3 Smallcaps With Potentially Huge Payoffs 

Dear viewers,

In today's video, I'm going to share the names of three companies that have diversified into non-core segments, which could have disproportionate payoffs.

I believe these companies that are at an inflection point with their diversification into a new area.

You must have heard - winners don't do different things. They do things differently.

There is no better example to quote than Southwest Airlines, an American airline founded in 1966.

The management wanted to set itself apart in a highly competitive and difficult airline industry. They realised that playing the peer game would not work.

These were the times when airline industry faced cut-throat competition. The players tried to woo customers with the usual and costly frills like lounge facilities, meals, seating choices etc.

Southwest Airlines got rid of these frills. This allowed it to cut costs and offer attractive prices, and more flights.

The company focused on frequent point to point departures for mid-sized cities. This is something established airlines weren't interested in. It was different from the then prevalent hub and spoke model. The latter was costlier and time consuming.

This approach resulted in shorter flight times, friendly service, and cheaper flying.

South West Airlines junked the 'me too' approach and came up with a unique value proposition for customers. It shifted its focus on what customers valued - low costs, fast and convenient travel.

With this strategic shift, the company was not just vying for a higher market share among existing fliers. Instead, it created a new class of customers. It made intercity car passengers opt for flight travel.

And indeed, that was reflected in its tagline, 'The speed of a plane at the price of a car whenever you need it'.

The message reached the masses and sales took off.

I came across this example while reading Blue Ocean Strategy by W. Chan Kim and Renee Mauborgne.

The book offers unique insights on what makes companies extraordinary. It speaks of the elements that render competition irrelevant, irrespective of the industries. It underlines different strategies and unique business models like Southwest Airlines.

Authors classify strategies in two classes - Red Ocean and Blue Ocean.

Red ocean implies a mature market with intense competition - ocean as saturated waters with sharks, where everyone is attacking each other and turning the waters red. Blue Ocean, on the other hand, is an unexplored marketplace.

Each business case study in the book is unique. However, the common underlying factor is a visionary management that spotted an opportunity and ventured to go for it.

Now when one thinks of blue oceans, or unchartered territories, what first comes to mind is startups. Companies like Airbnb, Ola, and Zomato have identified an unfulfilled need in the market and have decided a unique way of servicing it.

But many of these business models owe their success to venture or external capital. Despite burning billions of cash, these are yet to have a self-sustainable business model.

There are a few exceptions to this trend, such as Zerodha in the brokerage industry, but they are rare, or not listed. I'm interested in the listed businesses that can do this sustainably.

Businesses that are entering blue oceans without subjecting themselves to the possibility of drowning.

I thought of sharing three such cases with you where the companies are trying to trying to break a new ground through optionality.

Before I get to them, let's understand this concept of optionality.

Optionality is generated from an investment that has the potential to give huge returns, but the quantum of it cannot be ascertained at the initial stages while making that investment.

You can assess its intrinsic value only over a period of time. Playing optionalities comes with its fair share of risks. If these investments do not play out as expected, they are a drag on management bandwidth and returns on capital.

Yet, it makes sense to track them. That's because the payoff could be non-linear and disproportionate. And the loss is limited to the extent of investment. For companies that experiment with optionalities when the core business is strong, calculated risks can be taken without burning out.

A company that has successfully monetised such investments is InfoEdge with the listing of Zomato and Policybazaar.

What do not make the cut are businesses like Zomato, that is diversifying from one loss making business of food delivery to quick commerce.

Unfortunately, these are the latter kind of bets that attract most of the media attention. And it's often too late.

On the other hand, companies that take more calculated risks to not get their fair share of limelight.

So let me now highlight three such businesses to you.

The first example is Kabra Extrusiontechnik.

Kabra Extrusiontechnik is a smallcap company. It's the biggest maker of plastic extrusion machinery with around 40% market share. Its clients include Astral, Supreme, Ashirvad and Finolex to name a few.

The final products cater to sectors such as agriculture, irrigation, housing, infrastructure, construction, telecom and packaging.

Coming to the optionality in business. In 2019, the company made an announcement to enter into green energy systems with end applications in energy storage and EVs. The segment was termed Battrix.

From just being a battery assembler, Kabra has come a long way. It is now engaged in the R&D, manufacturing and has added capabilities like battery management systems, telematics, IOT Solutions.

It is now a designing and development partner with some OEMs, increasing wallet share from 10-60%. Within a short time, it has captured 15% market share in Li ion batteries for electric 2-wheelers. The company enjoys a strong order book in this new segment.

Battery costs make up for 35-40% of EV cost. Li ion battery capacity additions expected to grow at 53% CAGR this decade.

Considering the huge penetration opportunity of EV and battery storage systems in India, the runway for the company is long.

Kabra now aspires to be the largest chemistry agnostic battery pack manufacturer. Already catering to 2-wheeler and 3-wheeler electric segment, it has plans to penetrate electric 4-wheeler segment by FY24.

On the execution front, the performance has been impressive. The Battrix segment that was loss making has turned around in FY22.

In fact, for the half year of FY23, the EBIT or operating profit from Battrix is higher than the profit from extrusion machinery segment. Battrix has outperformed extrusion machinery segment at both sales and profit level.

At times when the inflationary pressures are shrinking margins for businesses across sectors, the company has reported 106% year growth in the sales and 50% growth in operating profit for the half year ended September 2022.

The company has capitalised on this opportunity in the non-core segment while keeping its debt to equity ratio below 0.3 times.

Its return on capital for FY22 stands at 13.3%. The stock is trading at a PE of 41 times and offers yield of 0.7%.

Kabra is a perfect example of a safe way of participating in participating in the new age and innovative businesses witnessing megatrends, without succumbing to gambling instincts and exposing yourself to a binary scenario in which you either win big and you lose it all.

The second example is BSE Ltd.

Most people know it as just a stock exchange. But that's an understatement. With its multiple ventures, it is a growing fintech company that could inspire any startup.

BSE has turned over quite a few rocks to become a force to reckon with.

The company has entered new streams over last few years. These include commodity derivatives, launch of platform for mutual funds under Star MF, an international arm India INX, an insurance broking platform, an agriculture platform, and the SME platform for listing and trading of SME firms. The company already enjoys a leading market shares in most of these.

BSE has a stake of 22.6% stake in Hindustan Power exchange. This year itself, BSE Ltd picked 5.9% stake in ONDC, or open network for digital commerce, a new age business and a megatrend in the making.

The ONDC platform will allow buyers and sellers to discover each other through platform for ecommerce transactions. This could be compared to an early stage Indiamart.

With multiple such investments, be it in power exchange, insurance broking or ONDC, BSE is creating multiple optionalities that could offer significant payoffs in the future, the way CDSL did.

It's a well-known fact that BSE was a parent company of CDSL. Since listing, CDSL is now more valuable than the parent company. BSE still holds 20% stake in CDSL.

Coming to financials, BSE is debt free company with return on capital employed at 9%, trading at a PE of 33 times, and with a dividend yield of 2.3%. The stock is trading at a PE of 33 times. The company had bought back shares in 2019 at a price of Rs 680.

The third and last on the list is Cosmo First, that belongs to the packaging sector.

The company is a pioneer in BOPP films industry in India and is the biggest exporter of this product from India.

It is also the world's largest producer in thermal lamination films and industrial application films and the second largest globally in specialty label films.

Specialised products form around 64% of the volumes, while rest is commoditised. The company aims to increase the share of specialty mix to 80% by FY24.

Coming to optionality aspect, the company has launched ZIGLY which is India's first tech-enabled integrated pet-care platform.

It's a Direct to Consumer or D2C omnichannel model to address pet needs across life stages. With this, the company aims to build India's largest pet care ecosystem with presence across multiple channels such as experience centers, online, mobile vans etc.

The company plans to launch about 15 experience centers during FY23 and enhance to 150 experience centers in next a couple of years. In the medium term, it plans to de-merge pet care vertical into separate company.

The future will tell if and how well the company rides this opportunity. But considering that the pet care industry in India itself is growing at 25% CAGR, the progress is worth tracking.

Further, in 2022, it has also entered specialty chemical business.

With these new engines, the company is targeting 20% CAGR growth over next 3 years.

For FY22, its return on equity and capital employed stand at 29% and 39% respectively.

Net debt to equity stands at 0.25 times. The dividend yield is 4.4% using FY22 dividend and current price. The stock is trading at a PE of 5.3 times and has witnessed insider buying in September 2022.

Please note that the inclusion of these names does not reflect any view on the stock.

This video is for educational purpose and aims to make viewers aware of different ways to approach long term investing.

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Thank you for watching. Goodbye.