SMEs far from bubble territory, FY25 IPOs will exceed FY24: SKG Investments' Kush Gupta

Since 2022, a great deal of interest has been taken in SME IPOs. In 2022, the average subscription of the top 10 most subscribed SME IPOs stood at 323.05 times. In 2023, it jumped to 641 times, with robust participation from the HNI, retail and QIB segments. So far in 2024, similar figures are seen with a surge in the total amount committed to IPOs.

We expect higher fundraising going into FY25. Investors are now more attuned to the risk-reward ratio in the segment.

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SME investing is an idea whose time has come. Growth-oriented companies are coming forward to tap capital markets and increased equity participation is ensuring steady demand from investors. They play a pivotal role in fostering jobs, income, capabilities, and ecosystems for sustained growth in consumption, manufacturing, and infrastructure investments.

And having recognized that, the New Age investors are no longer interested only in large caps. They are willing to put their money behind this growth story and we expect the sentiment to continue through this year.

Do you think green energy is going to be a big theme in the coming years?

Green energy is a very relevant theme and one that cannot be ignored as a point of interest. But from an investment point of view, I feel it will not become big at least in the next 3-4 years.

Let’s understand what makes a theme relevant to investors, it’s a sector that looks profitable and sustainable for 8-10 quarters. Green energy right now is at a very nascent stage; it is neither sustainable nor mainstream and it is far from being profitable. One cannot ignore the uncertainties that will come along the way.

We are yet to see EVs (electric vehicles) becoming mainstream, a theme that has now been around for almost a decade and we still don’t have high profit-making Indian companies in the sector. While we acknowledge that green energy is the future, will it be an investable asset class soon? I doubt that.

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Is valuation really a concern in SME IPOs while investing?

For any IPO, SME or largecap, I feel valuation is always a matter of concern. If I am being offered a stock at a PE of 30-35, then it makes no sense at all irrespective of the sector or market cap. In SMEs, I feel valuations play an even bigger role because liquidity becomes a challenge during profit booking.

A high-priced stock will see profit booking and the price will fall easily, leaving the investor with an illiquid asset. The very thesis behind the SME market is to connect the financial world with high-growth companies that are available cheaply for two reasons. Firstly, they are not a point of interest for the majority of investors and secondly, they should ideally reward the risk taker.

So to invest in a fresh SME offering at high valuations is the exact opposite of the ideal scenario. Yet, we see high valuations coming in because companies are enjoying the euphoria around SMEs and IPOs. They are getting oversubscribed either way but from an investor point of view, high valuations should be passed.

Which are the top themes on your radar for FY25?

If we look at the political situation in India, I think FY25 would be a very interesting year. The incumbent government is at its peak, with a robust majority they can continue policy-making and reforms that can have a massive effect on various sectors. The government’s focus is on building India, connecting cities, and providing seamless digital infrastructure to the most remote parts of the country.

Key themes that I think will benefit will be infrastructure, manufacturing, finance (because of digitisation), FMCG and power. Infrastructure development is crucial in supporting economic growth and improving quality of life. Projects related to roads, highways, airports, railways, power generation, and urban infrastructure are among the areas that offer potential returns for investors.

With young India’s spending power and growing preferences, FMCG is another space experiencing steady growth. According to IBEF, the Indian FMCG market is projected to reach US $220 billion by 2025, with a CAGR of 9.4 percent during 2020-2025.

As a valuer, what in your view, are the key factors one should consider before investing in SMEs?

Companies in the SME space can be a little more tricky to evaluate as opposed to largecaps or mature midcaps. Their competitive advantages are more often attributed to quality, total cost of ownership, excellent performance, and tight client relationships rather than cost leadership. Since they are tightly held and in most cases family-driven, promoter profile, ethics and vision become one of the biggest factors to consider.

The usual parameters like revenue, PAT, debt etc play their part but to invest in a small company, conviction comes from truly understanding the management’s capability to take it to another level. One can’t easily assess that, so speaking quantitatively, investors should use a bottom-up approach and an understanding of an enterprise’s internal workings can help in the prediction of its assets' and securities’ future performance.

The idea is to uncover undervalued or overlooked companies that have strong growth potential. This can lead to superior returns when these companies are eventually recognised by the market.

Considering the huge flow of SME IPOs, do you see any bubble kind of environment in the segment?

We have been hearing a lot about the so-called ‘bubble’ in the SME space. Especially after the SEBI chairman’s statement in early March. A few key points of consideration before reaching that conclusion:

Markets have given a stellar return in 2022 and 2023, so it is natural for it to have certain elation and overconfidence that leads to excessive fund inflow. It exists in SMEs as well as in the largecap space and it’s the very nature of the stock market. I always highlight shifts in the investment space—equity participation has increased manifold. In such a scenario demand sometimes exceeds the supply of investable companies and investors are lining up to become a part of a new IPO growth story.

So, it is merely the demand-supply forces playing out and creating a huge flow that will in time flatten out instead of bursting like a bubble. As of now, there are approximately 400 companies listed on the NSE Emerge and 500 on the BSE SME exchange. For a large country like India, where SMEs are the backbone, this is a very small number. Some of these companies can be expensive in the stock market but we are far away from saying this sector is in 'bubble' territory.

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