25 Small Caps Cherry Picked

At DSIJ, we try to bring something new and valuable for our esteemed readers in every new issue. In a similar attempt, based on the theme of ‘Small is Beautiful,’ we had recommended 50 small cap counters to our investors last year at the same time. We had then stated that in this fast changing world, small is becoming a buzzword and has the capacity to turn into something big. At a time when many on the streets ignored the small cap stocks on account of the high risk factor, we had mentioned that, “The world of small cap stocks can be a dangerous minefield for the uninformed speculator but a goldmine for investors willing to do the necessary research to uncover market gems.” We took the initiative and recommended 50 small cap counters to our investors. And if the performance of those recommendations is anything to go by, this is really turning out to be a goldmine for investors. Our 50 handpicked small cap counters have provided robust returns of 61 per cent as compared to a miniscule 13 per cent of the Sensex.

There are some who feel that the performance of our recommendations was just a fluke and we have performed well just because the small cap brigade as a whole has moved up together. The reality is that the BSE Small Cap Index during a similar period has only provided 23.40 per cent returns. This clearly indicates that our performance is backed by solid research. You should also remember that we had asked investors to book profits in many counters in a span of just two months. The point we are trying to make is that the actual returns are in fact higher than what they appear to be. This time, we have come up with the second installment of this hugely successful cover story. Going ahead, we will probably make it a yearly feature. The only difference this year is that based on the request of our investors, who found it difficult to choose among the 50 counters last time, we are recommending only 25 instead of 50 companies. There are numerous small cap counters out there and most appear like they are going to be the next big thing. Will all of them succeed in attaining that level eventually? The answer is probably no. We can tell you from experience that the charms of many of them will fade away within a short span of time. [PAGE BREAK]

The idea therefore is to stay away from such counters and to spot the genuinely good ones so that you can make money. What we would like to say is that opportunities are available but extra efforts are needed while recommending a small cap stock. And we have gone that extra mile for our investors while selecting these 25 small cap stocks. Ahead on these pages, we have recommended some value picks.

But Why Now?
We had stated the reason for the timing of the story last year itself but for the benefit of our new readers we are explaining the same again. A study done by our research team suggests that in the month of December, the Small Cap Index outperforms the Sensex. (Refer to the table Small cap vs. Sensex performance). This clearly shows that in the last six years, the Small Cap Index has outperformed the Sensex five times! Further, the times when the Sensex has outperformed the Small Cap Index, the difference has been miniscule. On the other hand, the out performance of the Small Cap Index is significant. The best part is that none of the time returns from the Small Cap Index are negative in the month of December.

Selection Strategy
First let’s understand what a small cap company is. It is a firm that has a market capitalization lower than Rs 1,000 crore. As stated above, small cap companies need a careful selection strategy and that is what we have done. We have selected only those companies that have posted YoY and QoQ growth in the topline as well as the bottomline for Q2 FY11. Further, we have added one more filter, that of consistent growth in the topline and the bottomline on a YoY basis for the trailing four quarters. The idea behind the same is that it clearly shows that the company is growing. Further, the criterion has been quite stringent on the volumes front so that the investors should get proper entry and exit. The yearly financial performance and the business model have also been considered before recommending the stock to our investors. Valuations play an important role in recommending a counter. Our selection criterion is also[PAGE BREAK] 

focused on stocks that are available at low valuations. Our last year’s picks had also been predicted along similar lines and investors generated solid returns in no time. This time too we have taken extreme care while selecting the stocks. In a nutshell, we have put in great efforts before recommending a stock and used utmost caution in handpicking the small cap counters so that our readers can reap the benefits. Our 25 companies are a good mix of Textile, Pharma, Infra, Automobile Ancillaries, Engineering and Chemicals. As a good strategy, invest in all the recommended companies in equal proportion. We suggest that investors go for scrips with a long term outlook with expectations of a 20-25 per cent appreciation in a year’s time.

Action Construction Equipment
With the government focusing on the infrastructure sector, we have been quite bullish about it as well. Development in this sector is expected to accelerate and the infrastructure manufacturers too are well-positioned to witness good growth. Considering these factors, we are recommending investment in one of India’s leading crane manufacturers, Action Construction Equipment. The financial performance of the company has been good in the past and on the valuation front too, the scrip seems to be placed well with a trailing twelve month earnings discounting the CMP by 15.85x. Even the EV/EBITDA of 10.05x is in line with its peers.

Ador Welding
A pioneer of welding products, Ador Welding is one of the largest welding equipment and consumables manufacturer. The firm offers project engineering solutions, cutting solutions and welding automation products. It is a zero debt company and in a rising interest rate scenario, this is the only fact that guides us to suggest the counter to our investors. On the financial front, Ador’s performance has been very good in the trailing four quarters where the topline and the bottomline have consistently witnessed an upward movement on a YoY basis. As far as valuation is concerned, the scrip is trading at 8.91x of its trailing four quarter earnings while the EV/EBITDA stands comfortably at 4.33x.[PAGE BREAK]

Amar Remedies
Investing in the FMCG market has always been considered a defensive play in uncertain markets. Keeping this in mind, we are recommending Amar Remedies. The firm manufactures products like toothpaste, tooth brush, talcum powder, herbal soap and ayurvedic ointments. All the categories are witnessing good growth and this fact is evident from the strong financial performance of the company. Amar Remedies’ topline and bottomline witnessed a growth surge on a YoY basis for the trailing four quarters. On the valuation front, this FMCG counter is available at 11.43x of the trailing four quarter earnings and the EV/EBITDA stands at just 7.08x.

Ambika Cotton Mills
The textile sector has underperformed during the last year but the financial achievement of the textile companies has been very good in the same time period. Nonetheless, some textile counters are available at lower valuations. Ambika Cotton Mills is one such example. The scrip is available at just 4.51x of its trailing four quarter earnings and a EV/EBITDA of 4.61x. Regarding the growth factors, the floods in Pakistan have made the Indian spinning players competitive in the world market which provides good opportunities for expansion. Further, Ambika Cotton Mills is a dividend paying company and this provides solace to the investors.

Artson Engineering
Very few know that this once loss making company is now managed by the Tata Group. This is the main reason we are suggesting this counter for our investors. There has been no looking back for Artson Engineering ever since one of the Tata Group companies claimed a majority stake in it. The firm has not only turned profitable but has a good order book too. On the valuation front, a P/E of 32.90x and a EV/EBITDA of 23.64x may seem to be higher but the company is improving on the financial front and has a huge potential to become one of the key players in the engineering segment.[PAGE BREAK]

Bannari Amman Spinning Mills
As mentioned earlier, textile companies have done very well on the financial front during the past year yet they have largely underperformed. Now we feel there is value in the textile sector. Bannari Amman Spinning Mills is trading at7.88x of its trailing four quarter earnings and the EV/EBITDA stands at 6.66x. The firm has a capacity of 1,35,000 spindles and a technical textile division which is expected to drive growth in the future. It is a consistent dividend paying company which provides solace to the investors.

Bliss GSV Pharma
Investment in the pharmaceutical sector is also used as a defensive play in uncertain markets. We are recommending Bliss GSV Pharma following the same strategy. Its main products are female contraceptives, soft pessaries and suppositories. Its most popular product is contraceptive pessaries. On the financial front, the company is very strong and has witnessed topline and bottomline growth for four consecutive quarters on YoY basis. This is another factor for recommending the scrip. On the valuation front, the scrip is trading at 7.66x of its trailing four quarter earnings and  the EV/EBITDA stands at 5.92x.

Cera Sanitaryware
Cera Sanitaryware is engaged in the manufacturing of sanitaryware and is tapping the rapidly increasing markets in Tier II and Tier III towns to propel growth further. This consistent dividend company has posted a strong financial performance in the past. With their new manufacturing line that started recently, volumes growth is also expected. Additionally, Cera is looking at international markets like Europe for expansion opportunities. On the valuation front, the scrip is trading at 7.76x of its trailing four quarter earnings and the EV/EBITDA of 3.95 is also placed well.

DCW
DCW is into the manufacturing of caustic soda, liquid chlorine PVC resin and soda ash. The company has performed well on the financial[PAGE BREAK]

front evident from the fact that the topline and the bottomline growth has been very good in the trailing four quarters. While the topline stood at Rs 1042.68 crore, the bottomline stood at Rs 50.21 crore as against Rs 967.21 crore and Rs 34.30 crore respectively for the preceding four trailing quarters. On the valuation front, the CMP discounts its trailing four quarter earnings by 5.92x and the EV/EBITDA stands comfortably at 5.48x.

Empire Industries
Empire Industries is into the manufacturing of machine tools, industrial equipments and real estate. It also makes glass containers for pharmaceutical players. A diversified portfolio provides stability to the firm’s topline. This little known company has been posting excellent financial results since the last four quarters. The topline and bottomline growth has been very strong and consistent. On the valuation front, the CMP discounts its trailing four quarter earnings by 14.47x and the EV/EBITDA stands at 8.25x. We propose that investors go ahead and buy this scrip at current levels.

Everonn Education
Education is one of the fastest growing segments in India. With the government providing a higher impetus to the sector, firms in this category have an even larger opportunity for accelerated growth. Everonn Education is one such company that has posted a strong financial performance in the trailing four quarters. The topline and bottomline growth has been consistent. On the valuation front, the scrip is trading at 17.59x of its trailing four quarter earnings and the EV/EBITDA stands at 3.86x. This is much lower than the other players in the education industry thus providing a good scope for the upward movement for the scrip.

GTN Textiles
GTN Textile manufactures superfine count yarns and specialized products. This is another counter which has posted a solid financial performance over the last four quarters and hence is a part of our recommendation list. With respect to business, it has an installed capacity of 58,864 yarns.[PAGE BREAK]

With the global markets witnessing excellent improvement, the company has also performed well. The scrip has witnessed an upward movement in the recent past. Yet despite this spurt, the valuation is still cheap. The CMP discounts its trailing four quarter earnings by 5.87x and the EV/EBITDA stands at just 0.17x.

Hi Tech Gears
The automobile sector has witnessed a dream run in the last one and half years. The same goes for the auto ancillary companies. Additionally, both are expected to sustain the growth momentum going forward. Considering this, we are recommending Hi Tech Gears to our investors. They manufacture PTU shafts, precision forging and two-wheeler transmission components. On the financial front, the firm’s performance has been very good and on the valuation front, the scrip is placed well. While the CMP discounts its trailing four quarter earnings by 9.45x, the EV/EBITDA stands at 4.78x.

Hindustan Composites
Hindustan Composites is another auto ancillary firm engaged in the manufacturing of automotive brake linings, roll linings, disc brake pads as well as industrial insulations. But the major factor for recommending this counter is the company’s possible expansion plan. They have recently sold their land and have a huge cash balance which is invested in liquid securities. While the cash is an added advantage, the upcoming expansion will help the company grow in terms of volumes. On the valuation front, even after excluding the cash available through the sale of land, the EV/EBITDA stands at 8.11x. This provides a scope for upward movement.

Kallam Spinning Mills
Kallam Spinning Mills has a capacity of 52,000 spindles but the best part is that in addition to this, they also have 2.4 MW of power generation capacity. Till date, the company earns major revenues from yarn. But going ahead, additional income from power and waste material is expected to be generated. The current power capacity indicates that the overall textile [PAGE BREAK]

business of the company is available at just Rs 131 crore (including debt). So the valuation itself becomes cheaper. But even after excluding the same, the CMP discounts its trailing four quarter earnings by just 3.79x and its EV/EBITDA stands at 5.50x.

La Opala RG
With the Indian economy surging ahead, there has been a decent amount of improvement in the disposable income of rural and semi urban areas. This has resulted in a soaring demand for consumer goods and decorative cutlery products. La Opala RG manufactures glassware brands like Opal and Crystal and is one of the beneficiaries of the above mentioned phenomenon. The financial performance of the company has been excellent and the CMP discounts its trailing four quarter earnings by 2.34x. Even the EV/EBITDA of 3.19x seems to be well-placed.

Meghmani Organics
Meghmani Organics Limited (MOL) manufactures pigments and pesticides. Pigments are used for providing colour properties and MOL supplies the same for printing ink, plastics and coatings. Demand from all the three segments is robust and the demand for pesticides has also been on the rise. The financial performance of the company has been good and the topline and bottomline witnessed strong YoY growth for the trailing four quarters. On the valuation front, the scrip is placed well as compared to its peers. The CMP discounts its trailing four quarter earnings by 6.24x and the EV/EBITDA stands at 4.10x.

Munjal Auto Industries
Munjal Auto Industries Limited (MAIL) is a part of the Hero Group which is the largest manufacturer of two-wheelers in India with the majority market share. MAIL is the largest maker of exhaust systems in the world, manufacturing 12,000 systems per day under a single roof. It is also engaged in the manufacturing of wheel rims and other automotive assemblies. With the two-wheeler industry posting record sales during the last year, MAIL has also performed well on the volumes as well as the financial front. As far as the valuation goes, [PAGE BREAK]

the CMP discounts its trailing four quarter earnings by 7.12x and the EV/EBITDA stands at 4.02x.

Natco Pharma
Natco Pharma, part of the Indian bulk drug and API biz, is one of the counters that have outperformed the broader indices in the recent past. Further, the defensive nature of the pharma sector guides us to recommend this scrip for our investors. The financial performance of the firm has been superlative, a fact evident from the company’s topline that has witnessed a strong growth on a QoQ and YoY basis for the trailing four quarters. On the valuation front, the CMP discounts its trailing four quarters earnings by 17.52x and the EV/EBITDA stands at 9.73x.

Nitin Spinners
Nitin Spinners which has the combined installed capacity of nearly 80000 spindles and 4000 rotors, manufacturing 25,000 tons of yarn and threads per annum, has been performing well on the financial front. It has managed to post profits after suffering losses in FY09. With the improved profitability, the company has been placed well on the valuation front also. The CMP of Rs 14.25 discounts its trailing four quarter earnings by 8.78x and the EV/EBITDA stands at 7.29x. This is in line with the firm’s peers and hence provides scope for upward movement.

Oriental Carbon & Chemicals
Oriental Carbon & Chemicals is into providing Insoluble Sulfur of specialty grade. This material is used in the manufacturing of tyres and its demand has been on an uptrend with an increase in domestic automobile sales volumes. Further, export demand for Insoluble Sulfur is expected to pick up on account of the improving global economy. The company is a part of the Duncan JP Goenka group. Thus, the management is an added advantage here. On the valuation front, the scrip has performed very well and the CMP discounts its trailing four quarters by 3.62x. Even the EV/EBITDA of 2.74x makes it an under-valued counter.

Rane (Madras)
Rane (Madras) manufactures manual steering gears, steering linkages and suspension components for every [PAGE BREAK]

segment of the automobile industry. It holds a major market share in the manual steering gear segment. With the auto segment witnessing a dream run, the financial performance of the company has also been good. With volumes growth in the automobile industry likely to continue its momentum, we feel Rane (Madras) may also witness another round of good performance. On the valuation front, the scrip is trading at 7.61x of its trailing four quarter earnings and EV/EBITDA stands at 4.68x.

Transport Corporation Of India
With the Indian economy witnessing a strong growth, transportation companies are bound to perform well. Further, improved infrastructure in terms of roads makes the company more efficient. Considering these factors, we are recommending TCI which is an integrated supply chain solutions provider with a global presence. With trade activities likely to improve further, we feel it is up for another round of good performance in the future. On the valuation front, the scrip is trading at 14.94x of its trailing four quarter earnings and the EV/EBITDA stands at 7.82x.

TVS Srichakera
TVS Srichakra, part of the reputed TVS Group of companies, is into the business of manufacturing tyres as well as tubes for motorcycles, three-wheelers and farm equipment. Moreover, TVS Srichakra reflects the strong volumes growth posted by its parent company. The financial performance of the tyre subsidiary has been superior in the past six quarters. On the valuation front, the scrip is trading at 6.62x of its trailing four quarter earnings and the EV/EBITDA stands at 4.62x. We feel the scrip is undervalued and can be accumulated at current levels.

Vardhman Industries
Vardhman Industries is into the business of manufacturing galvanized sheets and coils as well as colour coated sheets and coils. It also produces CR coils and strips catering to the precise requirements of the automotive sector, white goods and the general engineering industry. [PAGE BREAK]

The firm’s growth is expected to come from two segments viz., automotive and general engineering. On the valuation front, the scrip is trading at 4.27x of its trailing four quarter earnings and the EV/EBITDA stands at 4.75x. We feel this relatively unknown company is a good undervalued pick with a one year perspective.