Opto Circuits’ shares, which had plunged from Rs 157 levels after ICRA downgraded its rating for the company’s long-term debt, have recovered partly from the low of Rs 115. Analysts believe the issue raised by the rating agency about the debt and working capital are largely known and do not really change the outlook for the company, which is why the counter has seen some buying at the lower levels. The confidence also stems from the fact that the company is taking steps to enhance its financials.
“We maintain our Buy rating, as the company is taking steps to improve its earnings quality, which could help it to get a better credit rating from its new agency, CRISIL, and address long-standing investor demand for stronger cash flow,” says Sanjaya Satapathy, who is tracking the company at Bank of America (BofA) Merrill Lynch in a recent note published after the ICRA downgrade. The promoters and a few funds like HSBC Global Investment Funds have also raised their stake in the recent fall. At Rs 137, the stock is trading six times its FY13 estimated earnings and is offering a 2.2 per cent dividend yield. Further gains will depend on the company’s progress in resolving the working capital issues.
There is certainly a working capital issue given the nature of the company’s business. The issue came to highlight as it is now hurting the liquidity position and the ability of the company to service its debt. This is despite its debt to equity ratio being just 0.7 times and interest cover of nine times. In 2011-12, the company made a cash profit (net profit plus depreciation) of Rs 626.6 crore. However, a large part of this got deployed in working capital, which rose by Rs 478 crore. The remaining was obviously not enough to cover the capital expenditure (capex) requirement of over Rs 330 crore, dividend of Rs 84.2 crore and importantly, to repay part of its debt. This led to fresh borrowings, leading to an increase in debt levels from Rs 884 crore in FY11 to Rs 1,101 crore in June 2012. This cycle could repeat and the pressure could mount in the current financial year (and next year) if the company does not improve its cash flows.
Possible outcome
While there is a need to make the ends meet, the Opto management does not want to cut dividends. And, in terms of capex (Rs 300 crore in FY13) also, they said it would have to be undertaken as the company is shifting its manufacturing operations from the US and other high-cost markets to India and Malaysia, part of which is already done. The benefits of this will be seen on the improvement in operating profit margins and a further cut in working capital requirements. Since there is less leeway on these fronts, the management is working on bringing down its working capital requirements. The company has estimated the additional working capital requirements to the tune of Rs 159 crore (FY12 Rs 478 crore). This on an expected operating cash flow of Rs 625 crore should be sufficient to take care of its capex, dividend and service of debt in FY13.
In this direction, the company has already brought down the debtors’ days to 131 days in FY12 compared to 156 days in FY11. Also, during the same period, the inventory days have come down from 100 days to 79 days. From here on, the company is looking to bring down its working capital needs by 10 days from the current 180 days, which if implemented could bring down the funds requirements by another Rs 80-90 crore. “If you look at this quarter, we are 20 days better than the last quarter. We are improving on our working capital cycle every quarter. Liquidity is getting better and better. We have paid Rs 68 crore approximately in terms of loan to HDFC (Housing Development Finance Corp) in the last quarter,” says Vinod Ramnani, chairman and managing director, Opto Circuits.
“Opto Circuits is looking to turn free cash-positive in FY13 and generate substantial free cash from FY14 onward, as its investment is coming to an end,” says Sanjaya Satapathy, analyst, BofA Merrill Lynch. The company also said that once it pays off the Rs 100 crore of term loan, it should see free cash at the end of FY13. While these are some positives, investors need to monitor this.