs. It serves around 15% of the global population across 140 countries.

Shares of OFSS have seen a fall from its peak, making it attractive at the current valuations. At the current price of Rs 3,900, OFSS shares are available at a PE multiple of 18x compared to its 5-year average of 17.6x.

The recent fall is attributed to weak earnings reported by its parent firm Oracle Corp. Uncertainty's also running hot in the IT sector. Indian IT stocks were under pressure as a result of the global macroeconomic slowdown and the increase in interest rates.

In its second quarter for FY24, Oracle Financial Services reported a 5% YoY jump in net profit as well as revenue. With the adoption of artificial intelligence in every industry, the future of Oracle Financial looks promising.

Recently, OFSS became a founding member of CancerX, which is a public-private partnership to bring down the fatality rate related to cancer.

Oracle will offer its AI-related services along with its diversified team to assist in finding new solutions for cancer therapy. This can help OFSS to explore the healthcare industry which has heavy potential for incorporation of AI in the future.

The adoption of AI in financial services and fintech companies is expected to grow at a CAGR of 23.37% over the next two years, which is positive for Oracle Financial as a leader in the AI space.

#3 Laurus Labs

Third on this list is Laurus Labs.

Laurus Labs is a fully integrated pharmaceutical and biotechnology company, with a leadership position in generic active pharmaceutical ingredients (APIs).

The company has carved a niche for itself by supplying antiretroviral or ARVs (used to fight infections caused by retroviruses like HIV) and oncology (cancer) drugs. Despite being a relatively new player, its clients include giants like Pfizer, Teva Pharmaceutical Industries, and Merck.

The company's stock price has struggled in recent months. It has fallen quite a lot from its 52-week high and is hardly finding any buyers these days. The fall is due to a disappointing earnings reported by the company.

The second quarter of FY24 was the third straight quarter where Laurus Labs saw its revenue decline. This is on top of a series of missed earnings targets and has triggered pessimism.

The company has plans lined up for the next few quarters which could trigger a turnaround. Laurus Labs has a goal to invest up to 10% of profits on disruptive technologies. It recently had a breakthrough with its strategy to incubate businesses dedicated to disruptive technologies.

Its associate company ImmunoACT has received the approval of India's first (indigenously developed) CAR-T cell therapy - NexCAR19, from the Central Drugs Standard Control Organization (CDSCO).

Apart from these advance technologies, the company is diversifying the existing business streams, expanding into animal healthcare segment contract and long-term crop protection contract that are likely to contribute in the coming years.

In terms of financials, the company's topline has gone up by 2.5x over the last 5 years. The bottom line has grown by an even more impressive 6x during the same period.

Also, this growth has been accomplished without putting any kind of pressure on the balance sheet. The debt to equity ratio has actually seen a decline during this period.

The recent decline in its stock price and a visionary management to keep the growth engine chugging, makes us optimistic about its future.

#4 UPL

Fourth on this list is UPL.

Formerly known as United Phosphorous, the company engages in both agro and non-agro activities.

It's the fifth largest agrochemical company and fourth largest seed manufacturing company in the world. UPL also has a presence in over 138 countries with access to over 90% of the world's food basket.

The company's operating performance has been declining over the past many quarters which is reflected in the stock price.

Currently, the stock is trading at a PE ratio of 12.1x. This is well below the industry PE, its 5-year average PE of 17.2x and its 10-year average PE of 17.3x. The median 5-year P/B ratio is 3 times while currently the stock is available at 1.6x.

The global agrochemical industry has been going through a challenging phase over the last two quarters as distributors prioritised destocking and focused on tactical purchases amid high channel inventories.

Additionally, the market is witnessing pricing pressure given the high base of previous year and aggressive price competition from Chinese post patent exporters.

The company is optimistic of demand recovery in the second half of the financial year as the channel inventory approaches a new normalized level.

UPL has also announced that its board of directors has approved to hive off the specialty chemical business, including active ingredients manufacturing, to a 100% owned entity, UPL Specialty Chemicals Limited (USCL) for a consideration of Rs 35.7 bn.

This re-arrangement, which will be subject to approval of shareholders and expected to be completed in 3-4 months.

UPL's revenue has grown at a CAGR (compounded annual growth rate) of 15% in the last five years driven by volume and price. The company's net profit has also grown by a CAGR of 12%.

Its return ratios are comfortable. Its return on equity (RoE) was 18.2% and return on capital employed (RoCE) was 15.7% FY23.

The company has also reduced its debt significantly. It's debt to equity ratio stands at 1x, lower from 1.8x in the financial year 2019. UPL has grown through acquisitions in the last 25 years, and it plans to continue this in the future.

Promoters of the company seem to be making most of the opportunity and buying beaten down shares of UPL from the open market.

#5 Gujarat Gas

Last on this list is Gujarat Gas.

The company is a government enterprise engaged in the business of distribution of natural gas.

It's India's largest player in city gas distribution (CGD), with 27 licenses across 44 districts in six states and one union territory.

The company has a market share of 24% in domestic connections, 41% in commercial connections, 18% in CNG stations, and 36% in industrial connections.

Shares of the company are currently trading close to 52-week low levels. This decline is attributed to weak numbers in quarterly earnings as a result of lower volumes and price cuts.

The company's revenue and net profit have fallen consistently for many quarters due to a fall in industrial volumes as customers switched to cheaper alternatives such as propane due to increased prices of RLNG.

However, the company's financial performance has improved over the last five years. The revenue and net profit have grown at a CAGR of 16.3% and 29.6%, respectively.

The naturally monopolistic nature of the business, in tandem with infrastructure and quasi-marketing exclusivity, has helped the company expand its business and maintain margins.

The company also pays consistent dividends to its shareholders and has a five-year average dividend payout and dividend yield of 15% and 0.5%, respectively.

It plans to spend around Rs 10-12 bn in capex each year for the next four years to expand in existing and new states. The company plans to use its internal cashflows to fund this capex.

At the current price, the company trades at a PE multiple of 20.8x compared to its 5-year average of 26.3x. On the price to book value front, it trades at a P/BV multiple of 3.8x compared to its 5-year average of 6.2x.

Going forward, the company's expansion plans will drive volume growth, which in turn will strengthen its market position in the medium term.

Conclusion

It's said price is what you pay and value is what you get.

Going by this simple principle, one of the greatest investors of all time Warren Buffett has been able to beat the market for decades running.

Many companies fall out of favour due to whatsoever reasons, be it unexpected losses or growth in the business slowing down. But once the business gets up and running and investors come back to their senses, the share price of these undervalued companies shoots back up to its intrinsic value.

The companies mentioned above are strong contenders to bounce back in the medium term. So stay invested, wait for the recovery, and be greedy when others are fearful.

Happy Investing!

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...