Do you have these 2 small cap gems?

What he likes about Kothari Products is the strong balance sheet of the company and its cash flows.

Excerpts from CNBC - TV18’s exclusive interview with Ashish Chugh:

Q: You have got Jaypee Hotels lined up as your first hidden gem, why do you like that story?

A: If you look at the recent land transactions for hotel properties in Delhi, Emaar-MGF has bought land for two hotel properties in a place called Jasola for about Rs 388 crore. Then Parshavanth has got land for a hotel in Dwarka at about Rs 450 crore.

In the more recent times, Hotel Leela has bought a hotel plot in South Delhi for Rs 611 crore. All these companies are going to spend a couple of hundred crores towards the construction of hotels. And then you take the construction time and the initial teething problems. Against that backdrop, if you look at Jaypee Hotels, it owns two hotel properties in Delhi and one hotel property in Agra. Besides these three, this company manages Jaypee Greens also, which is a golf resort in Greater Noida and Jaypee Residency Manor , which is located at Mussoorie. They get management fee for managing these two resorts.

Jaypee Vasant Continental is a 120-room hotel and it is located at one of the most up-market areas of Delhi, it is also close to the airport. The second hotel in Delhi is called Jaypee Siddarth , which is located close to Connaught place. The property in Agra is a 350-room hotel spread over about more than 25 acres.

If you see the valuation of this company at the current price, the market cap of this company is just about Rs 330 crore. Add to it the debt in the balance sheet and the total valuation comes to about Rs 370-Rs 380 crore. This valuation does not even cover the cost of the land, which the other players have paid for constructing the hotels. One may argue that the difference between the existing hotels in Delhi and the ones coming up, is that the new hotels are entitled to income-tax exemption for five years. However to claim that exemption, you first have to make profit.

With asset creation at such higher prices, the room rentals in Delhi are expected to go up substantially. If that were to happen Jaypee Hotels, would be one of the biggest beneficiary along with the other established 5-star hotels in Delhi.

For financial year '06-'07, Jaypee did revenues of about Rs 128 crore and made a profit of about Rs 14 crore, which translates into an EPS of Rs 2.50. At the current price of about Rs 60 at a PE ratio of 23-24, this stock may seem to be fully priced. However, given the potential for the hotel sector, keeping the Commonwealth games also into account and the fact that the room rentals can go up substantially from these levels, the stock probably has a long way to go.

Q: Kothari Products is the other stock that you have picked today: what’s the story there?

A: Kothari Products manufactures pan masala under the brand name of Pan Parag , which has now become a generic name for pan masala. This company has got an excellent distribution network and this product is sold through lakhs of pan shops located all across the country. What we like about this company is the strong balance sheet of the company and its cash flows. If you take a closer look at the balance sheet of the company – this company has an equity capital of about Rs 6.63 crore. Promoters hold roughly 81% of the equity capital. This company has investments to the tune of about Rs 293 crore. Now this Rs 293 crore is the book value of the investments, as on March 31, 2006 and the market value of this investment was close to Rs 400 crore.

Assuming an increase of about 25% in the market value, where the Sensex has gone up by almost 30% from March 31, 2006 levels. To be conservative, if we assume that the investments have gone up by 25%, the present value of investment would be close to Rs 500 crore. This company also had a cash and bank balance of Rs 27-28 crore and they have loan side advances of close to Rs 90 crore. This makes the total liquid assets available with the company at more than Rs 600 crore. Against the liquid assets of Rs 600 crore, this company is totally debt free. This company is going at a market cap of just about Rs 350 crore. I am not even including the valuation of the business, which over the years has been responsible for creation of such huge assets. Even if you take the valuation of the business, I am sure it will be a few 100 crore.

For the first 9 months of the current financial year, this company has already made a profit after tax of about Rs 77 crore, which means an EPS of more than Rs 150 for 9 months. This company has been a regular dividend payer, for the last 8 years it has consistently paid dividends of more than 100% going even upto 160% in some years. Here we have a company, which is a debt free company, which has got a small equity, very high promoters stake.

Now in spite of the fact, that this is a business, which has always been looked at with suspicion and perceived to be on the declined because of health factors and social reasons, the company has been adding about Rs 100 every year to the shareholders’ kitty for the last few years.

Here you have a company, which is trading at substantial discount to the liquid assets available with the company. It is creating huge value for the shareholders, whereas the market price is not going up even by the amount of cash which the company is generating every year for its shareholders. At the current price of about Rs 530-540, this stock is a pure value play.

Q: Any disclosures?

A: Kothari Products – My family and I have investments in this company. My clients would also have position in this company. As regard Jaypee Hotels, I personally don’t hold any positions, but it was recommended to our clients, so they may be having investments in this company.