Sunday, 19 August, 2007

Small cap picks!

Sree Rayalaseema Hi-Strength Hypo (Rs 21.05):
The rewarding thing about trawling the papers day in and day out is that one day god may smile and say, “Bachcha, I am pleased with your devotion. I shall grant you a bargain penny stock that shall be hidden from public view as long as you want it.”

The moment manifested in the form of SRHSH. Looks at its 2006-07 financials: equity of Rs 10.18 crore, EBIDTA of Rs 13.2 crore, tax paid at 34 per cent, EPS of Rs 5.61, market cap of Rs 22 crore. First reaction: oh, one-off. Then SRHSH surprised with its first quarter: an EBIDTA of Rs 3.49 crore and an interest cover of 9. Nine!

SRHSH manufactures calcium hypochlorite and monochloroacetic acid; the former is being increasingly preferred as an environment-friendly alternative for chlorine in swimming pools and water purification the world over.

The company exports nearly all of this product so the results that you see in the first quarter of this year is after the impact of the rupee’s appreciation. The company manufactures the product through the specialised sodium route, developed in-house, mastered only by a few companies in Asia.

This is my turn-on: SRHSH has embarked on an expansion of its sodium hypochlorite capacity by 50 per cent and its monochloroacetic acid capacity by more than 100 per cent; out of internal accruals and debt, if you please; these will translate into reality by the end of 2007; enhanced utilisation should translate into revenues of Rs 160 crore for 2008-09. If margins are maintained, shareholders could be laughing all the way to the AGM. Provided it is not in Kurnool, Andhra Pradesh!

Jhunjhunwala Vanasapati (Rs 80.80):
Welcome to the next edition of Battle of Biases. If I told you that this company makes vanaspati and mustard oil, you are likely to turn up your nose and say, “Sunset business”.

But if I told you that the name of the company was Sterling Foods or something and that it was likely to report a turnover of Rs 1000 crore-plus in the current year, your first reaction would be, “What a franchise!”

If I told you that this is a 3 per cent EBIDTA business, you are likely to pass some uncharitable remarks about the intention of the management. But if I told you that the worst interest cover in the last five quarters was still a little over 8, you would be tempted to say, “Cash rich”.

If I told you that the company was headquartered in Benaras, your first reaction would be “Governance konni!” But if I told you that EBIDTA has increased across every single quarter of the last five quarters and the company quotes for a mere market cap of around Rs 65 crore against a projected EBIDTA of around Rs 30 crore for the current year, you are more likely to sheepishly concede “Accha, chalo aap bolte hain toh…”

Indag Rubber (Rs 42.65):
The biggest pre-cured tread rubber brand in India is the venerable Elgi, right? And the second biggest? Pakde gaye na? The industry leader enjoys a market capitalisation of around Rs 100 crore and the number two? A mere Rs 22 crore. And that is the mother of all my arguments for Indag, the crown prince.

The numbers come later: Indag’s first quarter EBIDTA in the current year was the fifth straight quarter-wise increase, peaking at Rs 2.51 crore this latest quarter; EBIDTA margin increased across each of the last four quarters; Elgi enjoyed an EBIDTA margin of around 10 per cent for 2006-07, whereas Indag’s was 14.57 per cent in the first quarter of this year; interest cover increased across each of the last five quarters peaking at 6.44 this latest quarter.

This is the nugget I like: its weight-mileage ratio is considered among the best in the industry; its technology, developed in-house, enabled it to more than neutralise the disadvantage of moving out of collaborator Bandag’s shadow (now a Bridgestone company); its export exposure is increasing now that the collaborator is out of sight; its low asset utilisation of only around 62% in 2006-07 is what my friends in the market call a high operating leverage; it can enhance overall capacity by 50 per cent at a negligible cost through a transfer of assets from its erstwhile Rewari plant.

This is what I like about its industry: roads are improving and truck overloading is declining so tyres are being protected enough to deserve a retread instead of being chucked; expensive radialisation means that users would rather retread tyres than throw away; large transporters are more likely to go in for organised retreaders for enhanced reliability and mileage; decline in sales tax in some states to 4 per cent is narrowing the differential between the organised and unorganised players, widening the market and strengthening Indag’s margins.

WS Industries (Rs 82.05):
Suddenly, half of India including my mother-in-law is bullish on this porcelain insulator company.

The reasons: India’s considerably-under-provided power transmission sector is the next big thing, the country’s transmission lines are graduating towards higher voltages, Power Grid’s next mega tender is around the corner, global opportunities are emerging in East Asia, Latin America, North America, North Africa and Europe (going through aggressive line refurbishment) and the insulator industry growth of 12-15 per cent over the last three years of the Tenth Plan is going to lead to an average 20-22 per cent per year in the Eleventh Plan.

So what does all this mean for dear WS? An order book for more than a year, a new plant under commissioning which will enhance capacity from 16,000 tpa to 27,000 tpa, additional capacity to go on stream in the first quarter of the next fiscal, project funded through a private placement (equity already diluted) and enriched product mix (first to develop products for the 800 KV line and is working on the 1200 KV line) will strengthen margins, a debt-equity ratio of less than 1 will translate into improving interest cover and the company possesses a full-blast revenue potential of around Rs 350 crore.

Now look over your shoulder. A company with large exports, WS Industries reported its highest ever EBIDTA margin in the quarter when the dollar slumped, interest cover rose almost every quarter over the last year; the company reported five quarters of back-to-back EBIDTA growth into the first quarter of the current fiscal; revenues of the first quarter of the current fiscal were better than the last quarter of 2006-07!

What is not widely public is that the business has a high fixed cost but once that is covered, it recruits people to count the money. But that’s only between you and me.

Akar Tools (Rs 37.10):
Quick, if you were being offered for Rs 22 crore a company with the possibility of earning Rs 9 crore in EBIDTA (earnings before interest, depreciation and tax) during the current financial year, would you yawn or call your merchant banker by reflex action?

And this is my pitch for this Aurangabad-based hand tool and leaf spring manufacturer, which surprised with a double digit EBIDTA margin in the first quarter of 2007-08 on a total income of Rs 17.83 crore and an equity of Rs 5.40 crore.

If you don’t trust these numbers, consider this: hand tool capacity increased from 2,400 tonne per annum (tpa) to 3,600 tpa last December and leaf spring capacity will increase from 3,600 tpa to 12,000 tpa by the last quarter of 2007-08 – all financed through internal accruals and debt.

Scale will address the growing demand of leaf springs from OEMs, and the product mix will evolve from conventional leaf springs to value-added parabolic springs. At full blast that could be a top line of Rs 140 crore at slightly better margins in 2008-09. Now reach for your calculator.