With the market touching new highs every day, there aren't too many undervalued stocks left over for a fresh look.
With the pros unanimous on the point that this rally is built on strong fundamentals - an economic recovery, solid corporate restructuring, lower interest rates and the outsourcing boom - even moderate performers across sectors have seen huge leaps in market cap.
These sectors range from mundane commodities like cement and steel to new economy businesses like IT services and BPO.
But when it comes to the three segments in the market - large-, mid- and small-cap stocks - we find that the gains have been quite uneven, even though a turnaround in the business environment should benefit small-cap companies as much as - if not more than - large-cap ones.
Over the last six months ending November 28, 2003, small-cap stocks gained 50.98 per cent, while mid-cap and large-cap stocks gained 70.57 per cent and 62.59 per cent respectively.
That's not surprising, for two reasons. First, while foreign institutional investors (FII) have poured money into large-cap stocks, domestic fund managers and brokers are busy scouting for opportunities in the mid-cap segment.
In the absence of buying support, small-caps still remain relatively under-invested. Second, the pleasant economic environment is just about starting to show up in the financials of small-cap companies.
For the trailing 12 months ended September 2003, 970 small-cap stocks recorded a cumulative loss of Rs 2,476 crore (Rs 24.76 billion), making them look fundamentally weak.
If one were to accept the basic proposition that the economic recovery will lift the performances of companies irrespective of size, there will be a huge investment opportunity in small-caps.
At the end of November, 970 small-cap companies had a puny market-cap of Rs 21,653 crore (Rs 216.53 billion) . In sharp contrast, 104 large-cap stocks had a combined market worth of Rs 7,28,982 crore and the 324 mid-cap stocks a value of Rs 1,05,184 crore.
Small-cap stocks with good fundamentals thus have every likelihood of becoming potential multi-baggers, thanks to the low base effect.
The Smart Investor has attempted to identify some potential winners among the small-caps. Before we go any further, we need to understand the potential risks associated with small-caps.
The key issue with small-caps is that of low floating stock. Generally, promoter holdings in small-cap stocks tend to be quite high, leaving very little floating stocks.
Thus, these stocks suffer from low liquidity. These stocks are under-researched and one would be lucky to get even their annual reports on time.
And then, as a class they leave a lot to be desired when it comes to proper disclosures and transparency. Besides, these stocks tend to be more sensitive to market movements; in other words, they have high beta values, rising or falling more than the market.
The biggest risk with small-caps, however, is that even if a stock has great potential it may take a long while for the markets to take cognizance of the value in the stock. (After all, stock ideas also need to be sold!) That may mean a long wait before the stock attains its fair price.
The methodology
The objective of this exercise has been to identify stocks which have escaped the investors' eye in the current rally despite splendid performance.
As mentioned above, one of the key issues with small-cap stocks is low liquidity. So, we addressed this concern in our very first filter. We eliminated stocks which were traded on less than 80 per cent of all trading days during the period from May to November 2003.
Besides, we also knocked off companies which had a average daily trading volume of less than Rs 1 lakh. We also eliminated all stocks with market prices below Rs 5 because these tend to be too volatile for comfort.
At the next stage, we short-listed companies which have shown continuous improvements in earnings over the last past quarters. We ended up with a selection of 28 companies which qualified based on the above criteria.
Out of these companies we have picked eight which look promising at current prices based on our interaction with some brokers who sporadically follow these stocks.
Not surprisingly, these stocks belong to sectors that are now hogging the limelight - like shipping, auto ancillaries and textiles.
"Many stocks are poised to gain based on their respective sectoral outlook. Stocks from sectors like auto ancillaries, shipping and textiles still have potential for an upside," says Pradip Doshi, chief executive officer, PC Doshi Securities.
It looks like these stocks are just waiting to announce their story of growth and turnarounds.
Banco Products
The company is in the business of manufacturing gaskets and radiators for automobile industrial applications.
Keeping in mind the fact that the industry is slowly replacing Cu-brass radiators with aluminium radiators for light vehicles, the company has successfully productionised aluminium radiators.
Gasket production has, however, shown negligible growth. Nevertheless, the company has managed to achieve an overall sales growth of 2.3 per cent over last year at Rs 91.32 crore (Rs 9313.2 million).
Banco has tied up with Japan Metal Gaskets Co to obtain technological know-how for multi-layer steel gaskets, which constitute advanced gasketing technology.
The company is also exploring the overseas market and there are new products in the pipeline. It posted a net profit of Rs 4.07 crore (Rs 40.7 million) for the quarter ended September 30, 2003.
Profit for year ended March 31, 2003 is Rs 7.5 crore - a marginal increase of 2.5 per cent over the previous year. The stock price currently trades at levels of Rs 127 with a PE multiple of 8.15.
Star Paper Mills
Star Paper Mills produces paper and paper board. The company is expected to benefit from a boost in paper demand, which is expected to grow in line with GDP.
Though there are supply side issues regarding the increase in domestic production and duty-free imports of newsprint, exports have helped maintain stability.
The domestic consumption of paper has huge potential for growth, as India is one of the lowest consumers of paper in the world - just four kg per capita.
The company is planning to install a non-fuel oil-based power generation unit which will help it reduce the cost of self-generated power.
It is also modernizing its paper-making machinery. While the primary objective is to improve quality, an increase in production is also expected.
The company is also seeking to restructure its term borrowings to reduce the cost of borrowings. The company posted a profit of Rs 3.05 crore (Rs 30.5 million) for the quarter ended September 30, 2003.
Profit for year ended March 31, 2003, stood at Rs 7.02 crore, an increase of 8.16 per cent over the previous year. The stock currently trades at levels of Rs 23 with a PE multiple of 3.25.
GTC Industries
The company produces low-cost cigarettes and has a major presence in the rural markets. The cigarette industry posted a growth of two per cent in 2002-03 after three consecutive years of decline.
Although the company's volumes dropped by 10 per cent compared to last year, in the low priced segment, where the company operates, its market share has increased to 35 per cent in the year 2002-03 compared to 31 per cent in the previous year.
The company has undertaken several cost reduction measures and gets a concessional rate of interest as per a BIFR scheme.
Due to these cost savings, the company has recorded a big 40 per cent increase in exports to Rs 53.07 crore (Rs 530.7 million), reflecting its success in targeting the international markets.
The company reported a profit of Rs 2.28 crore (Rs 22.8 million) for the quarter ended September 30, 2003. Profit for year ended March 31, 2003 is Rs 4.75 crore(Rs 47.5 million), recording a whopping increase of 176 per cent over the previous year. The scrip trades at levels of Rs 17 and quotes a PE multiple of 3.91.
MM Forgings
This auto components maker is expected to benefit from the big upturn in the auto sector.
While exports took a hit in recent years, thanks to the post-2000 slowdown in the US and European economies, the increase in domestic demand and ongoing revival in the global economy is expected to reflect in the company's balance-sheet positively.
The company has set up a manufacturing plant at Padappai (Tamil Nadu) and the machine shop in Guindy (Chennai) will be shifted here to curtail overhead costs.
Several product lines for machining of forgings are expected to be added in the current year. There has been a reduction in raw materials consumption by continuous improvements in design.
The company has undertaken research and developmental activities for improving the usage the major raw materials such as steel, fuel, and power.
The benefits derived from these cost savings will boost exports, which form a significant portion of the company's turnover (around 70 per cent of the company's turnover at Rs 57.60 crore). The company posted a net profit of Rs 2.02 crore (Rs 20.2 million) for the quarter ended September 30, 2003.
Profit for the year ended March 31, 2003 stands at Rs 6.54 crore (Rs 65.4 million), an increase of 10.7 per cent over the previous year. The price of the stock currently hovers around the levels of Rs 140 with a PE of 6.38.
Lumax Industries
Lumax Industries is another beneficiary of the auto boom. The company, which makes head lamps and other lighting accessories, sells to Maruti, Tata Motors and Bajaj Auto among OEMs.
Maruti contributes the largest chunk of 24.5 per cent to Lumax's revenues, followed by the other two.
Around 85 per cent of the revenues come from original equipment fitments. While sales volumes have grown, the industry is subject to considerable pricing pressure.
Further, the high growth rates in automobile sales may not be sustained in perpetuity and lower volumes and realizations may impact profitability.
The company posted a net profit of Rs 1.95 crore (Rs 19.5 million) for the quarter ended September 30, 2003. Profit for year ended March 31, 2003 stands at Rs 2.06 crore (Rs 20.6 million) registering an increase of 102 per cent over the previous year.
The stock prices currently trades around levels of Rs 82 with a PE multiple of 16.28.
Automobile Corporation of Goa
The company supplies assemblies, sub-assemblies and sheet metal components for automobiles, including bodies for buses.
While its performance in the past has not been particularly encouraging, the last fiscal saw a sea change in its operations. This is evident in the 155 per cent jump in the number of buses sold in FY03, which saw a turnaround in fortunes.
The critical change in its operations came due to the approval received from the quality approval body of the joint defense forces. This resulted in the company receiving orders for the supply of buses.
While the approval will help the company tap the high-margin defense sector, it is also doubling capacity to 2,400 buses per annum.
The company posted a net profit of Rs 1.78 crore for the quarter ended September 30, 2003. Profit for the year ended March 31, 2003 is Rs 0.21 crore, a turnaround from a loss of Rs 7.07 crore in the previous year.
The additional capacity will start contributing to performance by the end of the current fiscal. But risk comes from the increasing input prices of steel and components consumed. The scrip price trades around levels of Rs 110 with a PE multiple of 11.03.
Chemfab Alkalies
The company is into manufacturing heavy chemicals like caustic soda, chlorine, hydrogen gas, sodium chlorate and industrial grade salt for captive use.
Chemfab Alkalies has seen wide fluctuations in its performance. The main reason for its poor performance in the last fiscal was the weak pricing scenario in caustic soda as well as high power costs, which jumped 58 per cent.
Further, the caustic soda industry is subject to considerable competition from both domestic rivals as well as imports.
While Chemfab reported a decline 47 per cent in net profits in FY03 compared to FY02, the company showed a turnaround in the quarter ended September 2003 compared to the corresponding period of 2002.
The company has already posted a net profit of Rs 1.67 crore for the quarter ended September 30, 2003. Profit for the year ended March 31, 2003 is Rs 1.3 crore which is a decline of 45 per cent compared to the previous year.
The company intends to set up a captive power plant, which will help improve profitability by a considerable extent, since the sector is a capital-intensive one.
In the meanwhile, Chemfab will continue to suffer the high cost of grid power. The stock hovers around levels of Rs 54 with a PE multiple of 5.72.
Garware Shipping
The shipping company is expected to capitalize on positive trends in the industry. The industry, like many others, has benefited from the surge in demand from China for various commodities in the run-up to the Olympics.
While Garware does not have any ship directly on charter to international centres, the shortage of tonnage in general has led to an overall improvement in shipping rates across categories compared to last year.
Garware Shipping's business is driven mainly by contracts to ONGC.
These contracts are generally long-term in nature and, as a result, the improvement in performance is delayed compared to companies which give out ships on a spot basis.
The contracts have been renewed and, as a result, the surge in freight rates will be reflected in the current year.
The company has posted a net profit of Rs 4.26 crore for the quarter ended September 2003. Profit for the year ended December 31, 2002 stood at Rs 4.26 crore, an impressive increase of 326 per cent over the previous year. The company's stock currently trades around levels of Rs 25 and has a PE multiple of 4.03.
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