KUALA LUMPUR: As investors trained their eyes on blue chips in the local bourse's recent rally, the potential of small-cap stocks has not gone unnoticed.

Historical trends have shown that small-cap stocks, on the whole, had outperformed their larger peers, prompting analysts to take a closer look at what these smaller gems may have in store for investors.

In a note, CIMB Investment Bank Bhd analyst Nigel Foo said the research firm was maintaining its overweight stance on small-cap stocks on Bursa Malaysia following their generally good financials in the fourth quarter of 2009.

"Valuations of these stocks remain attractive even after their price rallies over the past few months," Foo wrote in a note to clients on March 9.

CIMB has placed the spotlight on sectors which exhibit steady and defensive earnings growth such as rubber glove manufacturers and plastic flexible packaging companies. Its other top small-cap picks include Notion VTec Bhd.

According to Foo, small-cap counters under CIMB's coverage generally turned in good results during the latest results season, but not as good as in the previous quarter.

Of the 17 companies which announced their results last month, two beat the research firm's expectations, 11 were in line and four fell short.

Small-cap stocks began 2010 on a strong note. In the first two months, the FBM Small Cap Index (SCI) gained 4.6% compared with the FTSE Bursa Malaysia KLCI’s 0.2% decline.

In 2009, the SCI was up 55%, outperforming the FBM KLCI's 45% rise. The FBM KLCI fell 6.28 points or 0.47% to 1,317.94 on profit taking on March 9, while SCI fell 27.21 points or 0.25% to 10,875.59.

Early this year, CIMB initiated coverage on three companies — Daibochi Plastic And Packaging Industry Bhd, Tomypak Holdings Bhd and Notion VTec Bhd — with outperform calls.

Daibochi and Tomypak bucked the trend to be among the top gainers on March 9, rising 8.09% (28 sen) and 6.33% (20 sen) to RM3.74 and RM3.36, respectively. Notion VTec rose 2.58% or eight sen to RM3.18.

"One of the key reasons we initiated coverage on plastic flexible packaging producers like Daibochi and Tomypak was because of their defensive business (more than 90% of customers are from the food and beverage industry), high dividend yields and attractive long-term growth prospects," Foo said.

The prospects of Daibochi — CIMB's top small-cap pick for this month — are worth noting. Foo said shares of Daibochi have a significant long-term price upside potential.

This is because the country's largest plastic flexible packaging producer is expected to gain from its diversification into the non-food and beverage (F&B) segment such as healthcare and tobacco, besides the electrical and electronic industry.

"If all goes well, earnings from Daibochi’s non-F&B market could start contributing significantly from 2011.

"Factors that could catalyse the stock include further margin expansion over the next few quarters, contracts from major non-F&B companies and, investors’ increasing awareness of its attractive 7% dividend yield," Foo said.

So far this year, CIMB had initiated upgrades for three firms. Pelikan International Corp Bhd was upgraded from neutral to trading buy while Suria Capital Holdings Bhd and Asia File Corp Bhd were upgraded from underperform to neutral.

Pelikan closed unchanged at RM1.27 on March 9. Suria fell five sen or 3.16% to RM1.53, while Asia File lost eight sen to RM5.02.

Last month, CIMB ceased coverage on interior-fit-out player LCL Corp Bhd after the company announced a RM334.72 million net loss in the fourth quarter ended Dec 31, 2009, wiping out its shareholders' funds.

"The company is in the midst of a major corporate restructuring which would likely involve a capital reduction exercise for its shareholders and haircut for its creditors. We might relook at the company should prospects improve after it completes its corporate exercise in the coming quarters," Foo said.

Blue chips were among the top losers on March 9. Nestle (M) Bhd lost 28 sen or 0.81% to RM34.10, Kuala Lumpur Kepong Bhd gave up 24 sen or 1.42% to RM16.64, United Plantations Bhd fell 22 sen or 1.6% to RM13.54, Genting Bhd declined 15 sen or 2.19% to RM6.70, while Malaysia Airports Holdings Bhd shed 13 sen or 2.6% to RM4.87.