2 in 1 Microcap Proxy Play for Defense and Green Hydrogen Theme 

Dear Viewers

You know things are headed the wrong way when regulators have to flash warning signals to the market participants.

Something similar happened in the Indian markets recently.

The Indian stock markets, especially small index has been trading at 0.6 times of Sensex, at a significant premium to the median PE of 0.43 times for sometime now.

You would expect most institutions dealing in retail money to exercise caution in these times.

But that's hardly the case.

Despite high valuations, more schemes have been launched in the small and midcap space to make the most of the greed in this space. No wonder then, AMFI and the market regulator had to step in. They have told asset management companies to have checks and balances to safeguard small investors. This includes limiting inflows, stress testing and portfolio rebalancing. Post such warnings, the smallcaps witnessed volatility and correction this month.

Now, there are thousands of listed stocks in mid and smallcaps, so why are regulators worried?

The reason is - over 90% of these inflows find way to just a few hundred stocks. The rest remain below the radar of funds due to issues like limited liquidity to absorb huge fund flows.

You know how this situation turns out.

When too much money flows into smallcaps with relatively low marketcap and liquidity, the PE multiple expands. However, this rerating is just driven by money, and not business performance.

So, while this could inflate the valuations of a limited set of stocks for a while, in case of any shock or negative news, the derating could be equally sharp, and the exit in these small-cap stocks could be stretched.

The notional gains turn into losses in a matter of few days.

So, how could you participate in this rally without getting butchered.

I believe it will require avoiding a beaten down path and taking a road less taken. Instead of following what smart investors or institutions are buying, be deliberate in looking for high potential undiscovered stocks.

This way, chances are you would benefit from not just the growth in the business (from a low base) but will position yourself well to ride the rerating gains.

But this is not as easy as it sounds.

There are thousands of such unknown stocks. And most of these will remain unknown throughout their lifecycles.

To ride a multibagger, you would need to combine low liquidity stocks in a business with huge opportunity, and with the backing of a strong management team.

Today, I want to highlight one such candidate that operates in defense, energy storage and aerospace.

With a marketcap of barely Rs 5 bn, High Energy Batteries (India) Ltd manufactures batteries that are used in defense and aerospace, autos and VRLA batteries are used extensively in power wheelchairs and mobility scooters, and in for power backup systems.

The company has the capabilities to design and manufacture batteries for mission critical platforms like torpedoes, fighter aircraft, supersonic missiles, army battle tanks, unmanned aerial vehicles, autonomous underwater vehicles, and satellite launch vehicles (SLVs).

Besides, it is pursuing opportunities in energy storage systems as well - working on areas like fuel cells where hydrogen could be used as a fuel.

It claims to be the only supplier of silver-zinc batteries to the Indian navy, with a market share between 65-70%. It also supplies nickel cadmium cells to the defence sector.

In fact, it has produced batteries for PRITHVI, AGNI etc., and for all the three variants of BrahMos. It remains a beneficiary of Make in India scheme. Its clients include Naval Science & Technological Laboratory, Advanced System Laboratory Brahmos Aerospace Pvt. Ltd, and private players like Bharat Dynamics Ltd.

The company is witnessing tailwinds with increase in defense budget and a major chunk of it earmarked for domestic production. In the energy segment, Cabinet has approved National Green Hydrogen Mission with an initial outlay of Rs 197 bn. Do note that the company is planning to foray into manufacturing Fuel Cell and Electrolysers in Green Hydrogen space.

Another product is silver based battery for getting signals underwater and for survey and surveillance and in oceanographic applications. Besides, it is working on 2^nd life usage of Li ion battery. What this means is Post their use in EVs, the batteries will be reusable in low power applications.

The management of the company has a strong technical background.

Coming to financials....

The debt on the balance sheet is minimal, at less than 0.2 times. The return ratios are above 30%. The cash flow from operations has been consistently positive in last five years. The five-year EBITDA margin is 30%. The stock has also seen insider buying in 2024 at stock price level of Rs 551 to Rs 574. The marketcap is Rs 5 bn and stock is trading at a TTM PE of 26 times.

Do not take this discussion as Buy view on the stock. The business has some inherent risks like overdependence on the defence sector, and an intensive working capital cycle. Nonetheless, it is a strong candidate for a watchlist of high potential, lesser-known stocks.

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Thank you for watching.

Goodbye.