Investing in smallcap stocks can be very exciting.
However, many investors often fail to realise that the most important thing to analyse in smallcaps is their underlying business.
You want a fundamentally strong business that has been around for a while. Something with a history of robust earnings and a healthy balance sheet. But even after you have found it, you can’t just buy it at any price.
You must buy the stock when it is trading at a discount to its fair value. This discount acts as a margin of safety.
On the off chance the business doesn’t do well, the margin of safety acts like an airbag. It cushions the blow.
Now that you understand the importance of value, let’s look at the ten undervalued smallcap stocks in India, that can offer potential returns in 2023.
#1 IG Petrochemicals
First on our list is IG Petrochemicals.
IG Petrochemicals is India’s largest phthalic anhydride (PAN) manufacturer that enjoys a domestic market share of over 50%.
PAN is used as an intermediate to produce plasticisers, unsaturated polyester resins, and alkyd resins & polyols. The product finds application in consumer as well as non-consumer durable segment and is widely used for manufacturing paints, inks, coatings, boxes, containers, and packaging films.
The company’s leading position and growing demand for chemicals have expanded its business in the past five years.
Sales and profits have nearly doubled, and their 5-year CAGR comes in at 10.6% and 21.7%%, respectively.
At present, IG Petrochemicals trades at a PE multiple of 5.9 times, which is a discount of 41% to its 10-year median of 10.1 times. This discount can be due to the company’s poor performance in the quarter ending December 2022, after which its share price took a hit.
#2 Kalyani Steels
Next on our list is Kalyani Steels.
The company is part of the Kalyani group, owners of the renowned auto ancillary unit Bharat Forge.
Kalyani Steels manufactures and supplies low and medium alloy steel to the forging industry in India. Their clients include leading national and international OEMs in the automotive, engineering, energy, aluminium smelting, defence, etc.
The company has been running this business for over four decades. The business has been doing well, with the profits doubling in the last five years while sales have grown at a CAGR of 3.9% during the same period.
The robust profit growth has propelled the company’s return ratios. Return on equity (ROE) has grown consistently from 14.7% to 18.1% in the past five years. The debt to equity ratio also stands at 0.25 times, well below the danger mark of over 1.
The stock currently trades at a PE multiple of 1.01 times, a discount of 28% to its 10-year median PE of 1.3 times.
#3 Satia Industries
Third on our list is Satia Industries.
The company is one of the leading wood and agro-based paper manufacturers in India, with a fully integrated manufacturing setup.
Satia Industries supplies paper directly to various state boards, accounting for over 40% of the business.
The state orders are tender driven, funded by the government and generate higher margins, in comparison to the paper sold in the open markets. They enjoy a 10-12% market share in the state orders and are well-poised to benefit from the country’s literacy mission.
In recent years, the company’s business has expanded significantly. While sales have grown at a CAGR of 11.7% in five years, net profit has grown by 9.6%.
The company has negligible debt on its books, and its RoE stands at 20.3%. It is well placed to benefit from the growing demand from schools across the country and the government funded education drive.
Currently, the stock is available at a PE multiple of 7.4 times, which is a 13% discount to its 10-year median PE of 8.6 times.
While the company’s financial performance remains intact, the stock is available at a discount due to weak market sentiments.
#4 Shreyas Shipping
Fourth on our list is Shreyas Shipping.
Shreyas Shipping is a part of the 40 year old global conglomerate Transworld Group. The company is a pioneer and market leader in domestic coastal container shipping services and coastal transhipment services covering most major ports and container terminals on the Indian coast.
It commands a majority market share of over 90% in the export-import transhipment business and more than 52% in the domestic container business.
India has a vast coastline. However, when it comes to coastal shipment, it remains widely unutilised.
The cost per tonne-km of moving cargo via coastal route can be 60-80% cheaper than moving by road or rail. Despite this, 60% of the cargo movement is by road and 34% by railway and only 6% by coastal shipping.
Internationally, cargo movement is 25-30% by road, 50-55% by railways, and 20-25% by waterways.
This disparity highlights a massive opportunity for robust growth. Shreyas Shipping is well-poised to benefit from it.
While the sales haven’t grown much, the company’s net profit has more than doubled in four years, growing at a CAGR of 27.4%. This has led to strong return ratios, with return on equity doubling in the past five years.
The business is also cash rich, allowing the company to maintain a low debt-to-equity ratio of 0.3. The 5 year average dividend yield stands at 0.3%.
The stock is currently trading at a price to book value (P/BV) of 0.8 times, a 37% discount to its historical 10-year average P/BV of 1.1 times.
The undervaluation could be due to poor performance in the quarter ending September 2022. Both sales and net profit fell compared to the previous quarter.
#5 Nitin Spinners
The fifth stock on our list is Nitin Spinners.
Nitin Spinners is a textile manufacturer specialising in Cotton & Blended Yarn, Knitted Fabrics, Greige & Finished Woven Fabrics.
India enjoys a comparative advantage in terms of skilled manpower and production costs, relative to major textile producers.
Moreover, the rising disposable income and aspirations in a country with a growing population, present textile companies with a great opportunity for long-term growth.
Nitin Spinners is well-placed to benefit from this opportunity. With negligible debt on its books, the company has expanded its business in the past five years.
While sales have doubled, the profits have multiplied by six times. This has driven the RoE, up threefold in five years and stands at 37% in the financial year 2022.
The stock price mirrors this performance, having doubled in the last five years.
However, it hasn’t performed well in the past year, falling 22% since February 2022.
This poor performance is due to the weak numbers reported by the company in the past couple of quarters. But the issue isn’t company specific; it’s industry wide.
The Indian cotton textile industry has faced multiple challenges in the past one year. The high price volatility and the higher absolute raw materials prices have dented the margins. The relative price differences compared to the international markets have led to a massive competitive disadvantage for most Indian textile players.
Apart from this, a demand slowdown due to geopolitical tensions and inflation in European and US economies has dented the profitability further.
At present, the stock trades at a PE multiple of 5.6 times, which is a 13% discount to its 10-year median PE of 6.5.
#6 Ambika Cotton Mills
Sixth on our list is Ambika Cotton Mills.
The company manufactures premium quality compact and elitwist cotton yarn used in hosiery and weaving. It is an established textile player in the international and domestic yarn market, with exports constituting over 60% of its revenues.
Ambika Cottom is well-poised to benefit from the growth in the textile segment, which comes from rising disposable income in the country and the low cost advantage in terms of skilled manpower.
The organised apparel segment is to grow at a compound annual growth rate (CAGR) of more than 13% over a ten-year period.
CAGR of 11.7% and 26.4%, respectively. The robust profits have doubled the return ratios. The RoE is up from 15.2% in the financial year 2018 to 27.8% in 2022. This phenomenal growth comes without any borrowing.
So it is no surprise that the stock has done well in the past few years. However, it has dwindled in the past few months.
The stock is trading at a PE multiple of 6 times, a discount of 60% to its 10-year median PE of 9.7 times. This is attributable to the drop in sales and profits by 16% and 4% in the quarter ending December 2022, compared to the previous quarter.
Apart from the December quarter, the profits in the preceding quarters also fell sharply, contributing to the stock price dip. The drop in sales and profitability is a textile industry wise phenomena as explained in the case of Nitin Spinners.
#7 Gloster India
Seventh on our list is Gloster India.
A textile company, Gloster is a leading manufacturer of jute & jute allied products. The company has a domestic and international presence, with exports accounting for over 27% of total revenues (the financial year 2022).
Rising concerns over reducing our carbon footprint open doors for biodegradable & sustainable products made from natural fibres, such as jute. This offers the company a huge opportunity to address a larger market.
However, there are concerns over raw material costs that are dependent on the monsoon in the country, the availability of water for the retting process and the competition from the Bangladesh jute market.
But despite these lingering threats and concerns, the business has performed well in the last five years.
The sales and profits have grown at a CAGR of 7.7% and 13.3%.
The stock is available at a premium to its 3.5-year historical median PE multiple. It trades at a PE of 13 times whereas the median PE stands at 10 times.
However, the short trading history does not paint the correct picture. The company’s performance in the last few quarters has been better than expected resulting in an uptick in the stock price.
#8 Sportking India
Eighth on our list is Sportking India.
The company is a textile manufacturer offering an array of products suitable for manufacturing woven and knitted fabrics for summer and winter wear. It operates in the domestic and international markets, with exports accounting for over 47% of the total revenues in the quarter ended December 2022.
Sportking caters to some of the marquee brands in the apparel industry, such as Zara, Marks and Spencer, H&M, Jockey etc.
The company has added over 30% of its existing capacity in the past four years, funded via a mix of internal accruals and borrowings.
The business has been doing well in the past five years. While sales have doubled, the profits are up five times in the same period. This has boosted the return on equity, up four times in the past five years.
The stock performance, up 56 times in the past five years, reflects the stellar business performance. However, the past year has been tough.
Sportking India share price has taken a beating, falling by 46% since February 2022. This comes on the back of a dip in profitability in the past few quarters. While sales are dwindling, profits have slumped due to advancing input costs.
The company even reported a minor loss in the quarter ending September 2022, affecting the stock price drastically.
At the current price, the stock is available at a PE multiple of 4.4 times, a premium of 41% to its 10-Yr median of 3.1.
#9 Indian Metals & Ferro Alloys (IMFA)
Next on our list is Indian Metals & Ferro Alloys.
Indian Metals & Ferro Alloys is India’s leading ferro chrome manufacturer. Ferro chrome is an alloy primarily used in the production of stainless steel. The company exports over 85% of its output to the Far East (China, Japan, and Taiwan).
China continues to be the world’s leading ferrochrome and stainless steel producer. But China imports the key raw material used in the production of ferro chrome, chromium.
India is the second largest producer of chromium 4.2 million (m) tonne, (m) after South Africa..
The Indian ferro chrome industry has traditionally focused on exports due to low domestic demand. However, given India’s increasing focus on infrastructure development and building industrial corridors, there should be a substantial increase in domestic demand for ferro chrome in the future as per capita stainless steel consumption rises.
The country’s stainless steel demand is estimated to grow at a CAGR of 6.6-7.5% between 2022 and 2025.
With no debt on its books and fully integrated operations, the company is confident of growing well in a cyclical industry.
In the past five years, the sales and net profits have grown at a CAGR of 8.9% and 15.3%, respectively. This growth was funded by a mix of internal accruals and negligible debt. The RoE has doubled, up from 15% in the financial year 2018 to 29.6% in 2022.
But the last year has been tough for the company. The lockdowns in China have affected the selling price of ferro chrome. This, combined with rising raw material prices, has dampened the profitability.
The stock currently trades at a price-to-book value of 0.93 times, a 30% premium to its 5-year median price-to-book value of 0.7 times.
#10 Jindal Polyfilms
Last on our list is Jindal Polyfilms.
The company is a manufacturer of packaging films such as BOPET (bi-axially oriented polyethene terephthalate) and BOPP (biaxially oriented polypropylene). These films are used by the FMCG sector for flexible packaging. They safeguard the product and extend its shelf life.
Apart from this, the company runs a textile business. It is the country’s leading manufacturer of non-woven fabric. The textile business accounted for over 10% of the total revenues in the financial year 2022.
The margins in the business are not robust. The major raw materials required for manufacturing packaging films are derivatives of crude oil. Consequently, the prices of the finished goods fluctuate with crude oil prices. Hence, the ability of the manufacturer to pass on raw material price increases is critical.
The industry is also overcrowded, making it difficult for companies to maintain high margins.
Despite this, the company has expanded its business.
The company demerged a small part of its business in the financial year 2018. Therefore a 5-year view doesn’t paint the right picture.
The stock is currently trading at a PE multiple of 2.4 times, a discount of 54% from its historical average.
This is due to the weakness in numbers reported in the quarter ending September 2022. While sales fell by 11.2%, profits were down 30% compared to the previous quarter.
Small businesses are far more agile and have additional room to grow in comparison to their larger peers.
By keeping an eye on undervalued small-cap stocks and staying disciplined in your investment strategy, you can potentially find attractive opportunities.
You might find a multibagger stock for 2025 from the list of small-cap stocks shared above.
But no matter how great the prospects, you must consider your risk-bearing capacity and investment horizon. That is what successful investing is all about.
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com
(Except for the headline, this story has not been edited by NDTV staff and is published from a syndicated feed.)
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