Forget Dixon Tech and Focus on These Smallcap Electronic Manufacturing Stocks

Let me write down the name of a country and next to it, write what the first thing which comes to my mind, from an economic perspective.

China - Factory of the world

India - IT capital of the world/ pharmacy of the world

Brazil - Sugar

Africa - Arabica coffee

Germany - Engineering and automation

USA - Capitalism

Dubai - Tourism

Saudi Arabia/ Gulf countries - Oil supplier to the world

This has been constant over many decades if not centuries. Saudi Arabia will always be known by its oil reserves. That won't change any time soon.

However, will oil be as relevant as what it was twenty years ago? And on a lighter note, will the US invade countries just for oil?

It's this constant ever evolving world and new technologies which will make certain countries lose their importance.

Take Europe for example.

A few decades ago, anything related to high technology or automation happened in European countries. The world could not do without them.

Now fast forward to 2023...

Not only China, but also countries like India have achieved a quantum leap in manufacturing and automation. The labour and power cost advantage is enormous in these countries.

The way things are going for many countries in Europe, it can at best be the tourism capital of the world. May be a cold and scenic alternative to Dubai.

While different countries have had their dominance in providing particular goods or services, one country stands out: China.

China makes everything required by the world. Basically, it's the factory of the world. You name the product and China is probably the largest producer.

While countries like Japan, Germany, even the US took a few decades to master production, China did it in about one decade.

India and China had the same per capita GDP in 1990. However, it was the next two decades that made the difference. China's per capita GDP today is 5.5 times more than India.

Now, there are two ways to look at the above GDP comparison. One is that China is way ahead of India and catching up will be difficult.

However, the other more opportunistic way would be that China is now stagnating. It's economy is growing so slowly that it's experiencing deflation.

India on the other hand has the benefit of lower base and is also at an inflection point.

In stock market parlance it's like betting on a fast-growing smallcap versus a near largecap. The largecap will never grow at the same pace it did when it was a smallcap a decade ago. But the smallcap, if the right ingredients are in place, it will rocket upwards.

The time for Indian economy to rocket into a higher orbit has come.

My job as an analyst is to find the right companies and the right sectors before it becomes news.

So let me list out certain undiscovered high-risk companies which are likely to benefit from India's growth story.

Please do note that these stocks are not recommendations. Also, these are smallcaps and are very risky in nature.

But first let me quickly discuss a sector that does not offer any good smallcap opportunities for investors right now.

Defence Stocks

While everybody talks about stocks like HAL, Bharat Dynamics, Cochin Shipyard, BEL, the drawback is that the stocks have run up sharply and have discounted the order book for the next 3-5 years.

While I believe these are good quality stocks but a lot of earnings growth has already happened which has led to re-rating of their PE multiples.

The question is, will there be another round of valuation multiple re-rating any time soon? The stock prices have already discounted the next three years of earnings growth.

Defence Stocks	P/E ratio	3-year median P/E	5 Year median P/E	Premium to 3-year P/E	Premium to 5-year P/E	1 year return
Hindustan Aeronautics	22	13	12	69%	83%	75%
Bharat Electronics	30	22	19	36%	58%	37%
Cochin Shipyard	30	9	9	233%	233%	93%
Mazagaon Dock	34	10	10	240%	240%	542%
Bharat Dynamics	59	25	20	136%	195%	35%

Source: Screener

The problem is the defence sector is so hot right now, there is no point analysing small-cap stocks.

EMS Sector

The next manufacturing thrust as we know is like to come from electronics manufacturing or as it's called EMS (electronic manufacturing sector).

Here are the two well-known stocks in the EMS space.

				EPS
Electronic Contract Manufacturing	P/E multiple	ROCE	ROE	2021	2022	2023
Dixon	105	25%	22%	27	32	42
					19%	31%
Amber	55	11%	9%	24	32	46
					33%	44%

Source: Screener

While Dixon and Amber are the best proxy plays to the contract manufacturing and the Make in India story, the problem is in their valuations.

Dixon has been growing at 20-30% over the past 2-3 years but has a multiple of over 100 times.

Dixon must grow every year consistently at 30% for the next four years to trade at a PE multiple of 45-50. This assumes that the stock price is stagnant and does not go up in that time.

The problem is that the multiple re-rating for the stock is over. The only way the stock price can go up now is if the company reports strong earnings growth in excess of the 30% average.

Amber Enterprises, on the other hand, has dismal return ratios. I mean how on earth can anyone be comfortable with a stock with a barely double digit return on capital and trades a PE of 55?

Now I came across two stocks which could be potential multibaggers with strong earnings growth.

				EPS in Rs
Electronic Contract Manufacturing	P/E multiple	ROCE	ROE	2021	2022	2023
Focus Lighting & Fixtures	42	45%	35%	-2	5	18
					Loss to Profit	296%
PG Electroplast	40	18%	22%	6	18	34
					200%	89%

Source: Screener

These are smallcaps which are growing rapidly.

Focus Lighting & Fixtures is engaged in the manufacturing and trading of innovative LED lights and fixtures. Its focus is on indigenous high-end retail and architectural lighting.

In last five years the company has started focusing on new segments like home lighting, infrastructure lighting & railways with focus on new technologies like IOT.

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The company has shown strong growth in revenues as well as earnings over the past three years and the stock is trading at a PE of 30.

The argument is the same for PG Electroplast which manufactures washing machines, air conditioners and coolers. The company has doubled its capacity. PG Electroplast is trading at a PE of 40 with strong growth.

Conclusion

While Dixon and Amber are established companies with a sizeable marketcap and a high revenue base, the real profits could be in smallcaps which are expected to continue their growth trajectory at a fast pace.

The opportunities are massive in the electronic space. But what is important is to be careful of valuations. Buying stocks in a buzzing sector with high valuations is a bad investment decision.

Happy investing.

Warm regards,


Aditya Vora
Research Analyst, Hidden Treasure