Lesser Known Smallcaps with Big Potential

Feb 23, 2024

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Lesser Known Smallcaps with Big Potential

Have smallcap stocks run up too high?

Is this rally in smallcaps going to continue further? Or are we going to witness a brutal crash?

If you are an investor, then I'm sure all these questions must be really bothering you right now.

Here's a quick summary of what's driving this rally.

AMFI data suggests that inflow in smallcap funds have trumped the inflows in mid and largecaps. A staggering Rs 372 bn from funds have found their way to smallcaps, as compared to an outflow of Rs 27 bn in largecaps and Rs 215 bn inflow in midcaps.

I'm mentioning dedicated buckets here, and not multicap, thematic or flexicap schemes here.

While the fundamentals of companies in the smallcap space have shown a recovery, it's the liquidity and valuation expansion that is driving the gains. This is evident from the rise in Smallcap to Sensex ratio.

At the start of 2023, the Smallcap to Sensex ratio was at 0.46 times, as compared to a long-term median of 0.43 times. In February 2024, the ratio is way past that average. At 0.63 times, the Smallcap to Sensex ratio has already breached the previous peak of 0.58 in 2018.

The earlier corrections from the peak have been in the range of 50% to 70%. The recovery from the last crash in smallcaps took 3 years. And that pales in comparison to 9 years post 2008 crash. As such, caution and not greed would be the right sentiment to approach smallcaps at present.

While Smallcap to Sensex ratio is flashing 'Caution' sign, the insider activity in Indian stock markets is not comforting either.

At Rs 1.1 trillion, insider selling this year has been almost 2x of insider selling in 2020. And almost six times higher than 2018.

Opposite trends in insider activity and institutional activity, in the context of high valuations, has led to a dilemma of whether to stay put or get out.

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I believe the answer is none of this.

The right strategy to play in smallcap space would be to be highly selective.

That would mean booking gains where earnings don't support valuation expansion.

And looking for undiscovered players that big investors are yet to get a whiff of. For it is here that you are likely to find the rare combination of growth and margin of safety in the current market.

Sticking to a selective approach has led investors ride over thousand percent gains in stocks like Hawkins, Page Industries, Persistent Sytems and Balkrishna Industries in the past cycles for smallcaps. While these stocks are considered junior bluechips now, there was a time they were ignored stocks.

And there is no dearth of high potential businesses in smallcaps that are still in the 'ignored' bucket, even in the current rally. Being under the radar of big investors, these stocks offer relatively a lot more margin of safety as compared to highly chased and overvalued set of smallcaps that institutions are buying.

Here is a list of three stocks that I believe you should keep on your smallcap watchlist for 2024.

#1 Pix Transmission Ltd

PIX Transmissions Ltd. is the leading manufacturer of belts and related mechanical power transmission products in India. It has an automated rubber mixing facility and a centralized logistics hub in Nagpur.

Its application areas include automotive including EVs, agri, ceramic, cold storage, mining, food processing, machine tools, cement, paper, oil and gas, steel, pharma, paper, and construction industry.

The company has a global presence with support infrastructure in including the UK, Germany, and UAE, and channel partners in over 100 countries. Exports comprise 60% of its revenue.

The customer concentration risk is low with top ten customers contributing about 36% (41%) towards total sales.

In FY23, the company increased its capacities to cater to growing demand of its products. It was also the year when the company reported its highest ever revenue despite challenges in the global economy.

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For trailing 12 months, the growth in the operating profits stands at 22.8% with EBITDA (earnings before interest depreciation and amortization) margins at 24.4% vs 20.8% (YoY).

The company has minimal debt on its balance sheet. With a return on equity of 16.6% and return on capital employed at 19.5%, it is currently trading at a PE of 22.8 times and PEG (Price earnings to growth) ratio of less than 1 time.

The key monitorables for the company are ability to sustain margin in case of raw material price fluctuations (mainly rubber) and working capital cycle.

The institutional stake in the stock is less than 5%, while promoters hold 61.82% stake in the company.

#2 RACL Geartech Ltd

The company's core competencies include gear cutting, precision machining, aluminium machining, process R&D and concurrent engineering, exports logistics handling.

Its products include transmission gears and shafts, sub- assemblies, precision machined parts, chassis parts and industrial gears.

With over 900 SKUs, it caters to 22 active customers in the auto and industrial segment - two wheelers, three wheelers, premium e bikes, passenger cars, commercial vehicles, ATVs, agricultural equipment and industrial gears.

Its clients include BMW Motorrad (Germany), Kubota Corporation, IT Switzerland, KTM AG, Schneider Electric, Dana, MAN, ZF. Top 5 customers accounted for ~60% of revenue in FY23.

Over last few years, the company has witnessed expansion in operating profit margins (25% in FY24) with value added products, and as a supplier to premium segment export customers. Exports comprised 76% of revenue in FY23.

Its turnover for FY23 stood at Rs 3.7 bn.

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The return ratios remain healthy at over 20%. While the debt is on the higher side (over 1x debt to equity), the interest coverage ratio stands at 3.5 times. The management is comfortable with the debt levels for now and doesn't wish to dilute equity. The business is working capital intensive.

It has undertaken a capex for increasing capacities and upgrading existing facilities. For FY24, the budgeted capex is at Rs 800 m. While the auto industry itself in cyclical in nature, exposure to premium segment mitigates this risk to some extent.

The growth guidance for FY24 is in the range of 15%-20%. The management expects margins to be sustainable in the range of 22%-24%. The institutional stake in the company is less than 1%. The stock is trading at a PE of 31 times and a PEG of less than one.

#3 MPS Ltd

It is one of the leading players globally in the publishing outsourcing space. It's a B2B model with end clients being scholarly and research community, education community, Edtech, corporate learning space.

Its clients include Macmillan, Cengage Learning, McGraw-Hill, Elsevier, Wolters and Kluwer.

The company has multiple segments - Content solutions that deals with content creation and delivery across different channels, platform business that offers a complete range of configurable platform solutions throughout the entire content lifecycle, delivered as SaaS and e learning segment.

The management has shared a vision of revenue base of Rs 15 bn by FY28, almost 5x of current topline, with significant contribution (60%) from acquisitions. The operating profit margins for the company are north of 40%. The balance sheet is almost debt free.

The return ratios stand above 25%. The institutional stake in the company is less than 4%. The stock is trading at a trailing 12-month PE (price to earnings ratio) of 25x.

Do note that none of the stocks mentioned above reflect a view on the stock. Any investment decision should be based on due diligence and keeping in mind the asset allocation guidelines.

Happy Investing,

Warm regards,

Richa Agarwal
Richa Agarwal
Editor and Research Analyst, Hidden Treasure

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1 Responses to "Lesser Known Smallcaps with Big Potential"

Dr RAJAN GARG

Feb 27, 2024

You have missed AVANTEL in Phase one alert stocks. You have accepted it.

This microcap is DOUBLE now. IT is a small cap COMPANY & you have not recommended it in any of your services.

THIS LESSOR KNOWN Small CAP HAS BIG MULTIBEGGAR POTENTIAL EVEN NOW. MAY GUIDE TO YOUR INVESTORS ON THIS.

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