I will kickstart this questioning with a company which you used to follow closely and which seems to be in the correction mode inspite of good results.
Opto circuits. What is bugging the company?
Is it the fear of debt loading or cash flows or any other negative triggers?
I read a recent update on opto from sharekhan and they have a buy call on it with target price of 302.
Even on expanded equity of 242 crores post bonus, the company has posted eps of around 23 per share although this includes some tax write back benefits. PBT has increased from 393 crores to 516 crores which seems to be good growth.
As on fy 12, short term borrowing are 864 crores and long term borrowings are 305 crores. cash and equivalents is around 174 crores.
Timely question as usual! I am not upto date/speed on Opto anymore! Will have to look at it again in-depth to reply with any specifics. Some overall comments for now:
1). Opto Circuits has been a fantastic investment for many (including me) in the past. I do not know of any other company that gave bonuses for straight seven years…ending in 2008!
2). Since 2008Organic Growthhas not been able to keep pace. To keep growing Opto’s strategy turned decisively towardsInorganic growth)- Acquisitions - pushing up costs (debts related) and diluting ownership for all. The first dilution was a whopping 12%! It also acquired lot of Goodwill in the process. Bonuses stopped
3). The company has a habit of making a success of quality, strategic acquisitions. No doubt about that. But at what cost? All these companies came with a sizeable Goodwill component (The premium you overpay, over and above BV Assets, for Intangibles such as Strong Brand Name, Customers, etc). Goodwill is a very heavy component in Opto’s BS - Take that out - and suddenly the BS doesn’t look that good - starts looking bloated and stretched - considering the debt accummulated!
4). All the new businesses are high-tech. and need continual big investments. Eurocor acquisition - that gave the company the ability to play in the big league of Stents (used in Bypass surgeries). But to play in the big league with sufficient stakes - you need to qualify to play in the biggest market - US. getting USFDA approval here is not like the Generics story …where Clinical data is already available. You need to generate huge amounts of Clinical data …at huge costs …Doctors/Administrators…As per the company, USFDA is still couple of years away…primarily because the company cannot afford to incur that heavy costs that fast!!
5). On the other hand…when USFDA for Stents does come …the rewards can be exemplary! Mind you they have not yet applied for Stents USFDA…that will take more time. If I remember correctly they have applied for the Magic Baloon - the DIOR product - which is a catheter baloon to stents - a less expensive, but supposedly more effective intervention! Even here the rewards can be exemplary.
6). It may be a good idea to keep a close Tab …on USFDA approvals for DIOR…its progress or absence of progress.Timing that to within a year…can make for huge returns!!!
I don’t know what specific overhangs are there on the business - currently. I suspect it is also a result of the above considerations by Mr Market.
Like those who are invested in Opto Circuits - to comment on current business/outlook/overhangs! Abhishek? Others?
Hitesh - Congratulations! once again. I think your idea of this new thread on Company Q&As may well turn around be great value addition. Key will be to get the guys who known the company deeply - to respond
Donald, I think, has captured nearly all the important factors. In acquiring companies, Opto has stretched its balance sheet considerably. The stock should start doing better once interest rates go down. Till then it looks like it will drag. Unless, of course there is some major breakthrough.
I haven’t been following the co now as we had exited 5-6 yrs back when it got re-rated in a big way. Since then I do keep a tab on their results etc but the B/S has been looking risky.
I fear frequent acquisitions…acquisitions are risky as Donald has mentioned above. If one looks at the b/s for last 2 years, the co is having goodwill of 4-500 Cr…which shows the amount to be written off in coming years. Plus the debts have been increasing…debtors are not under control etc. Hence will like to be cautious here.
Other than business fundamentals i.e. the working capital issue (which is somewhat improving â see last quarter results) and the debt/cash flows (debt will come down & cash flows will improve over time) â the company also suffered from the ownership structure.
Lot of FIIâs own this company & whenever there is macro stress/ panic â the price tends to go down drastically.
Basically, a lot of sellers with no buyers to absorb the quantity. It therefore tends to overshoot on the downside. See the current valuations.
I have owned this company for a number of years and from what I have observed - Management integrity & execution ability are strong. They have a good track record in assimilating the acquisitions and improving margins on the acquired company. Over the years, they have kept improving their market/distribution reach. Now new products are cross sold through the large channel reach. Approvals from FDA etc. create a moat.
The assets (organic & inorganic) are real and should continue to create returns for many years. The market demands for the companyâs products are attractive. The business model is overall sound â it however has inherent weakness that it requires large working capital due to sales channels and the long payment cycles.
Management is somewhat different â they are quite aggressive for growth but has almost never overpaid for an acquisition. When they have diluted equity they have also âboughtâ in at the same rates â to not dilute their holdings.
Think the debt they took on to do the most recent acquisition will be pared down.
There is fear & uncertainty at the present time around the debt, working capital and cash flow issues. The management is aware of these issues. Analysts I had discussed this with do not see any fundamental âproblemsâ â but cannot explain the very weak price.
My present thinking if the balance sheet improves, there could be rerating which might give above average returns.
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.
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.
