A $5 million tannery in Bangalore called Cosmos Leather Exports Ltd. has some new customers that are going to double its business. U.S. shoemaker Kenneth Cole has placed orders for nearly $4 million in outerwear, and The Limited is buying $800,000 worth of leather goods. Cosmos has also scooped up Bloomingdale's Inc. and Saks Fifth Avenue as customers. And even though the company is only four years old, it's gaining a worldwide reputation for marketing savvy and quality. "We have a state-of-the-art tannery," boasts Managing Director Rashid Khan.
Cosmos is the kind of Indian company that Gary Goldberg, portfolio manager at Peregrine Investment Holdings Ltd.'s $20 million Smaller Companies Fund, loves to buy: small, efficient, aggressive, and above all cheap. Cosmos trades at a modest price-earnings ratio of 7.4, while India's largest companies are around 25.
Cosmos is not an anomaly. The Bombay stock market is down 16% in 1995 and 30% since its highs of last fall. But that has only made even better bargains of the hundreds of small- and mid-cap stocks trading at p-e's of 6 to 15, say money managers who have been snapping them up for domestic and offshore funds.
EXIT NIGHTMARE. The small-cap issues are cheap because Indian investors tend to concentrate on the top 100 stocks, leaving the remaining 3,000 largely untouched and unanalyzed. But thanks to India's awakening economy, most analysts believe smaller companies will provide better rates of return than their larger, more entrenched competitors. "The growth prospects and valuation are more attractive," says Jeff Chowdhry, fund manager of the India Investment Company Fund, which has 70% of its assets in the stocks of companies worth less than $250 million. Run by Foreign & Colonial Emerging Markets, based in Britain, the fund trades in Luxembourg.
The best small-cap issues are in a handful of up-and-coming industries. High-tech stocks are a favorite, as India continues to make its presence felt in the international software arena. Vivek Reddy, CEO of ITI Pioneer AMC Ltd. fund group, likes Infosys Technologies, which produces software for banking, warehouse management, and distribution. Reddy points out that in the talent-dependent software business, Infosys retains people with incentives. Another favorite is NIIT Ltd., whose 120 training centers teach 90,000 people the ins and outs of computing every year. NIIT has also expanded into instructional software, and exports are on the rise. "None of our businesses is growing less than 50% [annually]," says founder Vijay Thadani.
With car and motorcycle sales exploding, smaller transportation stocks are also hot. For example, although its sales are growing by nearly 40% a year, Lakshmi Auto Components is still trading at a p-e of only 10. And many fund managers are snapping up hotel stocks because of a surge in business travel. Samir Arora, who manages the domestic Alliance '95 fund for Alliance Capital Management Corp., likes Hotel Leela Venture, which operates hostelries in Goa and Bombay. "The hotel in Bombay is completely packed," says Arora.
There's a price to pay for thinking small in India. Getting in and out of small stocks can be a nightmare. Liquidity in the Indian market is always of concern, but the problem is aggravated in small-cap trading. That's why the Alliance fund keeps less than 20% of its assets in smaller issues. Worse yet, notes Foreign & Colonial's Chowdhry, illiquid small-cap issues tend to underperform compared with the broad market when stocks are weakening. But other fund managers note that small caps also tend to beat their bigger competitors when the market moves higher.
Investors also need to tread with care. Take M.S. Shoes East, a New Delhi footwear maker that sought $150 million to enter the hotel business. Its shares crashed after Chairman Pavan Sachdeva was arrested in April amid allegations he may have misled investors and rigged the price of the stock. Sachdeva was released on bail. He has not been charged. His attorney, Anuradha Dutt, says Sachdeva denies wrongdoing.
The scandal was a reminder of the risks of investing in small Indian companies. But as long as small-caps maintain their sky-high growth prospects, the flow of funds into them will likely continue.