Bottom-up investing: 4 stocks in near-monopoly business and superior margins

The quest for a profitable stock idea is long and arduous. When markets begin to enter the bull phase, investors chase companies with bright growth prospects. During the peak bull run, a distinct focus on value stocks weeds out expensive bets. But, what happens when it becomes difficult to choose between either of these styles of investing? Currently, the valuation gap between value and growth stocks is at a record high given the high volatility. In such conditions, a bottom-up approach focusing on the returns potential comes in handy.

This approach focuses on companies having a niche or near-monopoly products with high entry barriers and superior margins. ETIG has shortlisted Clean Science and Technology, Sudarshan Chemical Industries, Tatva Chintan Pharma Chem and Sona BLW Precision Forgings. They are leaders in niche products in India and overseas.

For instance, Clean Science is the largest producer of monomethyl ether of hydroquinone (MeHQ), an absorbent used in baby diapers and sanitary pads. The company has a global market share of about 52%. It plans to increase the capacity by nearly 65% in 2-3 years. The company developed a greener route to produce anisole through a vapour phase technology, making it the only player globally to manufacture anisole. The innovation has helped in margin expansion and cost competitiveness.

Pune-based Sudarshan Chemical became the third-largest pigment maker globally in 2011 from among the top 20 players. Despite the commoditised nature of pigments, the company customises the end product for each customer, creating entry barriers for new players and also requiring a long approval cycle from customers. It has undertaken a capex of `750 crore to ramp up capacity and is building one of the most efficient chemical complexes in India and globally, with a strong focus on effluent treatment. This will help Sudarshan become a leading world-class colour solutions provider.

Investors may also consider Tatva Chintan, the only manufacturer of structured directing agents (SDA) for Zeolites in India and the second-largest globally. Zeolite-based SDA is used as a catalytic converter to reduce NOx emissions in BS6 engines. The SDA segment contributes 40% to the total revenues. The advanced chemistry is a high entry barrier. Besides, the company makes electrolyte salt for supercapacitor batteries that is crucial for battery efficiency.

The fourth company on our radar is Sona BLW Precision Forgings. The company's expertise in precision forging for gears has given it an edge in the electric vehicles (EV) segment as it can address requirements such as high power density, better torque and lightweight vehicles at lower prices. While there is a high barrier to entry for EV gear suppliers, Sona BLW's ability to gain share is higher due to its technological prowess and lowest cost advantage. It has an installed capacity of 40 million gears a year and plans a capex of `1,000 crore in three years to expand capacity.