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Safal Niveshak StockTalk #8: Opto Circuits

Welcome to the eighth issue of Safal Niveshak StockTalk.

After covering Clariant Chemicals last time, this time I’ve researched on a mid-cap company, Opto Circuits (India) Ltd (OCIL). Before we dive deeper into OCIL, here is a brief overview of the sections of this report.

  1. About OCIL
  2. Safal Niveshak’s 20-Point Checklist
  3. Intrinsic Value Assumptions
  4. Financial & Market Snapshot
  5. “Should I Buy OCIL?” Checklist

1. About OCIL

OCIL is a leading Indian medical device company headquartered in Bengaluru. It designs, manufactures, and sells a range of medical products that are used by healthcare establishments in more than 150 countries. The company owns 165+ patents and specializes in cardiac and vital signs monitoring, emergency cardiac care, vascular treatments and sensing technologies.

Having grown strongly over the past few years (consolidated sales have grown at an average annual rate of 57% over the past 5 years), OCIL is now a leading manufacturer of medical equipment and patient monitoring systems that are ‘invasive’ (products that are inserted inside the human body, like stents, balloons and catheters) and ‘non-invasive’ (devices like pulse oximeters, digital thermometers and emergency cardiac care equipments).

Given the rapidly rising number of cardiac cases around the world, OCIL’s invasive business is set to lead its growth in the future. What is also expected to add to the company’s growth is its rising international presence, where the company is still a marginal player and the pie to be captured is huge.

In order to grow fast and capture opportunities in different segments, OCIL has been on an acquisition spree over the past 10 years, having acquired 11 companies since 2002, including 3 big acquisitions in the US and Germany (Eurocor in Germany, and Criticare and Cardiac Science Corp. in the US). The management sees a cool-off period for some years while it consolidates its past acquisitions and bring them in line with the overall profitability of the company.


2. Safal Niveshak’s 20-Point Checklist

Keeping in mind the simplicity aspect that is otherwise missing in other company analysis reports you would come across, I’ve analyzed OCIL by answering 20 important questions that span its:

  1. Business performance,
  2. Financial performance,
  3. Management quality, and
  4. Competition.

Here is the complete 20-point checklist with my explanations.

Before we move ahead, here are the symbols that I’ve placed against each checklist point and that will tell you at a glance whether I have a positive or negative view on that particular point.

   Indicates my positive view

   Indicates my negative view

Let’s get started.

A. Business

1. Can I, in simple words, explain what the company does?
Yes. OCIL is India’s leading manufacturer of medical equipments, which are ‘invasive’ (products that are inserted inside the human body, like stents, balloons and catheters) and ‘non-invasive’ (devices like pulse oximeters, digital thermometers and emergency cardiac care equipments). The company is a well-known brand name in the segments it operates in, and enjoys a strong IP (intellectual property).

2. Does the business have high uncertainty?
Not really. Cardiac care is a fast growing industry, and given the lifestyle changes seen around the world, the case for this industry’s growth is strong. What is more, the products OCIL sells are non-discretionary in nature – which means there is always a ready and rising demand for the same. The company has presence in both the invasive and non-invasive product segments, and has a certain growth ahead of itself. The one major risk for the company is obsolescence, given that medical technologies are improving at a sharp rate.

However, as the management indicated in the conference call I had with them yesterday, OCIL has taken good care of this aspect via mergers and acquisitions (M&As) over the past 10 years. As per the management, M&As will remain a key business strategy for the company going forward though there will be a cooling off period as the company consolidates the past acquisitions, and especially the big one of Cardiac Science Corp. it made in the US in 2011.

As the management has reasoned, it can take years to develop new products and technology from scratch, and also that heavy investments in own R&D may not always bear fruit. So M&As can serve well in the company’s aim to enter new market segments and strengthen its product offerings.

For instance, OCIL’s foray into the clogged-artery-busting stents business gathered pace from its 2006 acquisition of Eurocor in Germany. On the other hand, its acquisition of Cardiac Science in the US in 2011 has strengthened its position in the non-invasive cardiac business.

3. Has the business got an enormous moat?
Though not huge, OCL’s competitive moat lies in its low cost structure, strong IPs, a wide product portfolio, and a highly respected brand presence. The biggest benefit that OCIL enjoys out of this moat is that of pricing power, which is a strong point for any business.

4. Does the business generate strong free cash flow?
No. In fact, this is one area of concern that I have for OCIL. The company has oscillated between positive and negative cash flows when it comes to its consolidated business. This is even when its standalone business has generated positive FCF for five of the past seven years. This indicates that the real problem on FCF account lies in OCIL’s subsidiaries, where the company is still in an investment phase.

As the management has indicated, the root cause for the consolidated business earning negative FCF is the high working capital – inventory and debtors – at its US subsidiary Cardiac Science Corporation (CSC), which has blocked overall cash flows for OCIL. During FY06 to FY11, while OCIL’s consolidated sales grew at an average rate of 63%, its inventory and debtors rose at rates of 40% and 56% respectively. Loans and advances to subsidiaries also increased by a sharp 107% annually during this period, thus leading to significant pressure on FCF.

The company is trying to reduce its working capital requirements by way of measures like shifting a part of manufacturing from the US to Malaysia and India, diversifying sales to more countries, and integrating the operations of CSC and other subsidiaries. While I do not see the working capital situation improving drastically over the next 2-3 years, the company’s efforts seem in the right direction.

Working capital and FCF are two factors you must keep a watch on in case of fast growing companies like OCIL. Over a period of time, such a company must not be compromising on its balance sheet for the sake of growth.


Data Source: Ace Equity, Safal Niveshak Research

5. What is the bargaining power of suppliers and buyers?
As we discussed above, OCIL has a good moat and therefore a good bargaining power against its suppliers and buyers.

B. Financial Performance

6. Does the business have a consistent sales and profit growth history and is there room for future growth?
Yes. OCIL has grown its consolidated sales and net profits at superb average annual rates of 48% and 60% over the past 9 years. As for the future, what will be more important to see is not whether the company is able to maintain such high growth rates (which it can maintain given the huge market opportunity internationally), but whether the balance sheet strength is getting compromised to achieve such a growth. Value investors might not like this second eventuality.


Data Source: Ace Equity, Safal Niveshak Research

7. Are EBITDA margins higher than 15%?
Yes, and comfortably. OCIL’s average operating margin over the past 10 years has been around 25%, which is a very good number. I believe one reason for the same is the company’s entrenched and superior position in its industry plus low cost manufacturing, which gives it the pricing power even in case of rising input cost inflation.

What is more, the management expects EBITDA margins to improve further by 2% in the current financial year (FY13), over FY12 margins of 26%. This is largely on the back of cost-cutting exercise that the company is working on, plus the impact of economies of scale.


Data Source: Ace Equity, Safal Niveshak Research

8. Is its operating cash flow higher than net profits?
No. Like FCF, OCIL’s consolidated operating cash flows have been consistently impacted by rising working capital, and thus have been lower than net profit for the past few years. This is worrying part, and something that you must keep a close watch on.


Data Source: Ace Equity, Safal Niveshak Research

9. Is the debt to equity below 0.5 times?
No. OCIL’s FY12 debt to equity ratio stood at around 0.7 times (which means the company has Rs 70 of debt for every Rs 100 of equity or shareholders’ funds). Even over the past 10 years, the ratio has averaged 0.65 times. While I prefer companies with a ratio of less than 0.5 (zero debt is always great), OCIL’s D/E ratio isn’t of much concern till the time it rises even further. In this regard, while the company has reduced its D/E ratio from 1.1 times in FY09 to 0.7 in FY12, the ratio has increased over FY10 level of 0.23 times. Again some concern here!

10. Is the current ratio greater than 1.5?
Yes. OCIL’s average current ratio has been around 3 times over the past 10 years, which is a comfortable number. As a general rule, a current ratio of 1.5 or greater suggests that a company can meet its short-term operating needs sufficiently. However, a higher current ratio can also suggest that a company is hoarding assets (like we have seen in case of rise in inventories and debtors for OCIL) instead of using them to grow the business. While this is not the worst thing in the world to do, it is something that could affect long-term returns.

11. Does the company have a good dividend history?
Fair enough. In terms of dividend payout (amount of dividend paid as percentage of net profit), OCIL has averaged around 36% over the past 10 years. While this is comfortable number on the face of it, dividends have remained almost stagnant for the past few years (in fact, the dividend reduced in the latest year, FY12). This can be attributed to the rapid expansion that the company is seeing in its business where it is diverting a lot of its profits, instead of paying them as higher dividends.

Till the time OCIL continues to generate good returns on its capital (like it has done in the past; the return on equity has averaged above 40% over the past 10 years), I wouldn’t be overly worried about the stagnant dividends.

12. Is the Altman Z score > 3?
Yes. OCIL’s Altman-Z score is 4.6, which makes it safe against any possible bankruptcy. Read more on the Altman Z-Score.

13. How capital intensive is the business?
Highly capital intensive. OCIL’s average capital employed per year during FY03 to FY11 (9 years) has been around Rs 5 billion. Against this, the company has earned average net sales of Rs 5 billion during this very period. This suggests that the capital turnover ratio has been around 1.0 time, thus indicating that the business is capital intensive (requires Re 1 of capital for every Re 1 of sales).

Now, when capital turnover ratio is low, the company cannot afford to have a low margin, because that will hurt its return on capital. In case of OCIL, we already know that capital turnover is around 1.0 time. So, the company must earn around 25% net margin to keep its return on capital at 25% (its return on capital employed has averaged around 29% over the past 10 years).

14. Has it got a high and consistent return on capital and return on equity?
Yes. OCIL’s average return on capital and return on equity have been around 29% and 40% respectively over the past 10 years, which are reasonably high numbers, and suggest the management’s good capital allocation skills.


Data Source: Ace Equity, Safal Niveshak Research

C. Management Quality

15. Is the management known for its capital allocation skill and integrity?
OCIL has been a great performer on the capital allocation front all these years. The management has guided the company well over the past few years, so the track record in terms of integrity seems fine. Even as far as the capital allocation part is concerned, we have seen how the company has continued to maintain a high return in equity (average of 40% over the past 10 years; 31% in FY11). So, overall, I’m comfortable with the management and its capability to guide the company in the future.

16. Has there been any substantial equity dilution in the past?
OCIL’s equity based has multiplied by almost four times over the past five years, thanks largely to three bonus issues and conversion of warrants into equity shares. While bonus issues aren’t any concern, what could be worrying for existing investors is when the company raises more money in the future via warrants or FCCBs (as has been the case with many fast growing Indian companies). This could lead to further dilution in the equity, and therefore all “per share” numbers.

17. Are management’s salaries too high?
OCIL’s CMD earned Rs 7.9 crore in compensation in FY11, which isn’t a big number as compared to the companies profits.

18. What has management done with the free cash in the past?
As we discussed above, OCIL has seen negative FCF over the past few years, largely due to a lot of its cash remaining stuck in the form of inventories and debtors. The company has also paid a good amount of dividend. So my overall view here is neutral.

D. Competition

19. Does the business face high competition?
Yes, but still enjoys the pricing power due to a good competitive moat.

20. Has the management focused on market share or profitability in the past?
A combination of both, which is good.

3. Intrinsic Value Assumptions

Before I move into calculating the intrinsic or fair value range for OCIL, let me make one thing very clear.

Intrinsic value isn’t a definite figure but just a ‘calculated’ value. In fact, the calculation of intrinsic value of a business mostly throws up a highly subjective figure. And this figure changes as estimates of variable like future cash flows are revised (given that the future is unknown).

Anyways, what I have done here is rather than arrive at a single intrinsic value figure for OCIL, I have calculated the value using 4 different methods and then arrived at a ‘fair value range’ for the stock.

1. Net present value based on a 2-stage 10-year DCF
Since OCIL has seen negative FCF over the past few years, it’s not possible to calculate the company’s intrinsic value using this method.

2. Earnings Power Value (EPV)
After DCF, the second most reliable measure of a firm’s intrinsic value is the value of its current earnings. This method is known as ‘Earning Power Value’ or EPV. This value can be estimated with more certainty than future earnings or cash flows, and it is more relevant to today’s values than are earnings in the past.

The formula for EPV of a company is:

EPV = Adjusted Earnings x 1/R

Here, ‘R’ is the cost of capital.

OCIL posted an adjusted EPS (earnings per share) of Rs 23.6 in the latest completed year FY12. Now, if the company’s profits were to stagnate and remain at Rs 23.6 per share going forward, and applying the EPV formula here, I multiply Rs 23.6 with 1/13% (13% is the approx. cost of capital for the company, assuming cost of equity at 15% and cost of debt at 9%, and debt-equity weightages at 40%-60%).

This gives me a value of Rs 182 per share, which is OCIL’s intrinsic value as per the EPV calculation.

3. Pricing relative to 10 year average P/E ratio
True value investors, as Graham has prescribed, won’t pay a price based on the stock’s latest P/E or the company’s latest earnings. They will take a much longer term view…as long as 10 years.

Here, I have attempted to estimate the intrinsic value of OCIL using the company’s last 3 years average earnings and last 10 years average P/E ratio. So the formula is:

Last 3 Years Average EPS x Last 10 Years Average P/E Ratio

OCIL’s average P/E ratio for the past 10 years has been around 20 times, while its last 3 years’ average EPS has been Rs 16.5 per share. Based on the formula, OCIL’s intrinsic value is coming to around Rs 330 per share.

4. Graham number
Graham number is the formula Ben Graham used to calculate the maximum price one should pay for a stock. As per this rule, the product of a stock’s price to earnings (P/E) and price to book value (P/BV) should not be more than 22.5 i.e., P/E of 15 multiplied by P/BV of 1.5.

But why did Graham specifically used a P/E of 15 and P/BV of 1.5? Why didn’t he use some other numbers?

Well, he thought that nobody should be willing to pay more than the AAA bond yield at that time. AAA bond yield at that time was 7.5%. Therefore, AAA P/E was arrived at 1/7.5 or 13.3, which was rounded up to 15. Similarly he thought that nobody should pay more than 1.5 P/BV for a stock.

Graham insisted that the product of the two shouldn’t be more than 22.5. In other words,

(P/E of 15) x (P/BV of 1.5) = 22.5

Put another way:

(P/E) x (P/BV) = 22.5

Price(sqr)/(EPS x BVPS) = 22.5

Price(sqr) = 22.5 x EPS x BVPS

Take the square root of both sides, and you get the equation for the Graham Number.

Fair Value Price = Square Root of (22.5 x EPS x BVPS)

Applying this formula, OCIL’s intrinsic value comes to around Rs 193 per share.
Fair Value Price = Square Root of (22.5 x 23.6 x 70) = 193

5. Dividend discount model
As we have discussed in the DCF method above, the value of a stock is worth all of the future cash flows expected to be generated by the firm, discounted by an appropriate risk-adjusted rate or discount rate. Now, as per the Dividend Discount Model or DDM, dividends are the cash flows that are returned to the shareholders.

Hence, to value a company using the DDM, you calculate the value of dividend payments that you think a stock will throw-off in the years ahead. Here is what the formula is:

Intrinsic value = Dividend per share/Discount rate

The modified formula for valuing a company with a constantly growing dividend is…

Intrinsic value = Dividend per share/(Discount rate – Dividend Growth Rate)

Given that OCIL has had stagnant dividends over the years, we use the first ‘constant dividend’ formula for calculating the stock’s intrinsic value.

Assuming a discount rate of 13%, and FY12 dividend of Rs 3 per share, and inputting these numbers in the above DDM formula, I get to an intrinsic value of Rs 23 per share.

Fair Value Range
I have calculated 4 different intrinsic values for OCIL using 4 different methods. So much for the ‘target prices’ you hear on business channels every day as if these were the holiest numbers!

As you can see from the above calculations, the ‘target price’ isn’t such a holy number and can differ based on the method used to calculate it.

Anyways, based on the above calculated intrinsic values for OCIL, I can arrive at a ‘fair value range’ for the stock. Here is how I calculate it:

High End of the Fair Value Range = [Average of above four intrinsic values] Low End = [(Average of above four intrinsic values) – (0.5) x (Std Dev)]

Based on this, the fair value range for OCIL’s stock is Rs 120 to Rs 180. Assuming a margin of safety of around 25% to the higher end of this range, the comfortable buying price for OCIL’s stock comes to Rs 135 using the intrinsic values calculated above.

Anyways, before taking any decision with respect to the stock, you will do yourself a world of good by reading the discussion in the Comments section of this report and also under my latest post on OCIL.

My biggest concern regarding OCIL, and I’ve mentioned this in the above analysis, is the company’s high working capital requirements, which is blocking precious cash. While the management has suggested that the working capital requirements are gradually coming down as the company is integrating its subsidiaries and shifting manufacturing closer to the markets in which it operates – which might subsequently result in faster finished goods delivery and thus faster payments by clients, but I’ll still wait for the actual numbers to see where the working capital and thus the FCF are heading.

Another concern relates to the large amount of goodwill that the company holds on its balance sheet. This goodwill was largely created owing to the acquisition of CSC. My concern arises from any risk of impairment of this goodwill, which will happen in case CSC’s business does not perform in line with what OCIL expected when it bought the former. Already in FY12, the goodwill has been written off by 28%, so this is a concern that investors must be aware of, as any write-off just hurts the balance sheet.

Another concern for the company could be from rupee’s constant depreciation. This is because OCIL imports 99% of its raw material requirements and rupee’s depreciation makes imports expensive. However, the company takes cares of this currency volatility by exporting its products. For instance, in FY11, while OCIL’s imports of raw materials were worth Rs 4,803 million, it exported products worth Rs 5,726 million (95% of standalone sales).

A third point of concern is the potential of competition increasing for OCL. If you were to look carefully at the company’s standalone P&L account, it becomes clear that OCIL’s is a highly profitable business that any potential competitor will try to tap. As per FY11 numbers, raw material costs formed around 94% of OCL’s total operating costs. And as I just mentioned above, the company imports 99% of its raw materials.

So here is what a potential competitor – even maybe the supplier of raw materials to OCL – might think…

OCIL imports 99% of its raw materials for its standalone business, does some value-addition, and earns 25%+ margins and 30%+ ROE…and all this while exporting the end product outside India. Its other operating costs – like power, fuel, employees, selling, administration etc. – are just 6% of total cost.

Why can’t I set up my manufacturing in India and do the same value addition, and export my products outside India? If I am a supplier of raw materials to OCIL as of now, I could earn an even better margin and RoE given that I will source some raw materials in-house! This seems like a great business to get in!

By the way, I laid out this potentiality in front of OCIL’s management in my discussion yesterday. It suggested that this might not be a concern given the competitive moat – like strong brand reputation, IP protection, and a wide product portfolio – that OCIL already enjoys. Plus, in the medical equipment industry, more than in any other industry, brand equity and relationships play a very dominant role given the criticality of the products involved.

Thus, OCIL’s strengths create an entry barrier for potential competitors. I agree to OCIL’s management’s point of view, but as an investor, it always pays to keep a close watch on emerging competition.


4. Financial & Market Snapshot


Data Source: Ace Equity, Safal Niveshak Research


Data Source: Ace Equity, Safal Niveshak Research

    
Data Source: Ace Equity, Safal Niveshak Research


5. “Should I Buy OCIL?” Checklist


Your feedback is important
So that was my take on OCIL as part of the Safal Niveshak StockTalk initiative. I’ve tried to be as comprehensive in my analysis, while trying to keep the report very simple. Let me know what you think of this report and the improvements therein.

Do you think I’ve missed mentioning something specific here? Can the Safal Niveshak 20-Point Checklist be modified or expanded any further? Do you find this report simple enough for your understanding?

Your answers would help me in making the Safal Niveshak StockTalk report, and the entire initiative, more beneficial for you.

Disclaimer: The author of this report, or any of his family members, does not own the stock(s) mentioned herein. The opinions in this report are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stock(s) mentioned or to solicit transactions or clients. The information in this report is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

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About the Author

Vishal Khandelwal is the founder of Safal Niveshak. He works with small investors to help them become smart and independent in their stock market investing decisions. He is a SEBI registered Research Analyst. Connect with Vishal on Twitter.

Comments

  1. Dear Mr. Vishal,

    You make stock analysis so simple for small investor. Appreciate your work.

    Regards

    Ajay

  2. Sanjeev Bhatia says:

    Hi Vishal, Nice Analysis as always.

    One factor on which I would like to have your opinion is on Promoter’s holding. Here in this case, the Promoter holding is just 28% while FII hold about 38%. As has been seen earlier too, in case of flight of capital by FII’s, even good stock can be battered left, right and center. This can be the case here too, given the turmoil in Eurozone and debt situation in US. Don’t you think high promoter holding provides higher confidence? Moreover, Possible FCCB issue later on, as you have pointed out, can further distort this.

    Another point (without any logic) is that recently there have been many so-called positive from different foras on Opto Circuits. Somehow, this makes me little bit apprehensive as to what is the true story behind all this. Doesn’t it make better sense to have higher MoS in such cases?

    Thanks

    • Thanks Sanjeev! As for promoter holding, one good part is that it has risen in the recent past. Secondly, the case of low promoter holding and high FII holding is also true in case of solid, established, less volatile stocks like Infosys (16% promoters and 39% FIIs) and HDFC (0% and 65%) as well. So the battering that stocks receive during a market crash depends more on the quality of the business and the quality of the FII and less on teh actual FII holding. So I would not be much worried here than I would be worried about a management’s intention, business practices, and the quality of the business, all of which are sound in case of OCIL.

      As for your point about a lot of other people talking positive about the company, yes is a concern always which I had captured in my last post on OCIL. But the idea must always be to bring the story into scrutiny and see if that really holds true. In other words, you need to get past the story-telling because it’s easy to fall into it saying, “Hey, this company is worth a lot!”…or “If this is on StockTalk, there must be a great story behind it!” This is what I’ve done by way of researching deeper into OCIL and then seeing whether the “story” is valid or not.

      But again, this is my understanding of the OCIL story. As I’ve always asked readers to do, my understanding isn’t “your” understanding. You still have to do your study/homework on the company and use my research just as a reference point. And this is the way you would negate all concerns around any hype that surrounds the stock, and which is creating that “confirmation bias” in your mind.

      As for the last point about a higher MoS, well again it depends on your own analysis of the stock and your own comfort levels with the business. A 25% MoS that I generally use shows my comfort level with the respective businesses. For someone else, it might be 20%, and then for someone, it might be even 50%. So it’s very subjective…but the greater the MoS you take into consideration, the safer you are playing…which is a very good thing in value investing. Regards.

  3. Thank you. Interesting analysis. The competition is a bit of black box though.

    • Thanks Sudhir! Well, there’s no dearth of competition for OCIL, and it largely comes from big names like GE, Siemens, Philips, Medtronics, Mindray, Drager, and Abbott…but the areas where OCIL is present are small businesses for these MNCs. Plus, OCIL has established relationships with its clients over the last 20 years, which helps it a lot in business building and references. The fact is that the market opportunity is so huge, and that its products are non-discretionary in nature…serves the company well.

      But yes, as I asked them in the call, even they do not see margins sustaining at such high levels of 26%+ over the long term. They see the margins fall and get steady at around 20-22% level. I see this as a reasonable expectation. Regards.

  4. Sanjeev Bhatia says:

    Bhai, mera number kab aayega?

  5. Hi Vishal,
    thanks for such a simple and easy to understand analysis of the company,
    Jalaj Karandikar

  6. Manish Sharma says:

    Hi Vishal,

    Very good analysis like always! Although, Opto is a favourite in the value investor club, but your thorough analysis presented a balanced story. I was looking at company’s AR last year and I found company is purchasing few companies in the US through debt funding. I was discussing this point with another star investor and he was indifferent with the acquisition and growing debt since the interest outgo is quite minimal. It seems those acquisitions are yet to pay off for Opto and until and unless situation on FCF improves, it isn’t feasible to bet on Opto .

    • Thanks for your feedback and inputs, Manish! Yes, as I mentioned in the report that more than the debt, the company’s intention of using the same is what would matter. Of course, if the debt were to rise further, it could be detrimental to the balance sheet’s strength.

      As for the acquisitions, yes they are yet to pay off for OCIL though the company is already doing well selling the products it acquired. The acquisition of CSC in the US is what has impacted the company’s working capital and thus its FCF. So the direction of that is also important to understand. But then, all these can be captured in the “margin of safety” if someone is looking to wet his foot in the stock.

  7. Hi Vishal, I had sent this mail yesterday to you, hope you had not noticed it, anyhow it is here now for your comments:)

    I have been following up your articles for quite sometime now and this is my first mail / comment to you.

    I like your ideas on safe and sensible investing and you are doing wonderful job of educating investors and root out myths about stock market investing.

    Though I am new to stock market, I had done my investing for small amount to get my hands-on the market.

    My Question for you today :

    To do detailed analysis (as mentioned in your 20-points checklist) on any company stock, where can we get details like cash flows, sales, profits, growth and other detailed required for various financial ratios? Is there a source where we depend upon? or how we can gather these details?

    Your guidance is highly appreciable.

    • Hi Ramky, yes I’d seen your email and was about to reply by tonight. 🙂

      Anyways, the best, free and most authentic source for company data is annual reports. Another good source I came across recently was Morningstar India’s website, where you can get past few years financial statements and ratios on companies.

      As far as paid sources are concerned, there are several. One of them in Ace Equity that I use. Another is CMIE’s Prowess.

      I hope this helps. Thanks anyways for your feedback on the Safal Niveshak initiative! Regards.

  8. Dear Mr. Vishal,

    Just a personal question. You said you had been a stock analyst with Independent Analyst for 8Years. I have heard this name in Equity Master? Did you work with them?

  9. Vishal,
    Thank you so much. Have been in stocks for > 20 yrs. But for the first time i have read an article that so very explicitly reveals the analysis of the intrinsic value of a stock; and more importantly guides and aids the DECISION TO BUY OR SELL…

    VISHAL! YOU ROCK

    • Dear Sam,

      Thanks for your feedback on the analysis….and welcome to the Safal Niveshak tribe of independent, sensible, long-term investors.

      Given your long experience in the stock market, we would love to see you contribute to the tribe-building by way of sharing your experiences (your wining moments, your mistakes) that can serve as lessons for the rest of us. Regards.

  10. vikrant says:

    Vishal,

    This Stock talk is really Pulling a lot of visitors for the blog, additionally i see that the comment section is filled with some wonderful comments, questions and Opinion. By the way i bought some today ( its only 2% of my total folio)

    • vikrant says:

      Additionally so far i was only reading your post, but now i have started reading the comments too. The only problem is i cant do it on the G-reader so i have to open your blog every-time i want to read the comments. I am not sure if G-reader has a option where i can read the comments, But yes i know that it can show how many comments the Post has got which is not present currently for you blog in G-reader.

  11. Waiting for the next ‘Boring’ stock analysis. 🙂

    • Hi Dev, a wise man once said – “All human wisdom is summed up in two words – wait and hope.” So please bear with me for some time. It will come.

      By the way, are you looking for a “boring analysis” or “analysis of a boring stock”? LOL

  12. couple of worrying points
    1) high margin and high debtor period ( i do not understand when the business has so much hold on pricing power then why not on payment terms) – big concern of something wrong is happening.

    2) how is this business so capital intensive

    3) operating cash flow is negative than net profits – again a big concern.

    4) split of production % is not provide by management.

    All in all something fishy is going on.

    if margins were really so high then sun pharmas ranbaxies dr reddys ciplas of the world would have definitely looked at this opportunity, if not then Sterling Biotech is an example to look out for. How the stock has got crashed when its manipulated business practices came out in market and the stock is ruling at single digits from the level of 250 rs.

    • Hi Prem, thanks for your feedback and observations. Specific to the high working capital, as I mentioned in the report above, this has been largely due to the acquisition of CSC in the US. However, the working capital is gradually reducing, so that is a positive.

      As for capital intensity, I would be looking at both the asset turnover and net margins which lead to return on asset. Since the net margin is good and thus leads to a reasonable ROA, there’s not to worry much here. Companies generally have either of two – high margins or high volumes. In OCIL’s case, it’s the former. Regards.

  13. Hi Vishal,

    Is Opto Circuits capital intensive business?
    If we look at the increase in Sales and increase in gross block for last 4 years, the increase is the same percentage, i.e. 300%.
    Secondly, the Asset Turnover ratio is almost same over the last 4 years.
    Also, there’s 300% increase in Net Current Assets in last 4 years.
    Does this say that it’s high maintenance business?

    Regards,
    Avadhut

    • Yes Avadhut. Given that capex has moved in line with sales, it indicates the high capital intensity of the business. As for the rise in net current assets, it’s largely owing to rise in debtors and inventory owing to the acquisition of CSC in US which had poor numbers on these fronts.

      • Thanks for clearing my doubt,Vishal. According to you, what should be the Asset Turnover for such companies (Capital Intensive) then?

  14. Read you report Mr Khandelwal. One of the most important things that is missing is that the company pays no tax. For the last 10 years the tax payment is close to one percent of the profits. That is indeed strange given that MAT in India is was 15% and now is 20%. Opto must have some very great tax planners with the company who can have a profit of Rs 240 crores and pay only Rs 2 crores tax. In fact over the last 10 years Opto has hardly paid any tax. Dont you think this is strange. Add to this the high receivables and inventories on the asset side of the balance sheet coupled with good will as the largest fixed asset makes this company deserve very very poor valuations. In my opinion you have just had a look at the presentations on the website of the company and not put your mind on the bigger picture. With hardly any fixed assets how can Opto have such a high turnover which means that it is largely a trading company. The negative cash flows are a huge red light if you combine with the above negatives. If that is true then the margins cannot be so so high. Please have a look at other companies in this sector that manufacture products and compare their margins with Opto. I am very very skeptical of this company and every investor should question the management at the AGM and seek an explanation. In fact no domestic fund owns any shares in the company. The management is owning only 28% of the equity with foreign investors owning close to 40% of the capital. Please bring out m0re relevant points in your analysis. A company that does not pay tax one has to question everything.

    • Thanks for your feedback, Saher! First thing, I don’t look at company presentations and then write my reports on companies. I read their annual reports, do my own assumptions, calculate my intrinsic values, and only then create my reports.

      Anyways, as for you point on why has OCIL paid almost zero tax in the past, the answer is not that it has had smart tax planners, but due to its Export Oriented Unit (EOU) status (which has provided them 100% tax exemption). So, if yoy read their annual reports, while they have paid taxes in the past, they have got the refund via MAT credit.

      On your point about inventory, I have duly raised this concern in the report above, so that must settle the doubt.

      On the point of management shareholding, even companies like HDFC and Infosys have very low promoter shareholding, so I won’t take much cues from there…also given that OCIL promoters have been upping their stake. As for MF holding, well some Indian funds do hold the stock in their portfolios (though it doesn’t mean anything to me whether MFs hold a particular stock or not).

      I have outlined the risks to OCIL in the above report, and the company may still get bankrupt and I may be proven completely wrong in my analysis. But believe me, before that comes to happen, I would have accepted my mistake and would sell out at a loss (in case I were to have OCIL in my portfolio).

      But I will never write a report on a company believing it is participating in a beauty contest. You need to be a Safal Niveshak reader “for long” to understand that 🙂

  15. Sir the writing is on the wall no cash-flow, no fixed assets, only goodwill stock and debtors in balance sheet, never pays tax (mat is there in India since 6-7 years so eou argument does not hold),all dividends paid out of borrowed money, I am sure all the debt is real, earns abnormally high margins but does not make cash please check how many companies with such a high opm have negative cash flows and lastly liberal bonuses for no reason. The two large cash inflows are from issue of shares. Not to forget the company has absolutely no disputes with any tax or other govt authority as per the annual report that is rarity. A most interesting company no analysis required in my opinion.

    • Here is what tax law says – “For a company located in an EOU, income arising or accruing on or after April 1, 2005 from any business carried on, or services rendered would be exempt from MAT under section 115JB.” That’s the reason OCIL pays almost no tax, and that’s why it has no disputes with the IT men.

      Debt has been taken to acquire companies, which I understand is a risk if the acquisitions don’t pay off. So that’s a call we need to take.

      The case about high margins and the risk of competition eyeing the same has been mentioned in the report above. Then, bonuses don’t impact a company’s financials. On fixed assets, of course it has a lot on its books and is adding to the same owing to capacity expansion. Not sure what made your arrive at the conclusion that there’s no fixed asset!

      On FCF, the standalone business has been earning positive FCF in the past. It’s just that the FCF has gone negative for the consolidated entity on the back of weak working capital scenario at its subsidiary, CSC.

  16. Respected sir MAT under section 115JB of the income tax act is applicable to ALL companies irrespective of where they are located. Also the earlier section Section 80HHC where EOU would get tax exemption was phased out in a gradual manner from FY 2001 onwards hence all exporting companies would see their taxes rising from FY 2001 onwards please check the profit and loss accounts of all exporting companies especially the IT Companies. Secondly the standalone entity has a Net block of only Rs 79 crores which is mostly furniture, vehicles and software. The consolidated entity has a Net block of Rs 1070 crores out of which Rs 630 crores is good will. The plant and machinery is hardly 4-5% of Net block in FY 2011. Coming to the disputes they have no disputes with any authority leave alone tax authorities please pick up the annual reports of 100 companies and almost all of them will have some litigation going on. It is good that Opto does not have any but that is strange since it has operations in many countries. Coming to competition I am not referring to competition if a company earns such high margins then means it commands very good pricing power so where is the cash flow. Auto ancillary companies that have to invest every year have better cash flows and lastly giving bonuses in the last few years seems to be a ploy to create a positive investor sentiment. I rest my case it is a very very risky company to invest in my opinion and fundamental value investors should stay clear. I don’t own any shares in this case company even though it has such a track record in the market a simple reading of the last 10 years accounts throws up many many serious questions.

    • I’ll repeat the above tax law – “For a company located in an EOU, income arising or accruing on or after April 1, 2005 from any business carried on, or services rendered would be exempt from MAT under section 115JB.”

      I understand that MAT provisions are u/s 115JB, but then EOUs are except from this tax. And this was the case till 2009.

      As for the net block, yes the standalone entity had a net block of Rs 80 crore in FY11, but 81% of this is plant and machinery. This is from their annual report (page 67). Furniture & vehicles are just 4% of the net block. So I’m not sure from where you are sourcing your data!

      As for the consolidated business, net block is Rs 272 crore, out of which 35% is plant and machinery. Goodwill is 39%, but as I mentioned in the report above, that’s because of the large acquisition in the US.

      As for the company having no disputes with tax authorities, there can be 2 probabilities – either the company is truly clean, or it has such a strong network with tax authorities across the world that no one has raised any dispute against it till now! In that case, should I consider it guilty till not proven innocent?

      As for the cash flows, again I’m not sure where you are looking at as I can see positive FCF for the standalone entity for 6 of the past 8 years. It’s only that the consolidated FCF has suffered due to weak working capital in the US subsidiary.

      Anyways, thanks for sharing your views.

  17. I hope you have gone through the report the company has been downgraded from AA to B straight that is like a 3-4 notch downgrade at one go that is rare. Rating agencies are always late in downgrading companies and I think in this case also they are late. But if the debt is junk status then how can their be any value of the equity of this company? Be cautious the stock has not fallen that means there is no delivery based selling yet. I am sure this downgrade has attracted the attention of some of the large shareholders.

    • Indeed Saher, it’s true that rating agencies are always late in downgrading companies. Well, I clarified the issue with the company and it has mentioned that they have not had a relationship with ICRA for some time, and the company has switched to CRISIL (not that CRISIL is any better). Anyways, it’s then a surprise that an agency that is not anymore hired to rate a company’s debt is doing so.

      Secondly, the Rs 538 crore of working capital debt on which ICRA has suspended its rating on (and there’s a difference between suspending ratings and assigning a junk rating!) is for the standalone business that has much better balance sheet strength than the consolidated business. So what ICRA has effectively done is used this standalone working-capital debt and has compared it with the consolidated entity’s financial position (without considering the business growth that the acquired entities are seeing).

      Thirdly, the Rs 538 debt that the company took was in FY11, while ICRA talks about FY12, when some part of the debt has already been rolled over as it’s a working capital loan.

      Fourth, it amazes me that a rating agency that has had positive ratings for junk construction and realty companies in the past, is talking negative about a company that has a debt/equity ratio of less than 0.7x (and long term debt/equity ratio of just 0.2x).

      Fifth, the working capital situation that ICRA is worried about is actually improving. From inventory and debtors days of 100 and 156 in FY11 (OCIL’s consolidated business), these numbers have fallen to 79 and 131 in FY12, which is a positive.

      Given all this, ICRA definitely seems a lot late in its rating – that too it has suspended rating and has not rated OCIL’s debt as junk (which you have talked about).

      Finally, when large investors would sell, I would be a buyer in case I view their actions as madness (which most often is the case).

      See, I’ll repeat again, I might be wrong in my view on OCIL, but I will still like to go by the facts than some random thoughts…and especially not by the thoughts of credit rating agencies that have a dubious history of rating junk companies as darlings and vice versa!

      A final disclaimer – I have no emotional attachment to OCIL!

  18. Dear Vishal,
    I landed on your website while researching Opto. Took some time to go through the website and I thank you for the effort you are undertaking and wish you luck. I am sure you will be successful.

    Coming back to Opto. I started researching this company six months ago with the intention to buy the stock. Then a series of red flag started coming which kept me on hold. After the recent ICRA downgrade (yes is a downgrade to junk status before suspending rating, please read ICRA press release, and as a person familiar with rating process (however flawed it is) it means the debt repayment capacity is severely impaired. In fact after this downgrade if CRISIL gives anywhere above B- ICRA’s credibility will be a toast and I am sure they will not take that risk).

    I am again looking at Opto to test my earlier analysis. Here were my red flags then and I will use current quarters data so that it is easier to test.

    Lets start with Standalone entity first

    1. The first red flag was tax which is very well elaborated in your exchange with Saher above and I will not reiterate it but suffice here to say I go with Saher’s argument that MAT has to be paid and by your admission at least after 2009. Also there is no such thing a EOU tax free from 2007 after all even SEZ has to pay tax and MAT. Look how much tax Opto paid this quarter 2%.

    2. The revenue per employee ( I understand that Opto has 500 employee in standalone entity but I may be wrong as I have no latest data) for opto is over Rs 37 lac/quarter or Rs 1.5Crore per year and profit per employee is over Rs 50 lac per year. But here what is red flag for me the average cost per employee is just Rs 1.2 lac per year (yes per year ). At average salary of Rs 1.2 lac I have my doubt one can get intellectual capital which will churn out revenues of Rs 1.5Cr per year. Mind you this averages includes all the Presidents and VPs Opto has so the median will be far lower. Contrast that with the rest of the world operations of Opto where I understand about 700 employees work where the average salary is about Rs 30 lac per year fairly reasonable.
    3. My third red flag was power and fuel bill (for which I have data for FY 11 only as of now) and then it stood at Rs 96 lac under the head factory expenses which is on a monthly basis works out to be Rs 8 lacs way too low for a facility that produced Rs 600 Cr + turnover in my opinion.
    4 My fourth red flag was cash balances. As of 31 March 2011 Opto had cash balances of Rs 116 Cr almost the same amount as last year in its current account. But the interest earned was just Rs 19.5 lacs. Clearly cash not been put to use by a debt laden company a big red flag.

    I got many more minor red flags but I had given up by then.

    I will like to understand your views on these red flags and how material you consider them.

    Today I had another major red flag added to the analysis by chance. I was intrigued what prompted Cardiac Sciences Corporation, which was having a revenue run rate of $265 million to sell itself to Opto for $64 million. The answer was the liability from product recall after FDA mandated it to recall/replace products which made it bankrupt and it was unable to raise money to run operation. So by curiosity I goggled Cardiac Science Corporation & FDA& recall & 2012 and was stunned to learn that there has been recalls this year as well. I do not find any information from Opto to either exchanges. Clearly they do not consider it material but for me this is a risk best avoided having known that in its earlier avatar Cardiac Science got sold at distressed valuation.

    Anyway my intention is to share information and analysis and not to cast aspersions. I am fully aware that I may well be proven wrong and Opto will go on to become a spectacular success. Only time can tell that.

    Thanks again for your effort.

    atul

    • Thanks a lot for bringing out the red flags in respect of OCIL, Atul!

      This would surely make me read deeper, and in case I’m convinced about these red flags, I may as well change my view on the stock given that carrying on with OCIL will then be a mistake.

      One thing is sure from the discussion I’ve had with Saher above and you – and I hope readers take this as a lesson – even analysts may fail to identify the red flags that investors can find. And that’s why I’ve always laid stressed on why people must not agree with me on my stock analyses. 🙂

      Secondly, if you realize you made a mistake – which I’ll try to find out in case of OCIL – it’s good to get over them as soon as possible instead of simply ignoring them and falling into the “endowment bias”. Regards.

      • Dear Vishal,

        Please find below the 5 year PL of Stand Alone Opto Circuit. The absolute cost numbers as too good to be true and in my books what is too good to be true is indeed that way in stock market.

        Funny thing is if you use CAGR calculation probably almost all costs have increased at CAGR of 20+% probably even the employee cost at Rs 96 lacs for 600Cr turnover has a CAGR of 24%! That is the reason why nobody is bothered yet. I thing we take CAGR too seriously!

        31/03/07 31/03/08 31/03/09 31/03/10 31/03/11
        Sales Turnover 201.64 328.69 401.23 471.5 603.2
        Raw Materials 110.04 194.42 236.82 238.21 386.42
        Power & Fuel Cost 0.85 0.86 0.84 0.77 0.96
        Employee Cost 4.2 5.22 5.74 5.35 6.64
        Selling Expenses 9.08 10.55 9.61 9.87 14.72
        Depreciation 1.59 2.59 2.88 3.1 5.91
        Tax 0.97 0.43 0.88 16.48 2.68
        Profit After Tax 72.18 118.79 139.93 147.04 244.38

      • vishal,

        Have you been able to read much about the above stated?

  19. Nitin Jain says:

    One aspect that may also be considered is the high technology risk associated with this business…I believe there is lot of research going on to get better stents….more acceptable…easier to place…etc. There could be a company which comes up with these and takes a a big chunk of market…

  20. Bharat Patel says:

    Can anyone please throw some light on the MAT and employee cost issue?

  21. Hrishikesh Kale says:

    Hi,
    My views on Opto circuits:
    1. I think many a times analysts go into an analysis paralysis mode. E.g. the discussions about MAT right upto the IT section details is really irrelevant. I am sure that the IT chaps will not keep silent for all these years if the company was evading tax (Please check with Vodafone India and you will know. They will even go to retrospective amendment).
    2. The WC requirements will continue to be high for opto circuits. This is because of its international operations. This is a known fact and is an industry feature. But more important is the ratio of bad debts is very low as hospitals generally do not default on their payments. So long as the WC are priced and the margins are maintained this should be taken as a matter of fact.
    3. Opto has gulped a huge acquisition. So the cash flows are bound to be affected in the short run. Give it time to absorb and digest this acquisition. Again this will continue going forward as the company will have to make intelligent acquisitions to grow, as developing new products from scratch is costly and results are not guaranteed. This is much more safer that having ready made products (and with it the recall risk as well).

    So all these risks were the same one year before when the stock was a darling of the market. Its only now that the mood has turned. In about 3-4 quarters i think the cash flows will turn around.

    BTW I again differ with your IV calculations as with BHEL. I think the IV of Opto is around Rs. 200. With a 25% MOS, I think Rs. 150 is a great buy price for this company. As the cash flow improves and debt equity ratio improves I think it will gravitate to Rs. 200 -225 in a years time.

  22. Dear Vishal ,

    Whats your opinion about the recent free fall of Opto around -20%.
    do you have any updates??

  23. Kumaran Seenivasan says:

    Hi Vishal,

    I have been holding OCIL for a long time. The stock has fallen significantly in the last few days because of working capital, FCF and ICRA rating concerns. But apart from the rating thing, information about the high working capital and lack of FCF were known even a year ago and it did not affect the stock price then. In fact working capital cycle reduced a bit in the last 1 year. Do you think investors are over reacting or is there something wrong with the company? I was searching to see if there is anything wrong with OCIL and to my surprise you have written a detailed report on this. Please share your views.

    Regards,
    Kumaran.

    • Hi Kumaran, you can read my latest post on OCIL here – https://www.safalniveshak.com/what-to-do-with-opto-circuits/ 🙂

    • Kumaran Seenivasan says:

      Thanks Vishal. I see this as an opportunity. Samething happened to the Pharma Company “Strides Arcolab” an year ago. The stock came down from 450 levels to 270 levels on FCCB concern and don’t know if people bought it then, but look at the price now. It is trading above Rs.800. The rating agencies give very good ratings for companies with DE ratio of more than 1 and I fail to understand why investors are too concerned about a company which is doing well , with a DE Ratio of 0.7. If free cash flow is the concern, then there are lot of other companies with no FCF and are ruling at the PE of 10 and above. Also there are other companies with higher Debt than the Market cap itself. It just does not make sense. In fact I believe OCIL is mistreated and punished. I believe some firms are releasing false reports for their own benefit. Imagine the ICRA guy who wrote the report and how much he might have made had he shorted the stock? Same thing with Indiabulls Financial services. Lot of people are saying corporate governance issues etc, and Veritas released a report with some findings, but the company is paying 7% dividend and all the numbers in their presentation look great. I think these guys just write something, release the report and then short the stock to make money. Too many loopholes in Indian securities market helps them to get away with these things. Every company in India is doing something with the financial statements and only magnitude differs. Good promoters do less and others do more. It’s the world that we need to live at. In reality most of the guys who are crying out there about the corporate governance would do the samething if they are the promoters.

      Regards,
      Kumaran.

      • Thanks for the invaluable inputs, Kumaran! Though I am not so sure about Indiabulls Financial Services, where I would go with Veritas’s findings. 🙂

        • Kumaran Seenivasan says:

          As I said, veritas findings could be true, but most of the companies in the world does some kind of accounting malpractices no matter how good the company is. Many companies know how to be legally illegal (Even ITC did it few years ago and people have short term memory, so now ITC is darling of the investors). But Indiabulls is paying very good dividend of Rs. 13 per share. I am talking about the intention here. If the promoter wanted to cheat the shareholders entirely, why would he pay such a high dividend? Their holding is also not that high to pay themselves like other companies. In my view, it’s a decent company and not what it has been made out to be. Infact those analysts who wrote the report are not coming forward for the investigations and are evading. Also No promoter is working for the benefit of shareholders entirely and that’s for sure. If they do, then it would function like a PSU and then valuation will be meaningless like PSU banks. Private companies aggressiveness in business comes because of human tendency to benefit themselves to an extent rather than working for the benefit of shareholders entirely. We can talk about righteousness all day but at the end of the day we need to understand that the human greed takes over and every promoter is bound to work for their own benefit. We just have to accept that fact. Only thing is we need to find out who is doing less accounting malpractices and go with that stock. We people buy stocks and want to be rich in few months and expect promoters work for our benefits 100% and that belies human psychology. Politicians don’t come for social service. Actors don’t come to entertain us. Every human being is working towards some kind of financial benefit. Just few thoughts.

          Note: Argument sake people might bring Gandhi, Mother Theresa like people here. But for them my reply is that’s why there are not many like them around.

          Regards,
          Kumaran.

  24. Hi,

    I will advise all the investors to start trading using technical analysis. You can not believe any company/management in India and their yearly figures which are used for fundamental analysis as P/L statements, Balance sheets etc. which are forged most of the time. If Satyam falls then any bluechip can fell tomorrow; what to say about midcaps and smallcaps like OptoCircuit. Only price is the truth and as per my technical analysis 140-145 region was strong support; if that was broken one should have completed exited from the stock. No I am not saying fundamental analysis is waste but the basis used is not accurate and transparent. I have tremendous respect for Warren Buffett and his analysis but he is investing in US market where accounting practices are stronger and transparency is there in overall system. At least retails investor can believe in financial statements in US.

    If one is holding “Opto Circuit ” he has got 2 options now:
    1. As per technical analysis stock has broken important support so book losses-dump the stock and come out of it completely because next support visible only at 100 psychological level. God only know when it will return to 150 and above levels.
    2. Hold the stock for Long Term as per Buffett if you really believe in Long Term story OptoCircuit then do not panic; if you still believe in fundamentals of the company then one should not worry about any rating agency and short term price fluctuations. I will advice to accumulate few more quantity on every dip in price for Long Term if you have complete belief in yourself and your own analysis that company will perform better and price will follow the performance.

    Best luck and hope it will help burn-out investors.

    • Hi Rajendra, if you can’t believe the managements, I’m not sure how much faith you can put on the stock prices (which you term as the “only truth”) which are also decided my the madness of men (Mr. Market)!

      Also, keeping Satyam as a barometer for other comanies isn’t right, as Satyam was a “troubled” company from the very start (as a discerning investor, you could have found that out). Talking about the strength of accounting practices in the US, well, cases like Enron and Worldcom, and the latest banking crisis, point to something else!

      Since you follow Buffett, you must know what he had once said about TA – “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.” 🙂

    • Look how OptoCircuit is rejecting 140-145 levels which I have mentioned in my earlier post. Today, Sensex is up 400+ points and Opto is in RED. It made a recent high of 143.65 on 12-Sep and since then it is coming down. Those who are still holding this stock can release at least some quantity or entire today. Also if one wants to enter again can do so once Opto close above 145-146. I accept not everyone following Fundamentals will believe in levels; that is absolutely fine. But I want to say if you atleast use little bit of technical analysis will help you save from disastrous like Suzlon and Satyam. If Fundamental analysis is Father then Technical analysis is proud Son. It will help retail investors to stay away from crooks in the market who rises and falls prices of stocks for their own sake.

      • Dear all,

        Look how my above post has warned about the OCIL further downfall, those who would have exited around 140-145 levels must have saved some of their investments. Today OCIL is trading @ 50; what a disastrous fall it was. I don’t have anything to say about Buffett comment posted in earlier reply i.e. “I realized technical analysis didn’t work when I turned the charts upside down and didn’t get a different answer.” But the results are in-front of every one. Also I have nothing to prove here simply wanted to save retail investors including myself from big Sharks in the market. So start using Technical Analysis for your future investment decisions. Not every investor is Buffett and not every company is Coca-Cola. Finally I would like to repeat “Price is the only truth in the market”.

        Best Luck.

  25. I think there is an error in calculating the fair intrinsic value range. Looks like you have not considered the bonus issue which happened on 31 Mar 12. You have to multiply by 10/13 to arrive at the correct range for the intrinsic value. So the current price with a margin of safety (135) becomes 102. Therefore please wait for the price to fall to @ 100.

  26. Dear,
    Have read followings on one group on OCL. What is your comments please
    QUOTE
    there are plenty of things which makes one uncomfortable..lemme talk about a few of them..
    1) Goodwill: the company follows a curious accounting policy with regard to goodwill. Usually, goodwill is amortised over a period of time by writing it off to the P&L. In case of a technology driven company like opto, they do not write it off at all! In FY12, goodwill has reduced quite a lot, with no entry in the P&L..seems like they have directly adjusted it against reserves, which is quite ‘different’ accounting..and goodwill is not a small amount, it was 630 cr in FY11, which came down to 452 cr in FY12..where did the difference go, not very clear!
    2) I was unable to figure out their taxation..cant understand why they pay sooo low tax..
    3) Continuous negative cashflows in an industry which is usually flush with cash is also a question mark..also, company pays out high dividend, without corresponding cashflow. due to this, they need to raise debt and dilute equity..on one hand, they are raising money thru issue of equity shares, on the other, they are paying out high dividend..cant understand this..

    UNQUOTE

    • Thanks for the inputs, Kishor! I’ve added the concern on goodwill to the above post. I was aware of this risk but just missed out posting in the report earlier. My fault! 🙁

      Yes, lack of positive cash flows and corresponding high dividends is a concern as well.

  27. FYI – One more concern I’ve added to the above post relates to the large amount of goodwill that the company holds on its balance sheet. I was aware of this risk but just missed out posting in the report earlier. The goodwill was largely created owing to the acquisition of CSC. My concern arises from any risk of impairment of this goodwill, which will happen in case CSC’s business does not perform in line with what OCIL expected when it bought the former. Already in FY12, the goodwill has been written off by 28%, so this is a concern that investors must be aware of, as any write-off just hurts the balance sheet.

    • Vishal,

      The impairment has already started happening with the 28% write off, so why is it a concern? Do you think more impairment can came? If the earlier impairment has not affected company valuation why should the future impairment, which may not come, affect valuation?

  28. Opto Circuits is also the company which has been paying bonus over year on year……Its good buy at this time.

  29. Vishal
    Opto continues to intrigue me and hence I continue digging.

    Low level of tax absence of MAT etc. has been debated a lot. So I again went through the annual report of Opto line by line to see if I can find explanation and I find following entries in standalone Opto financials
    Page 61
    D.) Loans and Advances 2010-11 2009-10
    MAT credit Entitlement 17,46,12,055 20,51,09,720
    Advance Income Tax 17,05,07,110 23,47,02,238

    Page 62
    Schedule I
    Current Liabilities and Provisions
    Provision for MAT 8,05,27,280 19,97,04,552
    Provision for Taxation 14,06,53,002 17,39,42,981
    Provision of Interest on Tax 3,39,42,313 1,57,05,875

    So clearly the company recognizes MAT needs to be paid, just does not run it through P&L.
    Company has paid advance income tax and Company provides for Income Tax but does not recognize it in P&L.
    (There is separate entry for provision of dividend tax of over Rs 26 Cr. This is again twice the actual amount provided in P&L FY11!! ).
    I have found no logical explanation for this accounting treatment maybe someone in safalniveshak group can help.
    For me the last entry is most worrying which is the interest on Tax and that is not a small sum. At 12% interest rate the average income tax outstanding during the year is over Rs 28 Cr!

    Funny part is as per schedule D there is credit with IT department then why interest on tax. I am sure there is some logical explanation.

  30. Is there any fixed strategy which gives defiantly profit every month

  31. The story of opto circuits over the past 12 years is too good to be true.The promoters have been able to to succesfull aquisitions year after year and simulataneously rewarding the share holders with substantial dividends and bonuses.Along with this I totally find a lot of substance in the red flags raised in this forum.

    People bullish on this stock better take a relook at the fundamentals.Dont let your ego come in your way of making a correct judgement in light of the concerns raised in this forum.

  32. Interesting discussion and I am impressed with the amount of due diligence in the comments.

    When I consider a company for an investment, my first rule is
    1) Does the company produce consistent level of Free Cash Flow (FCF). I defined FCF as Cash Flows from Operations – capital expenditures. Looks like Opto Circuit failed this test on a consistent basis.

    This is usually more than enough for me to pass on such a company. Now, I have no idea about this company as I am a US based investor. Reading the comments and Vishals report, I find issues such as
    1) Weak Balance sheet.
    2) Constant acquisitions funded by debt — this is a big red flag.
    And I am not sure how they fund their dividend if FCF is not consistently positive. Either by issuing debt or equity…

    Most investors focus on the income statement and P/E ratios. If there is one take away from this case, let it be this — if a company does not have consistent Cash Flow and FCF, then just pass on this company. If a company wants to grow by acquisitions, if it is really a good business, it will fund those from cash flows and cash on the balance sheet ( Check Infosys).

    The most vital sign of a good business is that it throws of lots of cash. Check Asian Paints, Nestle, Infosys or any of the other companies. I know this is a different industry but there is no rule to invest in an industry / companty that is capital intensive.

    Oh yes, finally this comment from Vishal

    During FY06 to FY11, while OCIL’s consolidated sales grew at an average rate of 63%, its inventory and debtors rose at rates of 40% and 56% respectively. Loans and advances to subsidiaries also increased by a sharp 107% annually during this period, thus leading to significant pressure on FCF.

    — The growh of receivables of 107% was more than the growth in Sales of 63%. Big red flag.

    No FCF means no investment

    Adib Motiwala

    • In fact Adib, the due diligence has taken the discussion to a much higher level. Thanks anyways for sharing your ideas on FCF, which is such an important metric (and thus a concerning part for OCIL). Regards.

    • Hrishikesh Kale says:

      Adib,
      I have no specific love for opto but I will reply to your questions:
      1. About free cash flows you are right and the examples given by you are also right. Unfortunately the whole world knows about these companies and the result is that they are extremely costly.
      2. About acquisitions: I read an interview of the CMD. Inventing hitech medical equipment from scratch is a very time consuming and costly affair plus there are very high chances of failure. Hence the only way to grow the product portfolio is through acquisitions. This is how opto has grown. It acquires cos in europe and usa and then transfers all of most of the manufacturing facilities either to India or Malaysia. This is their model and they have done more than 11 acquisitions in the last 10 years.
      3. About free cash flows they have admitted that they will be negative for the next 4 quarters. They have just made a big acquisition and are going through a capex plan to shift 65% of manufacturing of cardiac care to malaysia and india. Hence first the acquisition and then the establishment of manufacturing has resulting in stress on their liquidity. I read the CFO interview and he stated that market is penalizing them as they are investing for the future growth of the company.
      4. I am disapointed with their dividend policy. Opto is no Infosys sitting on 16000 crores of cash ((I call it criminal wastage). A growing company should conserve capital rather than distribute it. So long as they can maintain a good ROCE it pays to retain it. (Check the non existent dividend history of berkshire).
      5. Inventory levels are going to be high. This is because they manufacture in india and sell it world wide. Receivable are also going to be high because hospitals generally pay in 6 months time. However the level of bad debts is almost 0. So working capital requirements will remain high for opto and this is a fact and it is not as though it is a revelation as it was there all along for the last 5 years.

      I will quote an interesting anecdote I read about Shivaji. He was returning in disguise after escaping from Auragnzeb’s clutches from Agra. He was having dinner at a poor lady’s hut and was having dal and roti. The Dal was served in plate and not a bowl and got scattered in the plate. The woman said ” Dont be like Shivaji just capturing forts and increasing the mess” (Precise marathi word is ‘Pasara’. The king intelligent as he was realized his mistake and when he came back to his kingdom called a truce with Aurangzeb. For 4 years he consolidated and set his kingdom and army in order. Only when he was fully prepared he went to war again.
      I think opto should now consolidate for the next 2-3 years.

      Cheers.
      Hrishikesh

  33. Dear Vishal,
    Thanks for your analysis and 20 check points. It may be better to add the peer companies comparison, to understand and avoid the negatives affecting the whole sector over a period of time.

    Lets say example Opto, could not find any real peer company in india, which are in medical equipment business(Avoided the Siemens healthare now merged with Siemens india). Seems, Opto is fighting with global majors(specific product areas only)like
    1. Medtronics,
    2. Boston Scientific
    3. Johnson and Johnson etc.
    even though the Opto is insignificant when comparing with such biggies. There seems sector specific problems currently affecting the medical device industry and above companies. Due to current economic crisis job cut and spinning of the different business units(Stents and Cardicac) are daily news.

    Are the Opto in a scale to compare with global peers(in debt, eps, sales)? Also the problems facing such biggies can act as positive trigger for Opto business due to proposed capex and manufacturing at Malaysia and Vizag.

    Another check list point, can be though of include is the “promoter history”. In case of Opto, Mr. Vinod Rammani and his struggles in US during his early career and the promoter vision is very much valid points in guiding the direction of the company. From my knowledge, Mr . Vinod Rammani is a man of commitment, purchased his prferential shares at 3 times above,Mr. Market price in 2009-10, where Ekta Kapoor of balaji telefilms run away from the promises (buying back Star stakes) 🙂

  34. An interesting article about the founder of Eurocor, Orlowski (https://www.tdmedical.nl/file655328.ashx). His new company now directly competes with Opto Eurocor in the same area. A lot of technical information about stents and their current market development is there but very technical so I am pasting some excerpts below with my comments.

    “Orlowski stayed with EuroCor for about four more years, remaining CEO, and even helping to develop several new products. But life within OptoCircuits wasn’t easy for Orlowski. The company was more of a capital equipment company than an interventional device company, and “adding a major new product line with a big market potential was a real challenge,” he says. In fact, under Orlowski, EuroCor developed the first CE-marked drug-eluting balloon, around the same time that Bruno Scheller, MD, and Ulrich Speck, PhD, were developing their drug-eluting balloon at the Charité University Hospital in Berlin, a device now marketed by B. Braun Medical Inc., in its coronary version, and Medrad Inc., in its peripheral. (See”B. Braun’s Bet on Balloons” – IN VIVO, December 2007.)”

    AVV comment : ( This the nightmare scenario for all companies when the founder and chief architect of your products sets up a shot competing with your product)

    “Look at India,” Orlowski goes on. “Five years ago, India was a market of around $200 million in interventional cardiology devices; today,it’s $600 million, and pretty soon it will be over $1 billion.”

    AVV comment : (why does opto circuits/eurocor products are not available/sold in India?)

    “No company better suggests that new reality than Johnson & Johnson in its 2011 decision to exit the coronary stent market. Having pioneered both the bare metal and drug-eluting stent markets, J&J officials looked at the future of coronary stents and decided that the market they helped build no longer held the potential for growth and return on investment that it once did. In an interview in IN VIVO last month, Alex Gorsky, J&J’s new CEO and the person who led the decision to exit coronary stents, explained J&J’s thinking. “We’re very proud of the fact that in the stent category we were the first to come out with a bare metal stent and later the first to come out with a drug-eluting stent,” he said. “We believe we played a critical role in advancing that field, saving a lot of lives and really making a difference. But a lot of other people picked up on the opportunity and once there were four or five stents out there and we began to look at how we all were going to differentiate ourselves, we began to make some different calculations.” Gorsky, too, pointed to the high cost of clinical trials, often resulting in small differences in data, as well as the flat market, characterized by declining prices as important factors in J&J’s decision. “Take late-stent thrombosis,” he went on. “We had to ask ourselves whether if we had to invest $200 million in clinical trials to prove that our stent had a lower LST rate than our competitors by 0.02%, was it really worth it? During the time when stents were growing by
    double digits every year, perhaps you could justify that kind of investment. But the stent market is now flat and we’ve seen pricing declining each year by 8 to 10% over the past several years, and we finally had to ask ourselves, what’s better for patients, what’s better for our organization in terms of where to invest our dollars – putting it into the next-generation stent? Or the next-generation lens or endovascular device or some other area where the opportunities are better? So we made the decision to exit the stent business.”

    AVV Comment.: (Eurocor profitability is directly opposite to the above statement from J &J . In FY 2011 it reported profit of Rs. 85 Cr on sales of Rs 321.5 a profit margin of 25%. Looks like J&J wants more profit margin than 25%)

  35. Vishal

    Opto annual report is now available at the website. However after spending alot of time I was unable to understand exactly how the goodwill writedown has happened. If some one in our tribe has understood the mechanics of writedown I will be greatful if a comment can be written on it.

    Atul

    • Hi Atul, they have written off the goodwill from “Surplus” (Page 93) with the description – “Impact of Restructuring of investment in Opto Cardiac Care Ltd and Opto Eurocor Healthcare Ltd as per AS -21”.

      Also, here is a statement from the report (Page 106) on why the goodwill has been w/o – “The restructuring transaction had the effect of altering downward the goodwill booked on original acquisition since these entities have grown in net asset value, post acquisition till date.”

      • Dear Vishal

        Thanks. I also read that statement but I am confused because if the entity have grown in net asset value that means there is mere transfer of balance from goodwill account to asset account and the net impact should be zero and not negative.

        In fact the confusion increases further because if you look at note 11 page 70 you will see a 700+ crore fall in non current investment will no logical explanation. On further searching I find this note in of all places in short term loans and advances.

        ” The company has undertaken a restructuring initiative to align complementary business lines to achieve cost effectiveness and operational efficiencies. Investment of three US-based subsidiaries: Cardiac Science Corporation, Criticare Systems Inc., and Unetixs Vascular Inc., were transferred to Opto Cardiac Care Limited, Investment of subsidiaries; Eurocor GmbH and N.S. Remedies Pvt. Ltd. were transferred to Opto Eurocor Health Care Ltd. both being wholly owned subsidiaries of Opto Circuits (India) Ltd. Each Consolidated business will operate with shared resources and will bundle product offerings, augmenting possibilities for enhanced share holder valuation. Due to this restructure of investments, the investments amount has been transferred to loans and advances. The total loans and advances transferred was ` 936 crores out of which the company has recovered adjusted ` 349 crores from the subsidiary. The remaining amount of ` 587 crores will be collected depending upon cash flow situation of the subsidiary.” .

        I think all these are connected. So the investment has become an short term advance. So a balance sheet item is transferred to p&L? Maybe I am reading too much

        By the way look at page 110 there is and entry share application money Rs 160 cr in Opto cardiac care. No explanation as to who is investing and imapct if any on Opto. I suspect this is also connected with this goodwill issue.

  36. Hi Vishal,
    I am a new subscriber to your blog and looking forward to interacting and learning.
    The financial metrics you’ve used in your research (EBITDA margins of 15%, current ratio > 1.5%, etc) have been uniformly applied across your stocks which are in diverse industry verticals (BHEL, Infosys). Could you explain the rationale behind this? I am curious to see if you use the same benchmarks for small to medium sized companies, which according to one of your comments, you plan to write about in future.
    -Giri

  37. Kumaran Seenivasan says:

    Guys,
    I feel people are over analyzing this stock. I might be wrong but I feel the following.

    1) This company is over analyzed like none. I have not seen investors analyzing and dissectring each and every line item for any other company. Of course this is good, but you will not find even 2 stocks in India if you do that. No matter what great company it is, you will find some negatives in the financial statements.

    2) If everything is good and this is a great, great company and they have the financial statements in the way you expect them to be, then this company WILL NOT BE trading at this price. It will be trading something like Rs. 350 and you would not be in a position to buy it.

    I have actually posted a detailed article regarding this on my blog in case if you are interested to go through.

    3) Great investments are made when there is short term pain for a company and not when everything is good.

  38. I was doing a bit of research on Opto Circuits India Ltd and stumbled upon your piece of analysis. Looks like you have spent time to do thorough research. As you have pointed out at that time that company has negative cash flows and I think that one thing should make alarm bells ringing because OCIL operates in Niche Medical Products and buyers usually have to pay up promptly. Stock has fallen quite a bit after your analysis and I think one should be careful buying such stocks even at current level unless one keeps strict stop-loss. I think PL account and balance sheet are not transparent. Wish Veritas will dig deeper into this one day.

    • Dear Safal Niveshak,
      I am looking at this page after many weeks I see there has been a lot of talk about this company. I believe it would be fair to assume that you have done your analysis of the annual report of Opto circuits for FY 2012. Your comments regarding the same would be appreciated. Thanks

  39. “In three years, we want to be USD 1 billion [Rs 5,400 crore] in revenue,” says Valiveti Bhaskar, CFO, Opto Circuits. From its current revenues of nearly USD 440 million (about Rs 2,376 crore), that implies a growth of over 2.2 times.

  40. Thanks for your insights on OCIL. I can’t understand why the consolidated balance sheets of OCIL are so difficult to understand. WOuld it not be advisable to look only at the stanalone figures?The c/f values are not the same and cant understand the method in which the acquisitions have been accounted. It would be a great help if you can throw some light.

  41. Dear Mr. Vishal,
    Opto is struggling & discussions been nil here.
    Could you provide uopdates of present situation WRT q2 results announced recently.

    br
    Mnju

    • Is there an Unusual delay by Opto Circuits’ management in conveying material information about the business to its shareholders? Does this show lack of corporate governance? Two points to worry about.

      1) They disengaged the services of credit rating agency ICRA on July 4, 2012, but they informed the shareholders about this material information only on August 14, 2012. A Big difference of almost 40 days !!!

      Source:

      Sparring ICRA, Opto Circuits leave investors on the ropes
      MUMBAI, AUG. 28:

      https://www.thehindubusinessline.com/markets/stock-markets/article3831998.ece?ref=wl_opinion

      2) They engaged a new credit rating agency CRISIL on July 4, 2012. In a public statement on August 23, 2012, the management of Opto Circuits said that the CRISIL rating and report will be available in a couple of weeks. It is an entire month now. What happened to those new ratings?

  42. Finally Opto got a investment grade rating. Ultimate rating shopping.
    “BSE Announcements on Opto Circuits. Opto Circuits (India) Ltd has informed BSE that the Company has secured BBB+ (pronounced ‘BWR Triple B Plus’) rating from Brickwork Ratings India Pvt. Ltd. for its fund based working capital facilities. The rating indicates a stable outlook…..”

  43. I’d be circumspect on Opto Circuits. The company CFOs continue to be much below the declared PAT. However what puzzles me the most is the fact that while the receivable days are 165 the payable days are only 47 on consolidated basis. What makes it so? Is it sale to related parties, forced sales??? What makes an industry structure so lopsided?

  44. Dear Vishal,

    Is it time to include this stock in the list of dud stock, considering the recent developments like late disclosure on change in company sec., sentiment boosting actions like issuance of warrants to promoters (I have noticed that they tend to do this just to boost the market sentiment, especially if the promoters knows the business is not doing well), no news on Crisil rating since June. Is this one more 3I infotech or bartronics or mic electronics or allied digital kind of stock. Is it worth holding on to this stock or should you go an average it out? Please throw some light on it…. All the stocks mentioned above were market analyst fancied mid/small cap stocks along with opto circuits and all of them are out of shape now, is it time to add opto to that list??

  45. Hi Vishal,
    Firstly let me start by appreciating your analysis and your honest efforts in building tribesman with great analysis and knowledge bank. While there is lots which has already been talked about OCIL I would like to know what is ur reading of the situation especially in light of there proposed 12th Feb 13 event
    Regards
    Varun Malik

  46. Why no one is talking about FII selling in this stock ? since last quarter , more than 10 FIIs have exited this stock and only HSBC has added it to their portfolio.

  47. Vishal

    Well the stock price movement is telling us that there is a serous risk to existence of Opto as a “going concern”. It is time for you to accept it explicitly rather than waiting for fundamental confirmation. The stock still trades in the fifties so people have still chance of recovering some money.

    AVV

  48. DNS AVATAR says:

    sir,
    I read your detailed report on Optoi Circuits.

    I wish to know, where this Company went wrong and left with huge losses to investors.

    Is there any issues with the quality of the management of this Company and are they really sincere and honest.
    Is the Management of Opto to keep and committed to bring back the Company on the tract.
    More importantly, why there is no follow up analysis for your above report.
    What is the answer you give to the investors who invested in Opto based on your above report.

    Kindly give your feedback.

    Thanks and regards,

  49. Avatar Damerla says:

    Dear sir
    I am still holding huge qty of OCIL hoping that it will revive anytime. Holding quantity increased due to my averaging over a period of time. Now I am struck and waiting to find an opportunity to exit.

    Would request you to give your view whether OCIL has the ability to revive at all, even after 100 FDI in medical equipment a bill passed.

    My average price is Rs 10/- over the current market price.

    Your advise will be an important one for me and a life saver.

    Thanks and regards,

  50. Avatar Damerla says:

    Sir

    I wish you should rework on OCIL in the current scenario and give your valuable advise to those small investors who got caught and waiting patiently for its revival.

    You need to take up with OCIL management and have your review to the current situation and give your findings to those who got caught in OCIL.

    Hope above is not a big task to you, considering the learnings can save a many small investors like me.

    When is your next programme in Hyderabad next?

    Thanks and regards

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