These small cap companies are fast-tracking railway safety. Are they worth investing in?

Last week the railway sector witnessed an untoward incident – a cylinder was placed on the tracks in Kanpur. Thankfully the emergency brakes were hit hard, causing the train to come to a screeching halt and averting a major accident. According to reports, the police also found a bottle of petrol, matchboxes and a bag with a gunpowder-like substance at the site.

What's more, this is not an isolated incident. Potentially hazardous items have been spotted on railway tracks more than a dozen times just this year.

Increased budgetary allocations to railways after covid has provided stocks in this sector a smooth run. But a few accidents could derail this growth. Investments are needed just for new tracks and trains, but also for railway safety systems. After all, human lives are at risk.

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Improving train safety requires several things – vigilance systems to ensure drivers remain alert, systems to eliminate human error, better safety at level crossings, complete track circuiting to monitor occupancy, managing visibility issues during adverse weather conditions, better signalling, bridge and track inspections, and repairs.

That’s a long list – and one that involves many technical aspects.

To be fair, we have come a long way. The number of train accidents has fallen from 473 in 2001 to 48 in 2023. But we have to aim for zero accidents, which will need ongoing investment in railway safety systems.

In 2017-2018, the amount allocated for railway safety was ₹1 trillion. In 2022, ₹1.08 trillion was allocated.

As they say, a chain is only as strong as its weakest link. There is only so much humans can do, so an accident-free railway system requires automation. 

Is Kavach the solution?

An indigenous, automatic train protection system, Kavach has been tested on Vande Bharat trains. It has been effective in stopping Vande Bharat trains (which travel at more than 150 kmph) 10 meters from danger using automatic brakes. Apparently, it's also the most cost-effective system of its kind in the world.

After a pilot in 2016, Kavach was adopted nationwide in 2020. As of now, Kavach-related work has been fast-tracked on more than 3,000 route kilometers (rkm). The target is to cover over 35,000 km over the next five years.

Which listed companies could benefit?

HBL Power Systems

HBL Power Systems prides itself on plugging technology gaps, especially in niche but scalable markets that are too small for big companies and too difficult for small ones.

Apart from railways, its customers are in oil & gas, electric vehicles, defence, energy storage systems, and data centers. The company exports to 50 countries. It avoids capital-intensive businesses and bolsters its engineering prowess with in-house R&D.

Its areas of focus include lead and lithium batteries, electric drive trains, defence electronics, electronic rail signalling, electronic interlocking systems, train management systems and centralised train control systems. It aims to be number one or number two in these areas. In most of them, it already is.

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

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As Kavach tenders are rolled out, the company expects 30% growth in FY26 driven by capex of ₹100 crore this year, and 20% growth from then until FY28. It aims to achieve this without a drop in operating profit margin, which stands at 20% for the past 12 months.

With a low debt-to-equity ratio, the company has posted a 34% return on capital employed. Its financials reflect a sharp improvement in working capital management.

The stock's PE multiple looks high at 52x. However, profits have grown at 137% in the past 12 months, leading to a benign price-to-earnings-growth (PEG) multiple of 0.4x.

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

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

Kernex Microsystems 

Kernex Microsystems (India) Ltd has a market cap of ₹1,500 crore. With its losses, negative return ratios, and long working-capital cycle, the company does not make the cut on financial screeners for high quality stocks.

But it caught our interest for two reasons. In August 2024, insiders bought the stock on the open market at ₹874. And in the June quarter, there was a turnaround in the financials.

Sectors it caters to include railway safety systems, telecom, defence, water management solutions, internet-of-things products, and turnkey project execution. It expects Kavach-related business to increase 10-fold from ₹120 crore in FY24 to ₹1,200 crore in FY27.

Only time will tell if there is a real turnaround story here, but this is another stock to keep an eye on.

Concord Control Systems Ltd

Another stock that deserves a mention here is that of an SME company, Concord Control Systems Ltd, which has a market cap of ₹1,100 crore. Its main business is traction and coach products such as battery chargers, lights, fans, couplers, and control and distribution panels. It's focussed on making advanced communication products used in locomotive operations. 

Concord invests in research-based companies and plugs them to its own railway ecosystem. It has a 26% stake in Progota India, which is involved in Kavach projects.

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Its order book swelled from ₹3,700 crore in FY23 to ₹19,700 crore in FY24. Operating profit margin rose from 16% to 26% over the same period. The balance sheet has little debt, and the return on equity is 28%.

Management aims to grow revenue at a compound annual rate of 40-50% over the next three to five years, with operating profit margin in the range of 23-25%.

Other stocks to keep an eye on in this space are Railtel and KEC International. For a longer list, click here.

Do keep in mind that each of these companies has its own set of risks. The discussion here does not constitute a recommendation, so make sure to do your due diligence before taking a decision.

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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