Opto Circuits (India) Ltd - Stock Valuation and Financial Performance

In our last update about Opto Circuits, we had informed you that the ‘Stop Loss’ trigger for the company had been hit and investors were advised to consider exiting from the stock. We have been monitoring Opto Circuits stock closely since its price-fall started. You can read our previous reports here. Since our last update, the stock price has risen slightly and is currently quoting at Rs. 111 (as on 7th January).

We met with the investor relations team of the company in order to get more insights and understanding about the company’s strategy and plans to go ahead. However, the information provided did not help us get good clarity about how the company plans to improve its financial performance going ahead. In addition to this, some new information provided to us by one of our subscribers, Mr. Mahesh Asrani has further made us more sceptical about the company and its financials.

The major concerns which are expected to weigh on the stock are:

1) Business model of the company under question:

Opto Circuits has followed an inorganic strategy of growth, acquiring around 10 companies over the last decade. While this has resulted in huge growth in Sales and profits, Opto’s cash generation has been consistently poor. This can largely be attributed to poor working capital management. The company has always stated that this is due to the nature of its business but over a period of time, this has hurt the company dearly.

With poor cash generation, Opto’s management has had to fund acquisitions by raising debt. Company has also diluted equity either by private placement or by issuing bonus shares. As a result promoter shareholding has come down and is currently 28.17% as of September 2012. What is concerning, is that while the company has had problems generating cash flows for sustaining and growing operations, it has continued to pay out high dividends. While the dividend payout ratio has come down over the years, in absolute terms the dividend paid out by the company is large. For e.g. in FY 2012, while it generated just Rs. 126 Cr. of cash flow from operations on a consolidated basis, it paid out Rs. 84 Cr. of dividends to its investors. This number seems very high if we also consider that Opto ended up investing cash to the tune of Rs. 337 Cr. in its business. Management could do well to stop dividend payouts altogether and invest the corresponding monies into the business rather than borrowing or diluting equity further.

The management has stated that now the company is not looking for any more acquisitions and will look to integrate the ones already made so as to improve performance. Latest quarterly results have been below our expectations with sales growth slowing down in some segments. Company is focusing on reducing its working capital needs but this may take some time.

The board of Directors has approved issue of convertible warrants to promoters which will infuse cash to the tune of Rs. 29 Cr. in the company. However, this won’t solve much of the problems faced by the company. We feel Opto’s business model has some structural issues which need to be looked at and based on the available evidence and information it remains to be seen whether they are corrected.

2) Doubtful accounting practices:

Adding to our concerns is the possibility of Opto following some doubtful accounting practices. A report shared by one of our subscribers Mr. Mahesh Asrani  delves into possible discrepancies in the way financials for its subsidiaries, tax payments, salaries, restructuring exercises and contingent liabilities are reported.

3) Negative sentiments related to credit rating suspension:

In one of our earlier updates, we had written about ICRA downgrading its rating of Opto’s long-term loan facilities and suspending its rating on Opto’s short-term loan facilities. The reason for suspension was cited as lack of requisite information provided by company. However, Opto management claimed that they had terminated the services of ICRA (in July) much before the report had come out and given the mandate of rating to CRISIL. CRISIL was expected to come out with its rating report in few days after this incident; however the report is yet to come out. In the quarterly conference call, management stated that CRISIL wanted financials for 2 quarters of FY 2013 which were now provided. The report is not out yet and it remains to be seen when it will be out. In summary, the entire incident has continued to weigh on the stock price.

So, what should investors do?

Considering all these issues, we are suspending our colour coding and valuation guidance for Opto Circuits. In our last update, we had advised investors to exit the stock as the stop loss was activated. We re-iterate our view and advice investors to exit the stock. We also advise new investors to not make any investments in this stock due to the above stated concerns. We will be monitoring the company closely and will keep our members updated about any new information.

In our last update about Opto Circuits sent out on 24th August, 2012, we had explained the reasons for the price fall and had advised our subscribers to remain cautious about the stock and not make any fresh investments in the stock. You can read this report here.

Since then, the stock price has fallen and is down by ~20% (Rs. 102.95 as on 23rd November). The company recently announced its Q2FY13 results which were below our expectations. The biggest concern was that the company slipped up once again with respect to working capital management. The quarter saw receivables days increasing to 160 days from 131 days at the end of March 2012.

CRISIL, which was given the new credit rating mandate, was expected to come out with a report. However, this has also gotten delayed and the management stated in the concall that they expect this report to come out soon. The reason given for the delay was that CRISIL wanted financial numbers for 2 quarters which were provided by the company after announcement of the results.

Apart from these short term issues, as mentioned in the last update, the structural issues like a stretched working capital cycle and inadequate cash flows continue to remain. The company has stated its plans to improve the situation but this will take time and is not expected to happen soon.

The fall in the stock price over the last few days has triggered our Stop Loss for Opto Circuits. Considering this and the absence of a strong positive catalyst which could drive the stock prices up in the short term, we advise investors to consider exiting the stock.  

We have scheduled a meeting with the management of the company in the first week of December and intend to get a detailed understanding about the company’s plans going ahead. We will be coming out with a detailed analysis post our visit. We also expect the CRISIL report to be out by then which will provide some important inputs. Investors can then take a call on whether to consider investing in the stock again based on our updated evaluation guidance.

Opto Circuits India Ltd (OCI) is engaged in the development, manufacture, distribution and marketing of medical equipment and devices. Its focus is in the niche areas of invasive (instruments that require the entry of a needle, or other instrument into a part of the body e.g. coronary stents) and non-invasive (instruments used to monitor health, but that do not enter body for e.g. Digital thermometer, sensors etc.) segments. Non-Invasive product segment contributes 75% to overall revenues of OCI and balance comes from Invasive. Opto Circuits is based in Bangalore, India and operates out of offices established in USA, Europe, South-East Asia, Latin America and the Middle East

So, what’s the problem?

The Opto Circuits stock has shed over 40 % of its value over the last six months. Especially over the last week, the stock price has fallen around 13%.

The poor performance of the stock can be attributed to concerns relating to high level of debt – which was taken for its aggressive expansion plans – and reduction in margins. Historically, the company has also had a stretched working capital situation owing to high receivable and inventory days which it has attributed to the nature of the business. All these things have affected the cash flows of the company. Further, on August 9, there was also news that ICRA had suspended the rating assigned to the Rs. 538 Cr. fund based facilities of Opto Circuits which led to a fall in the stock price.
Opto has completed 11 acquisitions between 2001 and 2010 – which has led to a debt of close to Rs. 1000 Cr. on its books. While it does not plan to buy out any more firms for now it still has projected a capital expenditure of Rs. 250 Cr. towards setting up manufacturing facilities, which again will eat into a large part of its free cash flows this year.

Opto’s products can be divided into 2 segments – Invasive and Non-invasive products. The invasive devices segment is a high-margin business. However, the company's last three acquisitions in 2010 were in the low-margin non-invasive segment. This resulted in its operating margins getting impacted last fiscal. The company now again intends to focus on the invasive segment by raising Rs 2500 crore. The invasive segment contributes only one-fifth to the company's consolidated revenues.

What does the company management have to say about this?

The CMD of the company Mr. Vinod Ramnani in an interview with CNBC TV18 has said that the company is not facing any stress on the liquidity position and its working capital cycle remains at 135-140 days. The company has shown some improvement and has reduced its working capital cycle by 20 days in the last quarter. It has provided a revenue growth guidance of 15-20% and EBITDA margins of 25-26% this fiscal.

About the suspension of the ICRA rating, management has stated that ICRA are no longer service providers for Opto and the new credit rating mandate has been given to CRISIL. This mandate was given in July , before the report by ICRA was released (August 9). The new credit rating by CRISIL will be out in some days. The company has also put up letters given by secured lenders (banks like Standard Chartered, IndusInd and DBS) which state that the company has been regular as far as debt repayment has been concerned.

So, what should you do?

While the recent price movement could be said to be due to market sentiments, the concerns about a stretched working capital situation remain. The management has also said that it will take around six quarters for the company to generate free cash flows once the bulk of the capital expenditure is incurred. Thus, in the short term the balance sheet will most likely remain under stress for a while despite the recent strong quarterly performance.

We advise our subscribers to remain cautious about the stock and not make any fresh investments in the stock for the time being. We are monitoring the stock continuously and will keep our subscribers updated about any changes in the valuation guidance.