Smallcaps to Ride the 'Kavach' Opportunity 

Dear Viewers

A few days ago, railways witnessed a worrisome event.

A cylinder was found laid on the railway track in Kanpur.

Thankfully, the emergency brakes were hit hard, causing the train to come to a screeching halt. A major accident was averted.

But the problem does not end here. As per the news, the police spotted petrol bottle, matchboxes, and a bag with gunpowder-like substance at the site.

What's more, it's not a standalone incident. This year, over a dozen such potential hazards have been reported.

Post Covid, the increased budget allocation to railways has led to a smooth run in the stocks of this sector.

But a few accidents could derail this story.

As such, the investment needs to be done not just in laying tracks and new trains, but also in the railway safety system. Afterall, its not just capital but human lives at risk.

To be fair, we have come a long way.

In 2017-2018, Rs 1 trillion were allocated to railway safety. By 2022, Rs 1.08 trillion was used.

From 473 in 2001, train accidents have come down to 48 in 2023. We have to target for zero.

As they say, a chain is as strong as its weakest link.

This requires investments in vigilance systems, elimination of human errors, in safety at level crossing gates, complete track circuiting ,in better visibility in poor weather signalling infrastructure, bridge and track inspections and repairs and so on.

An accident-free railway system needs automation. And 'Kavach' could be the solution.

Kavach is an indigenously Automated train protection system. It has been tested and found effective in Vande Bharat trains.

Apparently, it is also the most cost-effective system globally.

Started in pilot mode in 2016, Kavach was adopted as a nationwide system in 2020. And as I write this, Kavach related work is on fast track, covering over 3000 route kilometers (RKm).

And this is just the start. Over next 5 years, the target is to cover over 35,000 km.

So let's come to the part you must be waiting for- the listed companies that can benefit from these targets.

The first is HBL Power Systems Ltd.

HBl Power prides itself on plugging technology gaps, especially in niche but scalable markets - too small for big companies and too difficult to crack for small ones. Apart from railways, it caters to oil and gas, EVs, defense, energy storage systems and data centers. Its export markets span across 50 countries,

The management's philosophy is to avoid capital intensive businesses and to lead by engineering powered with inhouse R&D. Lead and lithium batteries, electric drive trains, defense electronics and in railways - electronic rail signalling, Kavach, electronic interlock, train management systems and centralized train control systems are its areas of focus. It aims to be number one or number two in the areas it is present in. In most of its verticals, it is already claiming that spot.

While Kavach became a commercial business in 2022, the company started working on train safety systems in 2007.

As kavach tenders are rolled out, with a capex of Rs 1 bn this year, HBL is expecting 30% growth in FY26, and 20% growth thereafter until FY28. The company expects to maintain EBITDA margins that stands at 20% for last 12 months. FY25 is likely to be flat on a high base of FY24.

With negligible debt to equity, the company has posted return on capital employed of 34%. Its financials reflect sharp improvement in working capital management. The stock's PE looks high at 52x. However, in last 12 months, its profit have grown at 137% leading to a benign price to earnings growth of 0.4x.

This discussion would be incomplete without flagging off potential risks. These include execution and ordering activity, stretched operating cycle inherent in the business and payoff on investments that it has made in associate entities to strengthen its tech offerings.

But all in all, I believe this is a good stock to have in your watchlist.

The second is Kernex Microsystems (India) Ltd, with a marketcap of Rs 14 bn.

The sectors it caters to include railway safety systems, telecom, defense, water management solutions, embedded or IOT (internet of things) products and turnkey project execution.

With its losses, negative return ratio and elongated working capital cycle, the company does not make the cut on financial screeners for quality stocks.

It caught my interest for two reasons.

First, in the month of August 2024, the insiders have bought the stock from the open market at Rs 874. Second, in its latest quarter results, the company's performance has turned around.

Kernex expects 'Kavach' based business to go up 10x from Rs 1.2 bn in FY24 to Rs 12 bn in FY27.

Time will tell if there is a successful turnaround story here, but this is another stock to monitor for 'Kavach' theme.

The third stock that deserves a mention here is an SME company - Concord Control Systems Ltd, with marketcap of Rs 11 bn.

Its main business is traction and coaching products (i.e. battery chargers, lights, fans, couplers, control and distribution panel etc), and it is focusing on making advance communication products used for locomotives operations. Concord invests in research-based companies, and post-acquisition, it plugs them to its own railway ecosystem. It has 26% stake in Progota India, which deals in 'Kavach' projects.

Its orderbook has swelled from Rs 37 bn to Rs 197 bn in just one year. Operating profit margin in the same period are up from 16% to 26%. The balance sheet has low debt. The return on equity is 28%.

The management is targeting a 40%-50% revenue CAGR in next 3 to 5 years, with operating profit margin in the range of 23% to 25%.

Other stocks under this theme include Railtel and KEC International.

For the longer list, click the link below the video.

Now do note that each of these companies and stocks comes with its own set or risks. The discussion here does not imply any view on the stocks. Readers are expected to do their due diligence before taking investment decisions. Nonetheless, the Kavach opportunity is big. And it would be good to add these names to your watchlist.

With that disclaimer, I have come to the end of the video. Let me know through your likes if you found it useful. Share your feedback in the comment section.

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