3 SME Stocks for Your Watchlist

Last month, I warned our subscribers of the growing bubble in SME space.

Here's what I wrote...

• The Indian stock markets are dealing with two realities that are highly conflicting.
  
  First, the huge influx of money. The number of demat accounts, first time investors, retail participation, inflows through SIPs.
  
  So much so that the impact of FII volatility has been subdued. Financialisation of savings is a trend in full momentum and with huge steam, giving legs to the rally.
  
  And then there is another reality - that the markets are frothy. Sensex PE at 24 may not raise eyebrows yet. But smallcaps, microcaps and SMEs are a different story.
  
  The BSE SME IPO index, a space rife for speculation, has grown over 58% CAGR in 10 years. Most of these gains have come in the post Covid market rally.

I'm wary of this space. One of the key concerns is limited disclosures and lot sizes, that make it too late and illiquid to exit in case business does not turn out as expected.

But for the many cases of gains disappearing in the thin air, there are some cases where SME stocks have proved they belonged to a different league.

While there could be many potential 'Varanium Cloud' like companies, there could be a few Gensol like candidates too that have multiplied returns overtime.

Some of the good SME companies over time have and will continue to migrate to main board, addressing primary concerns mentioned above.

For investors with high risk appetite, reduction in lot size is also a welcome event, which exchanges come up with every six months.

As such, it wouldn't be a bad idea to keep a watchlist ready.

So where do you start building a watchlist for potential multibaggers in this space which is inherently risky?

I believe tracking insider action is a good point. As I have shared before, this is a metric I track for smallcap companies.

Over last few months, I have noticed some SME companies figuring in the list.

And for this discussion, I'm focusing on companies where the prices at which insiders have bought recently is close to the current price.

The first is Essen Specialty Films.

It is a part of Rajoo Group . With over three decades of machine manufacturing experience of Rajoo Engineers Ltd, it has grown into a supplier to many Fortune 500 retailers and OEMs across 24 countries.

The company makes customised plastic and home decor products under six key categories - Bath area, kitchen & dining, home decor, storage and organization, fitness and lifestyle, outdoor and utility etc.

Some of its clients include Ikea, Walmart, Kmart, Bed Bath & Beyond, Rusta, Runsven, Kohl's, Kroger, H&M, Home Depot, H&M, Target etc.

IKEA is a major customer of ESFL. That said, with new customer additions, its share of sales from Ikea is down from 95% in FY20 to 35% in FY23. Top 5 customers now contribute to 75% of revenue (FY23).

Over 70% of its revenue comes from export markets. The shift in the global supply chains post pandemic could be an inflection point in the company's journey.

On a revenue base of Rs 1.4 bn, its operating profit and net profit margin stand at 18% and 10% respectively. The return on capital employed was 14% in FY24. The balance sheet is debt free.

Key risks to watch out for include slowdown risk in the end regions, customer concentration, and potential deterioration in the working capital cycle.

The marketcap stands at Rs 7.5 bn. The PE ratio for the stock is 58x, certainly not cheap on past earnings.

But the promoters have been buying the stock from the open market in last two months, showing more confidence in the future prospects. The latest buying was seen in month of September itself, at a price of Rs 361.

The next on the list is Vilas Transcore, with marketcap of Rs 9 bn. The company manufactures and supplies power distribution and transmission components, mainly to transformer and other power equipment manufacturers.

It has two manufacturing facilities in Gujarat with capacity of 12,000 MTPA. It is adding another 24,000 MTPA by the end of September this year. As such, the capacity is increasing 3x.

Its clients include Voltamp Transformers Limited, Electrotherm India Limited, Atlas Transformers India Limited, Shilchar Technologies Limited, etc. With the investments in the power and transmission sector, the company's products are likely to be in demand.

Its revenue in FY24 stood at Rs 3 bn, with operating profit margin at 11%. The company is net debt free.

The return on capital employed stands at 22%. The stock is trading at 42 times earnings. The latest insider buying has happened in August at a price of Rs 425.

The third is Harshdeep Hortico. The company makes and supplies planters for indoor and outdoor use.

Besides, it sells accessories like garden hose pipe & water can. Recently, it has entered into the field of roto moulded outdoor furniture.

It markets its products to around 27 states & union territories in India. Majority portion of the revenue comes from the state of Maharashtra.

It has two manufacturing facilities and three stores in Delhi, Pune, and Andhra Pradesh, along with distributors. Online is another channel for sales.

The company has a debt free balance sheet. On a revenue base of Rs 480 m in FY24, its operating profit margin and net profit margin stood at 22% and 13.6% respectively.

The return on capital employed is 25%. The business is working capital intensive, which needs to be monitored along with growth prospects.

The stock's PE stands at 17x. It has witnessed regular insider buying, latest in August at a price of Rs 69 per share, close to the current stock price.

Do note that no view on any of the stock is implied in the article.

The SME space is inherently risky. That said, I believe these are some of the names to track in a SME watchlist. Some of these may migrate to the mainboard, thus addressing liquidity concerns over time.

Warm regards,


Richa Agarwal
Editor and Research Analyst, Hidden Treasure
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)