Small But Bountiful

They may be off the radar of analysts and media, but a clutch of small companies are enjoying unwavering attention of some big investors. There is certainly something about these lesser-known cos to captivate their attention for so long. ET Intelligence Group’s Ramkrishna Kashelkar highlights a dozen of these small wonders for retail investors

Aesop's fables teach the principle that one is judged based on the company one keeps. Although the word 'company' here doesn't refer to those listed and unlisted entities an investor continues to hear about, the principle is applicable even to the world of equities. A company, which can count large, well-known investors among its shareholders, is generally considered well off.
That this alone may not be good for retail investors has been made clear by spectacular fiascos, like SKS Microfinance, Suzlon and Kingfisher. Still, as they say 'exceptions prove the principle', these instances don't diminish the overall importance of big investors. The endorsement of such shareholders always carries its weight, particularly if it remains unwavering even through the times of turbulence.
At ET Intelligence Group, we mined data on all such companies where mutual funds have either maintained or increased their stakes in the past couple of years, when the Indian market was underperforming global peers. The list threw a number of small and relatively unknown companies, where a sizeable chunk of equity is bought and held by MFs. Some of these companies may be underperforming currently, but there are others that have spectacularly beaten the market. Though being small, these companies have shown their ability to generate substantially better returns in a short span of time - something that tempted us to turn the spotlight on them for retail investors.
However, investors should bear in mind that all these companies may not be investment ideas, at present. But it will be a good idea to keep them on the watch list for possible revival signs. After all, a few large investors are betting on their brighter future ahead. 

Aarti Industries A leading manufacturer of benzene-based speciality chemicals & pharmaceuticals, Aarti Industries caters to diversified end-user industries such as pharmaceuticals, agrochemicals, polymer, additives, surfactants, pigments and dyes. Most global chemical majors such as DuPont, BASF, Clariant, Huntsman, Unilever, Pfizer etc are among its clients. The company is taking steps to expand production capacity. In FY12, it doubled hydrogenation capacity to 1,500 tonne per month. It is setting up its own captive hydrogen-generation plant, to take its output of hydrogenated compounds to 3,000 TPM, which will improve overall margins.
Aarti's pharma business is also set to grow rapidly, which is contributing 10% to its revenues at present and achieved a break-even for the first time in FY12. The company has two USFDA-approved facilities and exports four APIs to the US and 16 to Europe. Aarti Industries' valuation multiples are lower compared to other specialty chemical companies. 

Ador Welding Ador Welding is engaged in manufacture of welding and related products. The company caters to shipbuilding, defence, power, automobile, engineering and general fabrication industries. Given its diversified industrial clientele, the company, for 2011-12, had clocked in over 15% growth in turnover, notwithstanding the deep slump in the industrial sector. However, with higher operating costs and overheads eating into its profitability, its operating margins have taken a hit by over 400 basis points year-on-year.
However, domestic fund managers appear to have taken note of a consistent impressive growth in its turnover over the past three years and a relatively strong balance sheet not to forget a diversified number of industries that this company caters to. Ador Welding has clocked in over 12% growth in net sales consistently since FY09 and is insulated to high incidence of interest costs, given its near-zero debt status. The stock has also declined by nearly 50% in value over the past one year, making it an attractive buy at current levels. A major concern for the company, however, is its consistently declining operating margins, which has gradually shrunk from over 19% in FY10 to 12% by FY12. 

Ambika Cotton Mills Ambika Cotton Mills manufactures high-end cotton yarn used for hosiery and weaving. In spite of being from the textile industry, operating profit margins have remained high in the range of 27-31% in the past five years, except FY12, when it dipped to 20% due to various temporary reasons. Of late, the yard demand has been growing in domestic as well international markets as China increased cotton yarn consumption to augment its domestic raw material capacity while the cotton prices softened.
At present, the company already has an installed capacity of 109,872 spindles and has invested 73.2 crore for the expansion of its captive windmills to generate 27.4-MW power. On the valuation front, the company may appear slightly expensive than its peer Vardhman Textile. However, considering its better margins and strong balance sheet, the premium is justified. 

APL Apollo APL, erstwhile Bihar Tubes, is one of the largest ERW pipe manufacturers in India. It has, over the years, expanded its product profile to cater to sectors, including infrastructure, agriculture, engineering, oil & gas, automobiles and construction, with a production capacity of 490,000 tonnes per annum. Though sales have been growing above 40% over the past four quarters, rising raw material costs have resulted in a contraction of operating profit margins. During the March 2012 quarter, sales grew 56% to 422 crore, whereas profit increased by 7% to 17.6 crore.
Since the company earns a significant amount of its revenue through exports, the depreciation of the rupee benefits the company. The stock has run up 17% year to date. Despite the rise, it trades at a PE and EV/EBITDA of 7.1 times and 5 times which is fairly valued compared with its peers. 

CCL Products Guntur-based CCL Products is one of the leading export-oriented private label manufacturers of soluble coffee in the world. Its key markets in Europe, CIS and Far East have posted a good recovery after the financial downturn. The company has completed its coffee manufacturing plant in Vietnam with a capacity of 10,000 metric tonnes per annum. This unit, formed in one of the largest coffee-producer countries in the world, is expected to explore and expand in new markets. For the four quarters ended March 2012, the company's net sales were up 38% while its net profit rose 40% over the previous year. CCL's average operating margins for the past eight years have been 15%, with the company earning aboveaverage margins of 19.4% and 17.9%, respectively, in the past two consecutive years. Raw material costs constitute 60% of the company's revenues. Any short-term volatility in the raw material cost may impact the company's margins. The International Coffee Organisation has a positive outlook on the coffee sector. This augurs well for the company.
While the company's stock price is still 30% lower than its alltime high level, it has doubled since the beginning of this fiscal. Considering this run-up, most of the potential of the company's business seems to have been factored in. 

Indian Metals and Ferro Alloys Indian Metals and Ferro Alloys is India's largest integrated ferro alloy manufacturer with an annual capacity of 275,000 tonnes. Ferro chrome is used in the manufacturing of stainless steel, thereby making the company largely dependant on the stainless steel industry. Over the past four quarters, operating profit margins have been under pressure as ferro chrome prices declined sharply during the second half of 2011 whereas input costs kept increasing. But the recent rupee depreciation has worked to its advantage since the company earns about 85% of its revenue through exports.
During the March 2012 quarter, the company registered a sales growth of 10.4% to 304.7 crore whereas net profit declined 9.97% to 22 crore. Going forward, the company will benefit from the rise in ferro chrome prices and also the commissioning of its 2x60-MW captive power plant which is expected in the July-September 2012 quarter. The stock has gone up 31% year to date. With a P/E of 12.6 times and an EV/EBITDA of 6.17 times, the stock trades at a premium to its peers Jindal Stainless and Facor Alloys which trade at a P/E of 9.3 times and 4.88 times, respectively, and an EV/EBITDA of 2.33 times and 9.74 times, respectively. 

JBF Industries JBF Industries is a polyester chipmaker with a forward integration in polyester-oriented yarn (POY) and BOPET films. The company's FY12 numbers came under pressure due to forex as well as derivative losses. The company is currently setting up a 1.25-million-tonne-per-annum PTA plant, which is a key raw material for manufacturing PET at a cost of $600 million in the Mangalore SEZ. The project to be financed in the 70:30 debt-equity ratio has achieved financial closure and is expected to come up by 2015. This backward integration will enable it to save costs, improve margins and ensure better capacity utilisation levels critical in commodity businesses. The company also plans to set up a 390,000-TPA PET plant in Belgium and a 90,000-TPA BOPET film plant in Bahrain. The company's valuation multiples are higher than its peers. But that's justified in view of better financials. The company's return on capital is the highest among peers. Investors can accumulate the scrip in view of gains from expansion and backward integration projects. 

MBL Infrastructure MBL Infrastructure is a small-sized construction firm catering to rail, roads and industrial segments. As a company strategy, the firm intends to maintain its debt-minimum levels. Its current debt-to-equity ratio of 1.2 is one of the lowest in the industry. In the current high interest-rate scenario, this strategy has worked in favour of the company. Another interesting aspect is its project selection. The company only bids projects that follow FIDIC practices, which are an international standard for construction contracts. An international standard contract enables the company to receive payments on time, thereby maintaining the working capital at comfortable levels. It is one of the few construction companies, which has shown a net profit growth of more than 15% in FY12. At present, the company has an order book of 3,000 crore, which is nearly 2.5 times its FY12 revenues. 

Royal Orchid Hotels In the mid-sized hotels category, Bangalore-based Royal Orchid Hotels is currently suffering from subdued demand and oversupply situation in the hotels industry, particularly in its key markets of Bangalore and Ahmedabad. In FY12, the company reported a loss of 4.9 crore against a profit of 11.4 crore in FY11. In the past five years, margins have shrunk as the company grew from four to 16 properties. Its net profits have been on a downward trend. Its debt-to-equity ratio rose to 1 from 0.1 in the same period. The company recently sold its Ahmedabad property for 67 crore to bring down its debt, which currently stands at 216 crore at the consolidated level. Considering the lingering downtrend, the company doesn't appear a good buy at present. However, any recovery in the Bangalore market could prove crucial in its revival. 

SML ISUZU SML ISUZU, erstwhile Swaraj Mazda, is the well-known manufacturer of light commercial vehicles (LCV) in India. The company has collaborated with Mazda Motor Corporation of Japan for technical know-how and assistance.
Taking in the impact of the overall slowdown in the industrial sector, which has impacted sales of commercial vehicles across the automobile industry, SML reported a marginal increase of 6% in its sales volume for 2011-12. However, the fact that the company has clocked a growth of over 25% in sales volume in the previous two years justifies the popularity that its products enjoy with customers. 
SML also boasts of a strong balance sheet with a low debt on books and a consistently improving cash position. The company has also reported positive operating cash flows consistently since FY10. On the valuation front too, the stock currently commands a 12-month trailing P/E of 13, which is at a discount to its peers like Ashok Leyland and Eicher Motors. 

Texmaco Rail & Engineering Texmaco Rail & Engineering (TRE) is one of India's leading freight car manufacturers with a diversified engineering profile. The company designs and manufactures special purpose wagons for core sectors such as cement, coal, aluminium, steel, container freight cars, oil, chemicals, fertilisers, thermal power projects and the defence sector, among others. As TRE caters largely to the Indian Railways, the competition is pretty limited. This, in addition to a greater visibility for future earnings, stable balance sheet and decent financial performance, is also what appears to have lured domestic fund managers to this stock.
TRE has a near-zero debt and has maintained operating margins above 20% consistently for the past two years despite an 18% drop in turnover. The company's RoCE at 27% is better than its peers. This justifies the premium valuation it enjoys. 

Vesuvius India Vesuvius India makes refractory products, systems and services for steel, glass, cement and capital goods companies and is, therefore, dependant on these industries for demand. Its clientele includes companies such as SAIL, JSW Steel, Rashtriya Ispat Nigam, ESSAR and L&T. Though sales have been growing at 15-24% over the past four quarters, its operating profit margins have been under pressure due to higher raw material prices. During the March 2012 quarter, it posted a 15% growth in sales to 138 crore, but profit declined 11% to 11.6 crore.
Currently, about 30% of India's refractory requirement is imported. The fall in the rupee will force companies to increase their sourcing from domestic suppliers. Vesuvius has recently doubled the capacity at its Kolkata plant from 400 pieces a day to 800 pieces and is expected to be operational later this year. The stock has run up 20% year to date and is trading at a premium valuation compared to its domestic peers, which is justified in view of its leading status.