Monday, April 28, 2014

Opto Circuits India Ltd - High debt, debtors & inventory

Opto Circuits was established in 1991 and went public in 2000. It manufactures cardiac and vital signs monitors and other cardiac equipment and was a darling of the markets back in 2011. Since the Jun 2012 the sales have been falling and in Dec 2013 the quarterly sales number is less than half of what it was in Jun 2012. I don't understand what has led to the decline in sales but the debt numbers are very scary. I think currently the company is probably at a Debt/EBITDA of over 4 times (or 6 times of Last Qx4). The company has announced a board meeting on May 6th for raising more equity capital which is consistent with the high debt analysis. The promoter shareholding is already low at around 28% and this capital raise is only going to make it worse.

1. How big is the moat?

Grade C moat

  • The customers are not paying the company in time and the working capital cycle is very long. At the end of FY2013 debtors were 65% of sales which indicates a serious issue either in the revenue recognition or the customer relationships both of which drive down the moat grade
  • In the FY2013 report Mr. Vinod Ramnani highlights that the company's growth has been marred by the stretched working capital cycle
  • The main discussion here should be how would one have figured out in July or Sep 2012 when the Jun 2012 financials were out that the company was going to go down?
    • Debtors % of sales at the end of FY2012 was ~35% - which was already uncomfortable. By Sep 2012 it was over 44% which is a very bad sign
    • Cash flow from operations has consistently lagged net income by a large % - Differences of 78%, 64% and 31.6% in FY2012, 11, 10 respectively. These large differences would have been pointing to the impending down slide in the financials
  • The inventory % of sales in Sep 2013 stood at 44% which points to a weakness in operations as well.

2. Risks

  • Bankruptcy - this is the biggest risk for this firm given the Debt/EBITDA number
  • Inventory and debtors write downs as both are a very large % of sales

3. Financials

  • Not much to discuss here what has not already been mentioned
  • Inventory % of sales stood at over 30% In Mar 2013 and by Sep 2013 it had exceeded 44%. No manufacturing company can be sustained with this level of inventory. In fact this points to an impending inventory write down as well.
  • Debt/EBITDA stands at over 4 times TTM EBITDA and over 6 times last Quarterx4 EBITDA
  • Debtors % of sales in Sep 2013 stood at over 74% which is far higher than you should be comfortable with

4. Soft factors

  • Promoter shareholding is very low even by global standards. The capital raise may lower the promoter holding even below the current around 28.2%. This seems to have been a promoter driven company during its history and a reduction in promoter holding % might exacerbate issues
  • There was a news story talking about Goldman Sachs buying 26% of the company in a combination of new issuance and existing equity - which the company sort of denied in an announcement. This kind of rumor mongering with a large investment bank is never good.

5. Pricing

  • Pricing is irrelevant here as the underlying fundamentals point to either a massive dilution or a bankruptcy situation. I even expect that some of the inventory is obsolete or unusable and some of the debtors on the books will have to be written off. I will not go into it as it falls outside the realm of value investing in great companies but this company will probably be better valued on liquidation of assets rather than earnings due to the inventory and debtors write downs and uncertainty of earnings.

BSE: 532391
ISIN: INE808B01016

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