BSE SMALL-CAP –THE FII FAVOURITES

One of the important factors that drives the FIIs to Indian markets and also differentiates it from other emerging markets is the kind of length and breadth it provides in terms of sectors and stocks. Just to quantify, there are more than 3,000 actively traded counters on BSE itself.  What we want to indicate is that there are diverse sectors and amongst the sectors also there are many liquid companies to be invested into. This is a competitive advantage for India over other emerging economies which are either only commodity-focused or have got lower liquidity to attract foreign funds. No wonder since the past three years Indian markets have consistently witnessed FIIs inflow.

To put this in numbers, in 2012 FIIs were net buyers to the tune of Rs 1,28,360.70 crore and in 2013 they again invested Rs 1,13,026.70 crore. There were questions raised by many on the street whether the FIIs would continue to come to emerging markets in general and Indian markets in particular. Especially in a scenario when there was high speculation about the US Fed planning to start QE tapering and European economies again witnessing some jitters. If investors will recollect, we at DSIJ had at the start of the year categorically stated that the Indian equity markets are expected to continue witnessing flood of foreign funds. And with Rs 84,853.23 crore of net investment by FIIs we were proved right.

One interesting factor that struck our observation was that with consistent inflow for three consecutive years, many blue chip companies had already hit the upper boundaries of FII investment limits. As is usually happens and has also been seen in the past, the first lot of FII investment comes to large-cap blue chip stocks and eventually it comes to other broader markets like mid-cap and small-cap.

If we take a look at the historical performance of Sensex, mid-cap and small-cap indices it is clearly visible that the Sensex managed to outperform the mid-cap and small-cap indices on a three-year basis. However, in the past one year the small-cap index has categorically outperformed the Sensex as well as the mid-cap index (see chart on comparative performance). What we want to focus on is that companies from the BSE small-cap index managed to attract the attention of a lot of foreign funds as well. Commenting on this, Jayant Manglik, President - Retail Distribution, Religare Securities, says, “FIIs have an ongoing love affair with India and have been active participants, frequently bucking the trend. While most of their investments have been in large-caps, they have made their presence felt in the small-cap space also."

As a result we carried out a simple process of finding out financially sound stocks form the BSE small-cap stable which have witnessed a consistent increase in FII holding since the past three to five quarters. We deliberately ignored the counters that witnessed increase in FII holding in only the preceding one or two quarters as we wanted consistent players. Investors may also ask the question about why we have focused only on small-cap and not mid-cap companies. It is a very valid question and we have a very valid answer for that.

Markets usually discount the future and we expect more scope of growth in small-cap. To put it in the right perspective, while the Sensex is already trading at all time high levels, the BSE mid-cap index is only a striking distance away from its all time high level of 10,245.81 made on January 8, 2008. The BSE small-cap index is however still quite far away from its all time high level of 14,239.24 made on January 8, 2008, hence providing some breathing space for new investors as well.

As Manglik puts it, “One theme of the India growth story is that large-caps will aim for global size, some mid-caps will become large-caps, and some small-caps will grow to be mid-caps in the next few years.” He further adds, “Given the profits made in large-caps benefitting from the 30 per cent index growth in this calendar year, it is a good strategy and we expect the FIIs to continue to hunt for opportunities to invest in small-cap companies which meet their selection criteria. But since the FIIs’ key focus will always be large-caps, this will be a strategy to add alpha to their portfolio with limited downside.”

We believe that with macro factors like GDP growth rates, IIP figures, inflation and even India Inc. results indicating towards better days ahead along with a pro-reforms’ government at the Centre, we feel there is lot of scope in the small-cap stocks. Here we have found five stocks from the BSE small-cap index which we feel are expected to create value for its investors.

The Process

As mentioned earlier, we tried to focus on companies that have consistently witnessed increase in FII investment since the past three – five quarters. The prime reason behind considering three – five quarters is that it was the time when questions were being raised about the possibility of FIIs coming to Indian markets. Hence, despite a lot of confusion and cautiousness these companies witnessed FII interest. The table below provides a list of companies that managed to attract FIIs from the preceding three quarters. We have handpicked a few of those for our readers.

BSE SMALL-CAP RECOMMENDATIONS

Century Plyboards  | BSE CODE: 532548 | FACE VALUE: Rs.1 | CMP: Rs.140

Century Plyboards (India) has a presence is different segments like plywood, laminates and logistics. Earlier it had a ferro alloys and cement business which got demerged. Till date the ply industry was mostly unorganised; however going ahead we feel there is expected to be a structural shift in favour of organised players. Yes we expect the implementation of GST as a potential game-changer for the company. The plywood market today is largely controlled by the unorganised sector which accounts for 75 per cent of the market. However, driven by lower price differential and increasing preference for branded wood panel products, there is a clear shift with the organised players growing at higher rates.

Apart from this, the capacity expansions and distribution drive are also expected to push earnings’ growth. With 20 per cent capacity expansion in its plywood division (taking capacity to 200K CBMs) and a massive two-times expansion in the laminates segment (taking capacity to 4.8 million sheets), coupled with a commensurate expansion in the distribution network, we expect all the divisions to deliver healthy revenue growth. Further, with improving utilisation for the Kandla plant and the Kolkata laminate capacity, coupled with minimal forex loss, we expect its bottomline to improve further. The FII investment in the counter in September 2014 has increased to 5.87 per cent from the level of 1.19 per cent in September 2013. Though the pledging of shares is a bit of concern, we feel the growth drivers are already in place and hence recommend a buy with a target price of Rs 175.

Granules India  | BSE CODE: 532482 | FACE VALUE: Rs.10 | CMP: Rs.748

Granules India is a pharmaceutical company and operates in an integrated pharmaceutical business segment. It manufactures active pharmaceutical ingredients (APIs), pharmaceutical formulation intermediates (PFIs), and finished dosages (FDs). With its wide geographical presence with 69 per cent sales coming from the US, Canada and Europe it has managed to diversify the geographical risk. If we take a look at the growth drivers, going ahead FDs will be leading followed by PFIs and then by APIs. By FY16 its revenue mix would look like at least about 40 per cent as FDs, may be about 30-35 per cent PFIs, and the rest APIs. The company has begun working on ANDA filings and aims to file three ANDAs within the next 6-12 months.

Going ahead the overall topline growth is expected to be minimum 20 per cent and bottomline growth will be more than 20 per cent. The company also has good capex plans to invest about Rs 75 to Rs 100 crore during FY15E towards capex which includes normal capex of around Rs 30 crore. Long-term loans as on June 30 on a consolidated basis including payable in the next one year total Rs 327 crore and working capital loans are to the tune of Rs 116 crore. No wonder the FIIs have increased the stake to 6.08 per cent as on September 2014 as against 1.54 per cent in September 2013. On the valuation front the scrip is still trading at 18x of its trailing four-quarter earnings. We feel this provides a long-term growth opportunity and recommend a buy on the counter with a target price of Rs 1,050-1,100.
 
Vinati Organics  | BSE CODE: 524200 | FACE VALUE: Rs.2 | CMP: Rs.438

Vinati Organics is an Indian specialty chemical company engaged in the business of manufacturing and export of organic intermediates, monomers and polymers. The company has been a consistent performer on the financial front with topline and bottomline increasing consistently for the last few quarters. For the September 2014 quarter the company posted a topline of Rs 196.39 crore and bottomline of Rs 28.43 crore as against Rs 177.08 crore and Rs 22.66 crore posted in the September 2013 quarter. Going ahead the company is likely to get benefits of declining crude prices and hence the margins are likely to expand further.In the recent quarter only the PBTE margins increased to 21.68 per cent from the level of 19.98 per cent in September 2013. The best part is that not a single share of the company has been pledged. With consistent performance on the financial front, the FIIs have increased the stake to 4.66 per cent in September 2014 from the level of Rs 1.59 per cent in September 2013. Another advantage is that the company has reduced its debt to Rs 122.24 crore in March 2014 as against Rs 200.84 crore in March 2013. We recommend our readers to buy the scrip with a target price of Rs 550 in the next one year. 

Suprajit Engineering | BSE CODE: 532509 | FACE VALUE: 1 | CMP: Rs.120

Suprajit Engineering which manufactures automotive cables is an extension of our bullish call on the automobile sector as a whole. Apart from increased FII interest, there are three major factors that guide us to recommend Suprajit Engineering. The first and foremost factor is the improved business prospects on account of higher penetration in current clientele and inroads into new clientele as well. The second factor is that the company is going ahead with expansion at three plants, taking its manufacturing capacity to 225 million cables in FY16 from the current level of 150 million cables. Apart from that, the management is looking at focusing on European markets for the aftermarket share where the margins are higher.With the Indian automobile companies witnessing an up-move we feel the volume growth is expected to witness traction. As regards its financial performance, the company has posted strong financial performance in H1 FY15. It posted topline of Rs 294.10 crore as against Rs 231.30 crore in H1 FY14. On the bottomline front it posted Rs 25 crore and Rs 21.80 crore respectively. In terms of FII investment, the FIIs increased the stake to 3.84 per cent in September 2014 from the level of just 1.38 per cent in September 2013. On the valuation front the CMP discounts its trailing four-quarter earnings by 26x. We recommend readers to buy the scrip with a target price of Rs 150-155.

Gabriel India | BSE CODE: 505714 | FACE VALUE: 1 | CMP: Rs.96

Gabriel India is another automotive ancillary company which has witnessed an increase in FII holding. The company manufactures products like shock absorbers, front forks and struts for two-wheelers, three-wheelers, passenger cars and even commercial vehicles. While the company earns 60 per cent of revenues from two and three-wheelers and 30 per cent from passenger cars, the rest comes from commercial vehicles. With volume growth expected in the two and three-wheeler industry and launch of new models in the passenger vehicle segment we expect demand drivers are in place for the company. The best part is that the company does not earn more than 20 per cent revenue from a single company. It is now focusing on increasing its after-market share and is also focusing to establish new geographies.As a strategy it is also planning to reduce its debt and has succeeded in doing so over the past two years. Its debt equity ratio stands at 0.23. For further prospects it is also looking for the inorganic growth route. On the financial front, the first quarter performance has been good for FY15. Here it posted topline of Rs 352.43 crore and bottomline of Rs 13.70 crore as against Rs 296.65 crore and Rs 8.67 crore respectively in June 2013. On the valuation front, its CMP discounts its trailing four-quarter earnings by 25x. We recommend a buy with a target price of Rs 120.