India’s small and mid-cap stocks are set for big gains – here are three to buy now

History tells us that markets swing from colossal optimism to great pessimism. There is no better current example of this than India. Economically speaking Modi has gone from hero to zero and several mega-cap Indian stocks have been battered to multi-year lows. Our strategy of investing in small and mid-cap stocks found us caught in the centre of the crisis, which we have weathered thanks partly to our closed-end structure shielding investors from the worst price fluctuations.

It is too early to sound the economic “all-clear”, but the market has found its feet since the government’s decision to slash corporate tax rates. Other recent measures to restore growth and optimism include a sale of public-sector assets, aggressive interest-rate cuts and measures to tackle corruption. We believe the nation’s small- to mid-cap stocks will have the most to gain from these structural changes; we single out three favourites below. Note, however, that buying stocks in India can be a very bureaucratic process; sticking with a fund is easier.

India imbibes

Investors would be wise to recognise a shift in drinking habits across India. Traditionally, “men of a certain age” have underpinned a market dominated by whisky and beer as consumption was considered taboo for broader sections of society. However, a major shift is under way as society becomes more accepting, increasing the size of the pie as well expanding the product range. We manage our exposure to this theme through Radico Khaitan (Mumbai: RDCK), the third-largest spirits company in India. Profits have grown at a compound annual rate of around 20% over the last five years. Consumers’ tastes are evolving towards their products, especially vodka, which enjoys a 50% market share. Looking ahead, we expect revenue growth of 12% and earnings growth of 20% with years to go before the market matures.

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Fast-growing profits in hair oil

We’ve recently bought into Bajaj Consumer Care (BCC) (Mumbai: BAJAJCON), the leading manufacturer of almond oil, routinely used as a hair tonic by the male population. This specialist market segment enjoys consistent volume growth of 18% and BCC owns Almond Drops, the leading brand. The investment case is based on demand growth for hair oil remaining steady combined with “premiumisation” as wealthier consumers shift from unbranded to branded products. A modest re-rating of the valuation to 18 times forward earnings combined with conservative growth assumptions implies share-price upside

of 20%.

A solid lender to small companies

Beyond the consumer sphere, we have City Union Bank (Mumbai: CUBK), a high-quality private-sector bank with a strong lending business meeting small and medium-sized companies’ requirements for working capital. Thanks to a strong, independent board of directors and a well-respected management team, City Union Bank has weathered India’s banking crisis comfortably. The bank is winning market share and expanding loans at a rate of 17%-18%, focusing on quality and keeping in line with deposit growth. On a price-to-book ratio of 2.3 the stock is not cheap, but consistent growth and excellent management make up for it.