Small-cap stocks trading at a discount

The Indian stock market is going through a turbulent ride. Though the Sensex, which is representative of the thirty largest companies in the country in terms of market cap, has corrected by only around one percent in the last one year, the market has experienced a lot of volatility. The real mayhem though was seen in the small cap space with the S&P BSE Small Cap index correcting by more than 20 per cent in the last one year.

This correction offers an opportunity to bargain hunters in the small-cap space (with a market cap of between Rs 500-6000 crore). And so we looked at companies that are trading at a substantial discount of at least 30 per cent to their five-year median PE and at the same time have continued to generate a return on their equity of 15 per cent or more in each of the last five years. For further scrutiny, we included only those companies that have had a debt-to-equity of less than one in each of the last five years and which also generate positive cash flow from operations in each of the last five years. Finally, these companies have reported stable operating margins in the last three years. These are our two findings:

Accelya Solutions
The company is a software solution provider to the global airline and travel industry. Formerly known as Kale Consultants Ltd, the company was renamed Accelya Kale after the Spain-based Accelya Holdings acquired a controlling stake in 2010. It finally became Accelya Solutions in May 2019.

The company's expertise lies in billing, accounting and other ancillary services. It has a strong foothold in the revenue accounting space, and processes two billion transactions per year. Under this segment, it offers its product, Revera under long-term contracts with airline companies. This enables airline companies to have low capex and variable costs, and at the same time provides Accelya with high revenue visibility.

The strength of the company lies in having patented technology together with long-term contracts with airline clients. The long-term contracts involve constant data sharing and processing, leading to higher switching costs for airline companies. On the other hand, Accelya faces the risk of technological obsolescence/disruption and so needs to constantly advance technologically. In the near term, the ongoing US-China trade war can affect global air traffic, and hence impact the company's financials.

In the last three years since June 2019, the company grew its sales year-on-year by eight per cent while profits grew by nine per cent and operating margins ranged between 40-42 per cent. The company follows a June to May financial year and as of June 2018, the company is debt free with a three-year average ROE of 62.8 per. In the last one year, the stock has corrected by more than 10 per cent and currently trades at a PE of 11.8x compared to its five-year median PE of 21x.

Cyient
The company provides engineering, manufacturing, geospatial (analysis of various data points based upon geographic coordinates), digital networks and operations management solutions to global companies. Founded in 1991, the company has evolved from a pure designing firm to a manufacturing and MRO (maintenance, repair and overhaul) company. Cyient employs more than 15,000 people across 21 countries and deals with various industries categorised under the following business units: Aerospace and defence (37.5 per cent of FY19 revenue), communications (21.2 per cent), utilities and geospatial (12.9 per cent), transportation (10.8 per cent), industrial, energy & natural resources (9.4 per cent), medical (3.3 per cent), and semiconductor (4.7 per cent).

The company is a dominant player in Engineering R&D services, and is a market leader in aerospace and defence, servicing customers like Pratt & Whitney, Bombardier, Boeing and Siemens. In terms of the geographical spread of revenue, the company derived the majority of its FY19 revenue (52 per cent) from the North American region, followed by Asia Pacific (24.7 per cent) and Europe, Middle East, Africa (EMEA) (23.3 per cent).

Cyient is presently executing its S3 strategy, whereby it is transitioning from being mainly a service provider to being more of a services, systems and solutions provider. The S3 strategy will enable the company to partner with the client over the course of the complete product life cycle. Going forward, growth of 5G technology, automation in manufacturing sectors and further penetration in the ER&D domain provide tailwinds, while high client concentration (the top five contributed 37.1 per cent of FY19 revenue), single domain dependence and increasing populist measures by governments involving restrictions on immigartion of skilled workers around the world are some headwinds.

In the last three trailing years since ending June 2019, sales were up by 13 per cent while its profit grew by 15.4 per cent. Operating margins ranged between 16-17 per cent. The company has made various acquisitions in the past, with the latest being the Israel-based semiconductor company Ansem for Rs 113.5 crore. The debt-to-equity ratio has remained stable at 0.14x as of March 2019, while the ROE improved to 19 per cent from 16 per cent in March 2017. The stock currently trades at a PE of 10x compared to a five-year median PE of 17x.

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.