Small-Cap : Small in Size, Big in Gains

With the Nifty touching all-time highs and surprising market participants with tremendous gains in 2020 and 2021 alike, it is the category of small-cap stocks that is actually making a difference in an investor’s portfolio by not only outperforming Nifty in the past one year but by also delivering a broad-based market rally, thus allowing a majority of the investors to book profits. Yogesh Supekar highlights the trend in the smallcap universe while also focusing on the top-quality performers in the small-cap space

Frontline indices are trading at all-time highs and if one were to look at the derivatives’ data for the May series, it looks like the rollovers have been strong and there is every indication that the long bets have been rolled over into the June series. The maximum rollover has been observed in Bank Nifty and Nifty which suggests that the markets could make a fresh high in June. There is a strong momentum in equity markets no doubt; else it is rare for the markets to ignore comments made by the Reserve Bank of India (RBI) which had warned that the equity markets could be in a bubble zone.

The markets reacted to the RBI’s words of caution by making fresh lifetime highs. In normal circumstances, the markets pay heed to RBI’s comments very carefully and attempt to read between the lines. Meanwhile, the global markets are on a song and what is interesting is that the rally is broad-based which makes a majority of the investors richer, especially those who have shown a desire to make quick money in trending markets. Further, after a long spell of underperformance, small-caps are back with vengeance as has been seen in their performance over the past 12 months. The table below highlights the outperformance of small-cap indices over the Sensex.

Small-Cap Performance

In the past one year we have seen as many as 383 small-cap stocks from the BSE Small-Cap index constituents more than double their returns with an impressive 20 stocks that gained over 500 per cent in the past one year. Only 15 stocks turned out to deliver negative returns in this period. However, the number of small-caps that delivered negative returns in the past five years stands at 149 and only two BSE Small-Cap index constituents managed to gain more than 100 per cent in the past five years. This goes to show the contrast in performance by the small-cap index in the recent one year. The table below highlights the performance of BSE Small-Cap index constituents over various timeframes.

It is not just that the small-caps as a category have outperformed in India alone. This has been a global phenomenon. If we look at the small-caps in the developed markets, on an average the small-caps across developed markets delivered more than 60 per cent while the small-caps in the emerging markets on an average managed to gain by 51.79 per cent. The micro-cap companies where not left far behind with the average returns generated by the developed markets being 76.98 per cent for the micro-cap category. The table below highlights the performance of developed and emerging markets for small-caps.

In some of the small-cap indices in developed markets such as Ireland and The Netherlands the returns were in excess of 100 per cent in the past one year while the MSCI UK Small-Cap index gained more than 61 per cent, MSCI Germany Small-Cap index was up by 58.40 per cent and MSCI Spain Small-Cap index strengthened by 62 per cent.

MSCI Japanese Small-Cap index was the worst performer in the category, appreciating by only 21.52 per cent. In the emerging markets, the top performing MSCI Small-Cap indices were Africa Small-Cap index (109.57 per cent), Greece Small-Cap index (82.87 per cent), Korea Small-Cap index (82.55 per cent), Russia Small-Cap index (74.21 per cent), Brazil Small-Cap index (66 per cent) and China Small-Cap index (60.85 per cent). MSCI India Domestic Small-Cap Index was the best performing index, recording gains of 117 per cent. In the MSCI Micro-Cap category, the micro-cap indices of Ireland (141 per cent), Canada (128 per cent), The Netherlands (104 per cent), Germany (104 per cent) and USA (100 per cent) caught global investors’ attention.

Small-Cap Outlook

The outlook, while positive since the markets are at fresh highs and the small-cap index has already gained more than 100 per cent in a year, demands a cautious approach. At this point of time what is interesting to observe is the market sentiment – whether we are in a ‘risk on’ mode or a ‘risk off’ mode. If we go by what is happening to bitcoins, many of the traders are now getting cautious over risky assets and that mood may apply to equities as well. That does not mean we may have a sell-off like we saw in bitcoins; however, the incremental money flow into equities may slow down a little bit until the market faces the next big trigger in the form of earnings’ growth and positive economic data aided by the gradual opening of the global economy. The following small-caps declared positive results in the latest quarter.

Several small-cap-oriented mutual funds are also seen holding larger amount of cash than they were holding in the previous quarter, hinting at the risk off mood of fund managers. While it would be wise to have a cautious approach, investors can place bets on those small-caps whose earnings have been outstanding. With the small-caps gaining so much already one may wonder what space lies ahead for further gains in the small-cap domain. A piece of good news for the bulls that are looking for opportunities in the small-cap space is that recently we have seen the Nifty Small-Cap index has formed a so-called ‘golden crossover’.

This phenomenon has happened for the first time in almost seven years. During the previous week we have seen Nifty Small-Cap 100 index’s 50-week moving average cross the long-term 200 WMA. This can be considered extremely positive in the short-term at least. Going ahead, fears related to inflation, higher commodity prices, crude oil prices and the pandemic-led state-wise lockdown may influence the market sentiments. Buying on dips in small-caps could be the best course to adopt in the current market scenario. Small-caps are showing a lot of promise and expectations are sky-high from this group of stocks.

Conclusion

The best part about small-caps right now is the fact that they are not terribly overvalued even though some might argue they are. Trading at their 52-week high, the momentum is in line with the frontline indices for small-caps. Even after scaling fresh lifetime highs there is promise of growth in several counters. One of the advantages of scanning investing opportunities in the small-cap space is the variety available for investors to choose from. If we look closely at the composition of BSE Small-Cap index, the highest contribution in terms of market capitalisation comes from the healthcare sector followed by financials, chemicals and petroleum.

All these three sectors are growth-oriented and have shown steady performance in the past few years. The dominance of these three sectors in the index explains the outperformance of the BSE Small-Cap index. Investors ought to find incremental investing opportunities in these sectors in the small-cap space. It is known that small-caps are more volatile than their mid-cap and large cap peers, and hence a diversification approach to building a portfolio of small-caps is even more critical. An equal weightage portfolio of small-cap stocks that are showing consistent performance in terms of revenues growth, profitability and improvement in margins would be the perfect candidates for inclusion in a diversified portfolio. For a risk-averse investor small-caps can form around 5-10 per cent of the total portfolio. For a moderate risk-taker, the portion of small-cap stocks in the total portfolio can increase to 10-20 per cent of the total portfolio and for high-risk investors the small-cap weightage in the total portfolio can go up to 40 per cent. Small-caps usually tend to well when the economy is recovering and when the liquidity levels in the market are high. As the liquidity level increases one gets to see small-caps gaining traction. With the momentum picking up in the small-cap space, an increasing number of investors are joining the bandwagon. This quantum increase in the number of investors investing in small-caps leads the performance to skyrockets, thus leading to excess in valuations.

The valuation then becomes unsustainable and the prices correct, thus trapping several investors who may end up investing at the top. In order to avoid investing at the top and being trapped, investors have to have a well-diversified portfolio without leverage and the investments have to happen in a staggered manner. Buying on dips is a great strategy in the current market condition, even though there are indications of the market doing well in the near term. Adequate and proper use of fundamental and technical analysis can also help investors immensely while choosing small-cap stocks to contribute to the portfolio returns. It is easy to get carried away with the recent returns and one may paint all small-cap stocks with the same brush. This may be fatal to portfolio returns.

A huge basket of small-cap stocks is available – no one argues that, but how many of them are quality investable ideas is something one should focus on again and again. It is a stockpickers’ market and the rewards for stock-picking in small-caps can be very tempting. Invest in small-caps with confidence as these delightful tiny treasures are going to continue their forward march but don’t forget to pick the best of the lot as going ahead one can expect the markets to be volatile. Also, the expectations while bullish on small-caps should not lead to witnessing a repeat performance of last year when almost all the small-cap funds delivered returns in excess of 100 per cent with the best performer delivering returns in excess of 200 per cent. Going forward, it may be quite reasonable to expect higher double-digit returns in your small-cap portfolio.

Methodology

To come up with a ranked list of small-cap stocks, we took into consideration five crucial parameters. The first includes market capitalisation. The remaining parameters are obtained from the Profit & Loss Account and include Sales, Operating Profit and Net Profit. We also considered the PAT margin for ranking the stocks as it indicates how efficient a company has been in converting the given sales into profits. Each parameter taken from the income has been evaluated on a 3-Year CAGR basis to determine performance over a period of time. We have then ranked the companies by awarding it a carefully determined Methodology For Picking Small-Cap Stocks with a weightage based on their significance. We then segregated the companies into three categories as follows: 

✓ Turnaround Performance: These companies include those that successfully managed to turnaround the losses incurred in FY19 into profits in FY20.

✓ Improving Financials: Although these companies still reported losses in FY20 as they did in FY19, they succeeded in reducing these losses by a notable amount. This indicates that they are on the road to recovery.

✓ Thriving Companies: This list includes all the remaining small-cap stocks and their financial performance.

All the raw financial raw is sourced from Ace Equity and price-related information is as of May 28, 2021.

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Interviews

Amit Dahanukar
Chairman & Managing Director, Tilaknagar Industries Ltd

“Despite the pandemic, our revenues have remained steady in the financial year ended March 2021”

Tilaknagar Industries’ share is trading at a five-year high. How did you lead this turnaround performance?

The company’s remarkable turnaround was achieved primarily through a strategic and comprehensive debt-restructuring exercise. Executed in March 2020, the resolution plan has led to a sharp decline in the company’s total debt from Rs 1,100 crore to Rs 340 crore payable over four years. As a result, the finance cost has reduced significantly which in turn has had a huge positive impact on the company’s financial performance. The share price hitting a five-year high on the bourses is a reflection of the promising future outlook for the business. In addition to this, the entire debt recast operation which entailed one-time settlements and restructuring the balance liability has been implemented seamlessly. Currently, Edelweiss Asset Reconstruction Company (EARC) is the company’s sole and only lender. Also, the brand franchise of the company remains strong and its products continue to enjoy popularity with channel partners, trade and consumers.

How has the pandemic-led lockdown impacted your business operations? Is demand being affected?

The ongoing health crisis has had an adverse impact on people and businesses, globally. In India, the pandemic-induced lockdown that was imposed last year did have an impact on our operations and it will have a similar effect this year as well. Due to the second wave, most of our priority markets are witnessing partial or complete lockdowns. Kerala, Tamil Nadu and Puducherry are completely shut down while in other states like Karnataka and Telangana, partial lockdowns with restricted timings have been enforced for retail shops. In addition to this, closure of bars, clubs, permit rooms and the ban on public events has had a negative impact on the social consumption of liquor. Due to these reasons, sales may remain subdued even in the first quarter of financial year 2022. However, we anticipate demand to pick up significantly once the curbs are relaxed.

What are your top three strategic priorities?

Mansion House brandy is our flagship brand and we will continue to remain focused on growing this brand through deeper penetration in the existing markets while simultaneously exploring new territories. We feel there are many niche markets where our products may become an instant hit. We would focus on such markets to aggressively garner larger market share for our brands. Second, we will work towards further reducing the remaining liabilities. Our aim is to make the company debt-free by financial year 2024. Third, we will pursue complete digital transformation of the company. We will effectively leverage technology to further make our operations seamless – align with our customers, vendors and internal stakeholders, and also efficiently communicate with our target customers.

What is your earnings growth outlook that you can share with the investors?

Despite the pandemic, our revenues have remained steady in the financial year ended March 2021. As states are expected to unlock gradually over the next few weeks, we foresee a spurt in demand which will help further bolster the company’s revenues. In addition to this, consumers are increasingly becoming more brand conscious and are thus, moving up the value chain. This change in consumer behaviour is favourable and may have a positive impact on our business. The company is also focused on optimal utilisation of its state-of-the-art facilities. Recently, Tilaknagar Industries signed a 10-year deal with alcohol beverage giant Pernod Ricard. As part of the long-term agreement, Tilaknagar Industries will manufacture the French distiller’s flagship brands at its manufacturing unit in Maharashtra. The association is likely to be extended to more states in the near future.

Which product segment is contributing most to the overall profitability?

Tilaknagar Industries has emerged to be the largest manufacturer of premium brandy in India. Evidently, brandy remains the largest contributor to our product portfolio and in terms of revenues it accounts for almost 90 per cent. Our brands Mansion House and Courrier Napoleon enjoy leadership position in the segments they operate in. In fact, Mansion House, our flagship product, is one of the top five brands across categories in the country’s southern markets. The company intends to further harness its strength as a leading manufacturer of brandy by introducing exciting brands in the near future.

Dinesh Patidar
Chairman and Managing Director, Shakti Pumps India Ltd.

" Demand For Pumps Is Expected To Grow At A Steady Rate "

What is your outlook on the Indian pump industry?

My outlook is very positive, quite promising. I am quite hopeful about the future of the pumping solution industry. The Indian pump industry offers excellent growth opportunities for international collaborations. Indian pumps are exported to more than 100 countries. According to a report, the Indian pump market was worth over Rs 13,500 crore i.e. USD 18 billion in 2020. With over 800 pump manufacturers, our country manufactures more than a million pumps every year. Agriculture and building services comprise 46 per cent of the market by value of Rs 3,910 crore. This segment of the Indian pump market is highly fragmented as well as competitive with a large number of small and medium enterprises competing to increase their market share. The biggest markets for agricultural pump sets are the central Indian states of Madhya Pradesh, Maharashtra, Tamil Nadu, Karnataka and Andhra Pradesh.

The industrial sector comprises the remaining 54 per cent of the market by value of Rs 4,590 crore. This segment of the Indian pump market consists of sectors like water and sewage treatment, power generation, oil and gas, metals and mining and others. Being technologically intensive, it is a relatively hard sector for small and medium enterprises (SMEs) to penetrate. Energy-efficient pumps, solar pumps, agricultural sector pumps, centrifugal pumps and special submersible pumps are likely to contribute to the growth of the pump market in India during the forecast period. The pump market in India by revenue is expected to grow at a CAGR of over 7 per cent during the period 2021–2026. The demand for pumps is expected to grow at a steady rate due to the increasing application of pumps in several end-user sectors.

How has the pandemic affected the Indian pump industry?

I am quite hopeful that despite the odds the overall pump market in India would grow at a CAGR of over 7 per cent in the next five years. In the first wave of the pandemic the lockdown added stress to the industry, bringing almost everything to a standstill. Because people are the most important stakeholders in the manufacturing sector, the illness of the workers was one of the big challenges in the last 100 days. Things are coming back to normalcy and we are quite confident that with the new normal in place, business would be as usual very soon.

Do you expect the PM-KUSUM scheme to continue giving attractive results in FY 2021-22 as it gave in FY 2020-21?

Yes, I certainly expect the PM-KUSUM scheme to give attractive results this year as well. In fact, if the going is good, we expect better numbers this year. The last year was a kind of pilot project and more and more farmers need such solutions which will make them less dependent on electricity. Last year we had installed 15,000 pumps in the scheme and this year the expectation is to get tenders of approximately 60,000 to 70,000 pumps.

Going forward, how do you expect the demand for solar water pumps?

Solar pumps have a great future because practically there is no fuel cost as it uses the available free sunlight. Solar pumps have long operating life with high reliability and durability. The eco-friendly solution actually helps in saving heavy recurrent expenses. On the other side, diesel pumps are unviable for farmers and electric pumps have limitations. It can be understood from a simple comparison: the government has to make an investment of Rs 80 per watt for power generation and transmission whereas the solar power generation units cost only Rs 50 per watt. Not only this, power generation and distribution have huge maintenance cost, whereas in case of solar it’s almost zero. Thus, we can say that solar is beneficial for everyone, be it power generation companies i.e. the government public sector units, farmers and the environment.

What are your three main strategic objectives?

We are not sure if the pandemic is over or if there are more waves left. Keeping the safety of our team will of course be our top priority. We shall do whatever is required to keep the lives of the people of our company above everything. The second key objective is performance and productivity and to sustain and strive for growth. We shall be working hard to achieve the targets set for growth in international marketing and efficiency improvement in our operations. The last and the key strategic objective shall be research and development. We shall continue to see this as our key factor in the future.

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