Strong small-cap stocks below their five-year median PE

Over the last one year, small-cap stocks have taken a severe beating. While the S&P small-cap index has fallen by around 10 per cent from its peak, several small-cap stocks have plunged further. In fact, while analysing the list of our companies, we have found that more than 75 per cent of small-cap companies (excluding finance and banks) are now trading at less than their five-year median PE. This presents an opportune time to hunt for fundamentally strong small-cap companies that are available at cheap valuations.

Given this, we have taken a fresh look at the stocks in the small-cap universe trading below their five-year median PE. As always, we have used our fundamental filters of ROE greater than 15 per cent in each of the last five years; debt to equity of less than one and positive cash flow from operations in each of the last five years, which eliminated around 465 companies out of a list of 539. Finally, we have come up with a set of three companies that are trading at the highest discount to their five-year median PE.

Our filters:
1) ROE greater than 15 per cent in each of the last five years
2) Debt to equity of less one
3) Positive cash flow from operations in each of the last five years
4) Trading at a huge discount to their five-year median PE

Atul Auto
A manufacturer and seller of three-wheeler vehicles for both cargo and passenger segments, Atul sells 40-plus variants under the 350-kg as well as 500-kg payload capacity across multi-fuel choice, including diesel, petrol, CNG, LPG and electric. In 2019, it sold more than 50,000 vehicles, out of which 5,536 vehicles were exported to countries like Nepal, Ecuador, Mexico and others. With a production capacity of 60,000 units a year, it operated at 83.6 per cent utilisation in FY19.

In FY19, more than seven lakh three-wheelers were sold within the country, while around 5.7-lakh vehicles were exported. Domestically, Bajaj Auto controls around 58 per cent of the market share, followed by Piaggio (24 per cent) and M&M (nine per cent). In the recent past, the three-wheeler auto sector has been rocked by various challenges, including the shift to BS-VI compliance and the fast adoption of e-rickshaws.

In terms of financials, the company increased its revenue by seven per cent annually in the last three years till Sept 2019, while its net profit increased by around eight per cent. The company is debt-free and has given an ROE of more than 20 per cent in each of the last three years. Out of the Rs 180-200 crore capex that the company plans to make for its greenfield facility in Ahmedabad, it has already done around Rs 80 crore. This capex will boost the total capacity to 1.2 lakh units a year. The stock has corrected by 30 per cent in the last one year and currently trades at a PE of 9.5 times as compared to its five-year median of 22.3x.

Care Ratings
Starting its operations in 1993, CARE Ratings is the second-largest credit rating agency in India in terms of domestic rating income. It has completed 76,531 rating assignments since its inception, cumulatively adding Rs 128.4 lakh crore as of March 2019. In the last few years, the company has expanded its international footprint in Nepal, Mauritius and Kenya, through joint ventures. Last year, it also signed an MOU with a Russian rating agency for the development of a multilateral credit rating framework.

The Indian rating industry is dominated by four big players, including Care Ratings. Since the IL&FS debt crisis, rating companies have come under regulatory scanner as they failed to foresee the crisis. In fact, as per a report by Grant Thornton, rating companies were accused of colluding with each other and with the management of various IL&FS group companies for giving favourable ratings to the companies despite knowing about the financial trouble. However, rating agencies have denied this charge.

The company segments its revenue into new ratings (40 per cent of revenue) and surveillance (review of ratings during the life of a loan, 60 per cent of revenue). Over the last few years, slow credit uptake by private companies led to annual revenue decline of 2.2 per cent in the last three years ending September 2019. On the other hand, high fixed costs mainly related to employee expenses led to profit decline by seven per cent during the same time. The company is debt-free and has given an ROE in excess of 20 per cent in each of the last three years. Following the resignation of the erstwhile CEO after whistleblower complaints surfaced, the company is at present headed by an interim CEO. The stock currently trades at a PE of 15.9 as compared to its five-year median PE of 26.0.

Bajaj Consumer Care
Involved in selling hair and skin-care products, the company generates more than 90 per cent of its revenue from Almond Drops Hair Oil (ADHO), which has a volume market share of around 7.8 per cent in the total hair oil category. Backed by its nine manufacturing units and a network of 8,869 distributors, Bajaj Consumer Care supplies its products to around 40 million retail outlets.

As of September 2019, India's haircare market was pegged at Rs 25,562 crore, with hair oil accounting for Rs 8,261 crore. To tap into the Rs 1000-crore cooling hair oil market, the company launched an extension of ADHO, Bajaj Cool Almond Oil. Besides, its recent launch, Nomarks Ayurvedic sunscreen, is aimed at the country's Rs 250-crore sunscreen market. The company has also appointed Bain Consulting to devise a new growth strategy.

The company's revenue grew by 3.9 per cent in the three years ending September 2019. Its three-year average ROE and ROCE stood at 44.6 and 55.4, respectively (year ending March). Recently, the promoters brought down their stake from 60 per cent to 38 per cent in a bid to reduce pledging. Promoters pledged shares now stand at zero per cent as compared to 63 per cent before the sale.

Also, the company has appointed a new CEO, Jaideep Nandi, who was earlier with Asian Paints as CEO, Asian Paints PPG. The stock currently trades at a PE of 14.9 compared to its five-year median PE of 28.4.

Disclosure: The intent of the article is not to recommend any specific stocks. If you wish to invest in any of the above-mentioned securities, please do thorough research.