This article provides in-depth fundamental analysis of Salzer Electronics Ltd, an Indian small cap manufacturer of cam-operated rotary switches, toroidal transformers, isolators, modular switches, relays and other electrical goods.
Salzer Electronics Ltd Research Report by Reader
Q: Hi Vijay, Can you please let me know your views on Salzer Electronics Ltd for the long-term? Below is my analysis on this:
- L&T is the major stakeholder in Salzer Electronics Ltd.
- Their sales are increasing at 15% YOY. They are expanding their exports aggressively.
- Debt to Equity ratio is 0.8
- Recent March results of Salzer Electronics Ltd are also showing the positive momentum. OPM is consistently at 12% and cash flow is positive as well.
- Total net profit for this is INR 11.98 cr compared to last year INR 8.44 cr.
- Recently, astute investor Vijay Kedia bought 200,000 shares in Salzer Electronics Ltd and stockbroker, Sharekhan, has a strong buy call on this for quite some time.
Dr Vijay Malik’s Response
Thanks for writing to me!
Financial Analysis of Salzer Electronics Ltd:
Salzer Electronics Ltd has been growing its sales at a moderate pace of 15-20% year on year since last 11 years (FY2005-15). During this period, the operating profit margins (OPM) have been consistent at levels of about 12-15%, which is a good sign as it indicates that Salzer Electronics Ltd is able to pass on the increase in raw material costs to its customers.
However, when we observe net profit margins (NPM) of Salzer Electronics Ltd, then we see that NPM has been declining consistently over the years. Looking at the data, it becomes obvious that the main reason behind the decline in net profitability is continuously increasing interest cost. Interest cost has increased from INR 1 cr. in FY2005 to INR 12 cr. in FY2015.
Over the years, the tax payout ratio of Salzer Electronics Ltd has been fluctuating from 13% to 29%. The tax payout ratio is increasing in recent years. It indicates that there might be certain tax incentives, which Salzer Electronics Ltd was getting, that are currently in the process of getting over. An investor should study it in detail to understand whether Salzer Electronics Ltd has received any such tax concessions etc. from govt.
Operating Efficiency Analysis of Salzer Electronics Ltd:
Operating efficiency parameters of Salzer Electronics Ltd reflect that it was able to improve its efficiency levels during initial years of the period analysed, but the improving trend has reversed during recent years. Net fixed assets turnover improved from 2.6 in FY2005 to 3.8 in FY2012. However, since FY2012, the net fixed asset turnover has declined to 3.6 in FY2014. Similarly, inventory turnover ratio of Salzer Electronics Ltd has also declined from 5.3 in FY2011 to 4.4 in FY2014.
Declining fixed asset turnover and inventory turnover are not good signs, as they indicate decrease in the efficiency with which the company is able to use its assets. Under such situations, a company needs to put more and more funds in its operations to maintain and expand its operations. With low net profitability margins, as discussed above, Salzer Electronics Ltd is not able to generate sufficient funds from its profits that can fulfill its investment requirements.
Salzer Electronics Ltd has to rely consistently on the alternative sources of cash like equity and debt, to fund its operations. This is visible by increasing share capital over the years, which in absence of any bonus issue in the period analysed, indicates that Salzer Electronics Ltd has been diluting its equity over the years. Debt level of the company is also increasing year on year, as Salzer Electronics Ltd is not able to complete its funds requirement from profits and equity dilution.
Debt levels of Salzer Electronics Ltd have been increasing year on year. Total debt of Salzer Electronics Ltd has increased from INR 14 cr. in FY2005 to INR 80 cr. in FY2014. If one notices closely, then one would observe that the debt has increased sharply from INR 57 cr. in FY2012 to INR 80 cr. in FY2014. This is the same period during which fixed asset turnover and inventory turnover has deteriorated.
Increasing debt levels lead to low profitability margins due to increasing interest costs. Higher interest costs, in turn, reduce the money that is available for investment from profits. Reduced profits increase the dependence on debt or equity to fund operations & growth, which in turn increases the interest costs and a vicious cycle ensues.
Investors should be cautious of investing in companies, which have continuously increasing debt levels, as high debt has the potential of increasing the risk of bankruptcy and reduced profitability under tough business conditions.
You should read the analysis of two other companies: Ahmednagar Forgings Ltd and Amtek India Ltd, to understand the impact low fixed asset turnover can have on the debt levels of companies. You may read their analysis here:
Salzer Electronics Ltd has been able to convert its profits in to cash flow from operations. PAT for last 10 years (FY2005-14) is INR 58 cr. whereas the CFO over the similar period is INR 74 cr.
You have mentioned that Salzer Electronics Ltd has shown good results in March 2015 quarter. However, performance of any one quarter should not be considered for taking investment decision in any stock. The investment decision should be based on performance in the long term.
Investment by others should not be the reason for any investor to put her money in any stock. There are many reasons behind it:
- Their analysis might be wrong, as others are also human.
- This investment might be very small portion of others’ portfolio and they may afford to lose entire money in this company.
- Others might have different risk appetite.
Therefore, I believe that every investor should do her own research and invest if she find the opportunity attractive. She should not follow others’ while putting her hard-earned money in any stock.
Margin of Safety in the market price of Salzer Electronics Ltd:
However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.
In the absence of any strength in the business model of the company, a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.
- 3 Principles to Decide the Ideal P/E Ratio of a Stock for Value Investors
- How to Earn High Returns at Low Risk – Invest in Low P/E Stocks
- Hidden Risk of Investing in High P/E Stocks
Overall, Salzer Electronics Ltd seems to be a company growing at a moderate pace but unable to maintain its profitability margins due to increasing interest costs because of increasing debt burden. Salzer Electronics Ltd has seen its operating efficiency declining over the years, which have led to equity dilution, and increasing debt levels. An investor should keep a close watch on its operating efficiency parameters and debt levels. Investors should analyse Salzer Electronics Ltd further to understand the reasons for fluctuating tax payout ratios.
These are my views about Salzer Electronics Ltd. However, you should do your own analysis before taking any investment related decision about Salzer Electronics Ltd.
You may use the following steps to analyse the company: “How to do Detailed Analysis of a Company“
Hope it helps!
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- The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
- I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
- Currently, I do not own stocks of the companies mentioned above in my portfolio.