Top Smallcap Stocks in the Railway Sector

A few weeks ago, the railway sector witnessed an untoward event.

A cylinder was laid on the tracks in Kanpur.

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

Yet, it's worrisome. As per the news, the police also spotted petrol bottle, matchboxes, and a bag with gunpowder-like substance at the site.

What's more, this is not a standalone incident. This year, in over a dozen cases, potentially hazardous cases were spotted on railway tracks.

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.

Investments need to be done not just in laying tracks and new trains, but also in the railway safety system. After all, its not just capital but a matter of human lives at risk.

This requires multiple level checks - vigilance systems to ensure alertness of drivers, systems to eliminate errors due to human failure, safety at level crossing gates, complete track circuiting to monitor track occupancy, managing visibility issues during adverse weather, strong rails for track infrastructure, mechanisation of track laying, signalling infrastructure, bridge and track inspections, and repairs.

The list is long and there are many technical aspects involved.

To be fair, we have come a long way.

From 473 in the year 2001, train accidents have come down to 48 in 2023. We have to target zero accidents. This will need ongoing investment in railway safety systems.

In 2017-2018, the corpus allocated for railway safety was Rs 1 trillion. By 2022, Rs 1.08 trillion was used.

As they say, a chain is as strong as its weakest link. There is only so much human control that can be ensured.

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

It's an indigenously automated train protection system. Kavach has been tested on Vande Bharat trains. The system has been effective to stop Vande Bharat trains (running at over 150 kmph), ten meters before the danger signal through automatic brakes.

Apparently, it's 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 has been fast tracked in over 3,000 route kilometers (Rkm).

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

So what are the listed companies that can benefit from this?

The first is HBL Power Systems.

The company prides itself on plugging technology gaps, especially in niche but scalable markets that are too small for big companies and too difficult to crack for small ones.

The end sectors, apart from railways include but not limited to oil and gas, EVs, defence, energy storage systems, and data centers. The company exports to 50 countries.

It avoids capital intensive businesses and leads by engineering prowess with inhouse R&D.

Lead and lithium batteries, electric drive trains, defence electronics and electronic rail signalling Kavach, electronic interlock, train management systems and centralised train control systems) are its areas of focus.

It aims to be number one or number two in the areas it focuses on. 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 capex of Rs 1 bn this year, it's expecting 30% growth in FY26, with 20% growth thereafter until FY28, without a moderation in operating profit margin, that stands at 20% for last 12 months.

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 (PEG) of 0.4x.

This discussion would be incomplete without flagging off potential risks. These include execution and award of orders, stretched operating cycle inherent in the business, and payoff on investments in associate entities to strengthen its tech offerings.

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

The second is Kernex Microsystems (India) Ltd, with a marketcap of Rs 15 bn.

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

It caught my interest for two reasons. In the month of August 2024, insiders have bought the stock from the open market at Rs 874. And in the June quarter, there has been a turnaround in the financials as well.

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

It 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 real turnaround story here, but this is another stock to monitor in the 'Kavach' theme.

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

Its main business is traction and coaching products like battery chargers, lights, fans, couplers, control and distribution panel etc.

It's focusing on making advanced communication products used in locomotives operations. Concord invests in research based companies, and post acquisition, 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 is 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 23-25%.

Other stocks to keep on your radar for Kavach theme include Railtel and KEC International.

For the longer list, click here.

Now do note that each of these companies and stocks come with their 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.

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Warm regards,


Richa Agarwal
Editor and Research Analyst, Hidden Treasure
Equitymaster Research Private Limited (formerly Equitymaster Agora Research Private Limited) (Research Analyst)