These proxy small cap stocks could help you ride the electronics wave

These companies design and make air-conditioners for famous brands such as Voltas, Blue Star and Samsung, apart from washing machines and electronic appliances. They are called original design manufacturers (ODM).

Electronics manufacturing services (EMS) is another term used for companies that design, manufacture, test, distribute, and provide services for electronic components and assemble them for original equipment manufacturers (OEMs).

In the case of ACs, Voltas, Blue Star and Samsung command more than 90% of the ODM market. With the Make in India push and PLI scheme support, these companies have undertaken significant capacity expansion.

The reason these companies had blockbuster results was the rise in heat waves across the country, which caused the demand for ACs to spike. Much of this demand was from tier-2 towns and villages. What used to be a luxury is now a necessity. Neither the leading brands nor the ODMs had anticipated this, but as demand outstripped supply, their order books overflowed and they made huge money.

India, despite its harsh summers, has very low AC penetration. It stands at just 8%, versus 100% in China and 90% in the US and Japan. India also lags economies such as the Philippines and Mexico on this metric. So even if similar demand is not seen next year, AC penetration in India has a long way to go.

One way to bet on this is by investing in companies such as Voltas, Blue Star, and ODMs such as Amber, PG Electroplast and Epack Durable.

Exciting as this opportunity may be, one should be wary of these companies’ high valuations. With their stocks almost priced to perfection, some of them offer underwhelming returns despite the PLI support. A less harsh summer next year could lead to a correction in some of these stocks.

So, are there other ways to ride this trend? Well, yes. Consider these electronics proxy stocks for your watchlist.

Styrenix Performance Materials is a company makes engineering thermoplastics. These are used to manufacture home appliances, automobiles, consumer durables, healthcare products, packaging, and stationery.

The company’s clients include LG, Samsung, Haier, Godrej, Daikin, Havells, IFB, Orient, Crompton, Kent, Eureka Forbes, Hero, Honda, Bajaj, TVS, OLA, Yamaha, Aether, Maruti Suzuki, Tata, Mahindra and Ashok Leyland.

It has a strong balance sheet with almost no debt. Its return on equity and return on capital employed are 24% and 32.5%, respectively.

Bhansali Engineering Polymers is another stock that deserves to be on your watchlist.

It makes engineering plastics used in automobiles, home appliances, electronics, healthcare and kitchenware. It has a debt-free balance sheet, an 18% return on equity and a 24% return on capital employed.

The new gold rush

Proxy investing or pick-and-shovel investing traces its origin to the California gold rush of the 1800s. While many seekers wasted months digging for gold in gruesome conditions, some smart people found another way of profiting from the rush. Instead of searching for gold, they got into the business of supplying the tools (picks and shovels) needed to mine gold.

An outstanding example of this is the rise of Levi's jeans. These were designed especially for gold miners in the California rush, who needed pants that were highly durable. While the gold rush is a story of the past, the Levi’s brand lives on to this day.

If you open your eyes to the broader supply chain, there are multiple megatrends unfolding in India, driven by similar proxy players.

Do note that this article does not intend to share any view on the stocks in question. You should keep industry-specific risks in mind before you consider any investment.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com