These small-cap companies are accelerating rail safety. Are they worth investing in?

And this is not an isolated case. This year alone, potentially dangerous objects have been spotted on railway tracks more than a dozen times.

Increased budgetary allocations for the railways post-Covid have kept share prices in the sector running smoothly. But a few accidents could jeopardise this growth. Investment is needed not only for new tracks and trains, but also for railway safety systems. After all, human lives are at stake.

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Several things are needed to improve train safety: vigilance systems to keep drivers alert, systems to prevent human error, increased safety at level crossings, full track surveillance to monitor occupancy, addressing visibility problems in adverse weather conditions, better signalling, and inspections and repairs of bridges and tracks.

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

To be honest, we have already achieved a lot. The number of train accidents has fallen from 473 in 2001 to 48 in 2023. However, our goal must be zero accidents and this requires continuous investment in rail safety systems.

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

As the saying goes, a chain is only as strong as its weakest link. Human influence is limited, so automation is necessary for an accident-free railway system.

Is Kavach the solution?

Kavach, an indigenous automatic train protection system, has been tested on Vande Bharat trains. It has been able to bring Vande Bharat trains (which travel at over 150 kmph) to a halt 10 metres from the danger point using automatic brakes. It is also said to be the most cost-effective system of its kind in the world.

Following a pilot project in 2016, Kavach was rolled out nationwide in 2020. So far, work related to Kavach has been accelerated on more than 3,000 track kilometers (rkm), with the goal of covering over 35,000 km in the next five years.

Which listed companies could benefit?

HBL drive systems

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

In addition to the railway sector, its customers include oil and gas companies, electric vehicles, defense, energy storage systems and data centers. The company exports to 50 countries. It avoids capital-intensive business lines and strengthens its engineering expertise through in-house research and development.

Key areas of focus include lead and lithium batteries, electric powertrains, defense electronics, electronic signaling, electronic interlocking, train management systems and central train control systems. The company aims to be number one or two in these areas. In most of these areas, it already is.

Although Kavach did not become a commercial company until 2022, the company began working on train safety systems in 2007.

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With the introduction of Kavach tenders, the company expects growth of 30% in fiscal 2026, driven by investments in ₹100 crore this year and 20% growth from then till FY28. The aim is to achieve this without eroding the operating profit margin, which has been 20% for the last 12 months.

Despite a low debt-to-equity ratio, the company achieved a return on capital of 34%. The financial figures reflect a significant improvement in working capital management.

The stock's P/E ratio appears high at 52x. However, earnings have increased by 137% over the past 12 months, resulting in a favorable price-to-earnings (PEG) ratio of 0.4x.

This discussion would be incomplete without pointing out potential risks, including the execution and award of contracts, the extended operating cycle inherent in the business, and disbursements for investments in affiliates to strengthen technology offerings.

But all in all, we think it's a good stock to have on your watchlist.

Kernex Microsystems

Kernex Microsystems (India) Ltd has a market capitalization of ₹1,500 crore. With its losses, negative return metrics and long working capital cycles, the company is not considered in financial screens for 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 financial figures.

The sectors it serves include railway safety systems, telecommunications, defence, water management solutions, Internet of Things products and turnkey project execution. The Kavach-related business is expected to grow from ₹120 Crore in FY24 to ₹1,200 crore in FY27.

Only time will tell if this is a true turnaround, but it is another stock to keep an eye on.

Concord Control Systems GmbH

Another stock that deserves a mention here is that of an SME company, Concord Control Systems Ltd, with a market capitalization of ₹1,100 Crore. Its main business is traction and passenger train products such as battery chargers, lights, fans, couplings and control and distribution boards. Its main focus is on manufacturing advanced communication products for locomotive operations.

Concord invests in research-driven companies and integrates them into its own railway ecosystem. The company has a 26 percent stake in Progota India, which is involved in Kavach projects.

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The order backlog grew from ₹3,700 Crore in FY23 to ₹19,700 crore in FY24. Operating profit margin increased from 16% to 26% during the same period. The balance sheet has low debt and return on equity is 28%.

Management is targeting an average annual revenue increase of 40-50% over the next three to five years, with an operating profit margin in the range of 23-25%.

Other stocks to watch in this space include Railtel and KEC International. Click here to see a longer list.

Keep in mind that each of these companies carries its own risks. The discussion here does not constitute a recommendation, so please research carefully before making a decision.

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

This article is syndicated from Equitymaster.com