Rising costs, weak demand hit small, midcap Q3 earnings  

After outperforming large caps for most of FY24, Small and MidCap profits have now started to lag behind for the second consecutive quarter. This underperformance is largely attributed to a domestic slowdown, to which small and midcaps are more exposed, experts said.

According to Moneycontrol data, an aggregate of 683 firms in the BSE SmallCap Index reported a 7.1 percent increase in revenue for Q3, marking the seventh consecutive quarter of single-digit growth and the 13th straight quarter of sequential single-digit growth.

However, a sharp rise in the cost of finished goods purchases and employee expenses, both growing in double digits for the second consecutive quarter, has impacted profitability. Net profit for the December quarter recorded a modest 1.5 percent year-on-year increase, the slowest growth in six quarters, while sequentially, net profit declined for the second consecutive quarter. Only those firms that had comparable data for 15 previous quarters were chosen.

For the BSE MidCap Index, Moneycontrol has aggregate data for 85 firms. Despite a 12.9 percent rise in revenue for Q3, the highest in eight quarters, net profit increased by only 2 percent, marking the slowest growth in six quarters. The subdued profit growth, despite higher revenue, was attributed to rising total expenses and interest costs. Total costs surged by 11 percent, the steepest increase in six quarters, while interest costs soared over 27 percent, the highest jump in three quarters.

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Energy, banking and financial services companies were excluded from the study.

The weak earnings in the mid-cap and small-cap space can be attributed to poor demand, and inflationary pressures which directly affected consumer spending. Also, global uncertainties, rising input costs, and higher borrowing costs strained the bottom line figures. The growing premiumization trend has also affected smaller companies which are still at the nascent stage as compared to large counterparts, SMC Global Securities - a domestic brokerage house said.

Mayank Mundhra, FRM- VP Risk & Head Research Abans Group said weaker-than-expected growth—driven by sluggish global demand from key trade partners like the US and Europe—led to margin compression. This slowdown was further intensified by the 2024 election cycle, as markets anticipated potential shifts in political power globally, leading to cautious spending and weaker demand.

Sectors like capital goods, industrials, and consumer discretionary were hit hardest, struggling with weak demand and high capital needs. Rising borrowing costs further pressured profits despite revenue growth.

Experts say small and midcap margins are lower and more cyclical than large caps due to their growth focus. Post-COVID, they saw stronger margin gains, but with tailwinds fading, pressure is mounting. While consensus expects SMID profits to outperform in FY26, weak revenue and shrinking margins put this at risk. Continued underperformance could threaten their valuation premiums.

Motilal Oswal’s latest note highlights that the recent correction in broader markets has accounted for some potential earnings disappointments ahead. However, mid and small-cap valuations remain elevated compared to their historical averages and relative to the Nifty 50. The Nifty is currently trading at a 12-month forward P/E of 19.3x, below its long-term average of 20.5x. Given this backdrop, the brokerage maintains a preference for large-cap stocks.

Narinder Wadhwa, Managing Director & CEO of SKI capital services said key risks persist, including double-digit growth in employee costs, which could offset potential cost savings, and a weak demand environment that may constrain earnings growth. Additionally, global economic factors such as tariff wars and the likelihood of no Fed rate cuts further add to the uncertainty.Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.