Thanks Opto is significant part of my portfolio. Here’s my views, would like to have your comments on this.
The stock of Opto Circuits has been on a secular downtrend post the 3:10 bonus issue by the company in March 2012. Despite showing very good growth in sales and profits over the last few years, the stock has severely underperformed the markets.
Off late, after the reports of suspension of credit rating from ICRA Link: http://in.reuters.com/article/2012/08/14/idINL4E8JE2XZ20120814 the stock corrected heavily from 160 levels to below 145.
Post FY13Q1 result, major brokerages have put the stock on hold and expressed concerns on the stretched balance sheet and liquidity concerns.
The company is facing downsides not due to business but due to cash flow concerns. Despite showing good growth in sales and profits the stock is going no where. Why So ?
The reason is cash flows. The company has spent 800 Cr on 6 acquisitions in the past 5 years and has infused 860 Cr in working capital over last 5 years. Debtor and inventory days at 130 and 80 days (five years avg.)
The stock has very high debtor days. After a sharp increase in the working capital cycle from 221 days in FY11 to 241 days in H1FY12, the company was able to reduce the same to 179 days in Q4FY12. Again it has almost 180 days in Q1FY13.
This is due to the nature of business. So there money is struck with customers for 6 months. Let us look into this in a bit more details.
From management interaction with Opto Circuits MD Mr. Vinod Ramani, in the past
Opto Circuitas Debtor days are very high at 220 days (Opto standalone). This is significantly above the industry norms. Nihon Kodenas (108), Boston Scientific (66), Medtronics (89) debtor days. Even accounting for 30 days shipping too, this is a big disadvantage. Debtor-days have shown a deteriorating trend over the years (92, 141,131, 194,172,185 days aconsolidated FY03 to FY08)
What are the reasons? What are management plans on this?
"Opto Circuits products, though penetrating some markets rapidly, are still some way off from acquiring significant marketshare. Sales are driven primarily through distributors -MediAid in the US, AMDL in India, and distribution network of subsidiaries like EuroCor and Criticare, besides independent distributors.
Terms usually get set as per norms set in individual markets. for ex. in India leading hospitals like Wockhardt and Apollo demand 120-150 days. In the US it is around 90-120 days. Shipping accounts for another 30 days for the non-invasive segment.
The bigger players with dominant marketshare are able to get significantly better terms. Opto is slowly increasing its market share; things should get better as market penetration rises. Efforts are on to bring down the debtor days from around 180 days to about 170 days. However in the immediate future, next 2 years or so, there is unlikely to be any significant improvements due to above cited factors.
Having said that, Opto’s products are needed for critical care; there’s a certain dependency on these products. Besides as far as sensors are concerned -these are primarily the disposable patient-charged products. There is very minimal risk of defaults as customers are typically very big OEMs and leading hospitals. There hasn’t been any significant bad debt ever, except for the one odd instance of some 16 lakhs in the balance sheet."
Now with growing sales, more and more money is being struck up in inventory and pending with customers.
So it needs more and more working capital (Current Assets - Current Liabilities) to fund these and hence more short term loans from banks.
Add with this already huge burden of past debt from acquisitions and finance costs are rising every quarter, hurts profits big time.
Again it needs to pay cost to R&D (which is now expended under quarterly costs) and also Capital expansion on facilities, more cash outflow, stretched liquidity, further loans, further cost.
Also dividend payout to shareholders, more cash outflow. All these is putting stress on the balance sheet and company is struggling.
So unless it cuts down debt, improves working capital cycle, market won`t assign a high P/E.
Profits have grown, but the stock which use to trade at 15-16 P/E has now come down to 5-6 P/E.
So in a nutshell, despite having a sound business stock is getting punished.
Things will improve once they start paying on debt, and reduce working capital, but unless that happens stock will remain range bound.
**What are the chances of getting back to positive cash flows : **
The company is expected to become cash flow positive mainly on following counts:
A) No additional outflow from acquisitions over FY13-FY15 which has been a major dent to cashflow
B) Cost savings from shifting production to developing countries.
C) Equity raising at a subsidiary level, though this will lead to equity dilution and hence lower EPS
D) As debt reduces, savings in financing cost, as working capital loans are much cheaper.
Improvement in business mix to higher margin invasive components revenue
At present the mix of low margin non-invasive : high margin invasive business is around 76:24
The company has been trying hard to get approvals for their invasive products in the US market. Once that happens margins will improve and boost bottom lines.
One key point to note here is that company’s debtors are all major Hospitals and healthcare institutes. Hence chances of bad debt are zero to negligible.
Near terms there are two key monitor able items -
A) Initiating coverage debt rating from CRISIL due around the first week of September 2012, will give us much needed clarity on the liquidity crunch
B) Annual report 2012, will give clarity regarding net debt positions, write off on intangibles from past acquisitions and debt servicing.
I did a project on Johnjohn & Johnjohn 's acquisition of Synthes, where we saw the holding tree like structure for Med tech companies, pumping in cash into subsidiaries as and when required. The market is so large, a player like Opto can sustain for a long long time.
Please share all negative views/major concerns