TEL - Bel Fuse: Margins - Check Revenue Growth Next Up On Management's To-Do List

2023-11-09 02:18:40 ET

Summary

• Bel Fuse has undergone a significant transformation with the appointment of a new CFO, signaling a new era for the company.
• The company has made bold moves to improve margins, including closing/consolidating certain operations, selling assets, and walking away from unprofitable business.
• The company sells into growing aerospace and e-mobility markets, but these are only about 10% of revenue right now, and a recent M&A move could be a misfire.
• Until Bel Fuse can pivot to consistent top line growth, it is a Hold for investors looking for long-term compounders.

The Business Model

Bel Fuse ( BELFA , BELFB ) designs, manufactures, and markets "a broad array of products that power, protect and connect electronic circuits." (Source: Q3 10-Q , p.18) The company has 3 segments, Connectivity, Power Solutions, and Magnetics, and sells its products into a variety of end markets.

Bel Fuse's footprint is impressive for a company of its size. It manufactures and sells around the world.

New CFO, New Era

I pay a lot of attention to a company's management. Over time, it's a key differentiator between companies that grow earnings and add value, and companies that don't.

Bel Fuse ushered in a new era when it hired Farouq Turweiq as the CFO in February of 2021. Mr. Turweiq came to the company from the investment banking world. He was "getting jealous" of the operators and decided to make the jump to Bel Fuse (1:45 of this video ).

Since then, the company has made a series of bold moves that increased profitability dramatically in a short period of time (more on this later). We don't know whether Mr. Turweiq's signature was on all of these moves, but the timelines line up, and Bel Fuse has implied his hiring a watershed moment.

Note the box at the top left of the presentation. Mr. Turweiq's hiring is the starting point for the "Journey of Change."

Bold Moves

Profitability and Balance Sheet Improvements

The company has made a series of moves since February 2021 to improve profitability and bolster the balance sheet:

• Increased prices on business that wasn't profitable (2021-22)
• Hedged all $60M of remaining term debt at ~2.5% interest through August 2026 (completed December 2021, seems prescient now, 10-Q p.13) and paid off the remaining balance of the revolver (Q2 2023)
• Closed/consolidated 4 facilities (closed Tempe, AZ, and Sudbury, UK; combined two China facilities into one larger facility, 10-Q p.12, ~$5.4M in annual run rate savings to be realized in 2024)
• Sold its New Jersey headquarters of 20 years for $5.9M, moving 25 employees to a more cost-effective location (June 2023)
• Sold its "non-core" Czech business for $5M (June 2023, divesting $5.2M in annual sales)
• "Walked away" from $9M in unprofitable business ( Q3 Conference Call , CEO's intro remarks and Mr. Turweiq's Q&A)

Some of these moves showed up in gross margins, which increased from 22% to 35% in 10 quarters.

Companies sometimes "cut corners" in order to improve margins, compromising long-term profitability for short-term gain. Bel Fuse clears a couple of quick checks here. R&D is up slightly YOY and tracking for ~$24 million in 2023. Inventories have come down about $30 million from their post-Covid peak to $140 million, but they are still in line with Bel Fuse's historic inventory as a percentage of revenue.

Net Cash

These actions have strengthened the company's balance sheet. Here are highlights from the Q3 report, which are admittedly eye-catching for a company with a $670 million market cap.

• $30 million increase in cash QOQ
• $100 million total cash position
• No increase in LTD of $60 million QOQ
• Net cash position of $40 million (over $3/share, on ~12.8 million shares outstanding)

The market reacted favorably to the Q3 report pushing up shares 35% from $40 to $54 after the announcement (since settled back to $52). Even after this pop, Bel Fuse's EV/Operating Cash Flow still sits at a low 6.5x.

Pivoting to Growth

So why is the market giving Bel Fuse such a low multiple? The company has been mired in a cycle of no revenue growth for 6 quarters. Here is another view of gross profits with revenue added.

It's a busy chart, but I included the data table because it's important to see how the improvements in margin percentage from the first chart are having diminishing returns on margin dollars due to revenue rolling over. June and September are Bel Fuse's strongest quarters, but gross profit dollars barely budged over the seasonally weakest March quarter.

Also, the company is guiding for only $150 million in Q4 revenue at the midpoint, which would be down 12% YOY.

Management Offsite A Springboard?

Management recognizes that it's time to pivot to growth.

This journey slide was shared above. I repeated it here with emphasis to show the timing of the Executive Offsite meetings. The big question now is whether management can grow revenue as successfully as they improved margins.

If the company developed a 3-5 year strategic growth plan coming out of the Offsite Meeting, it would have been nice to see something on this in a presentation.

Organic Options

A company can grow organically by (1) maintaining share in fast-growing end markets, and/or (2) winning new business, either with existing customers or by adding new customers.

Growing End Markets

Bel Fuse touts that it sells into two growing end markets.

These markets combined make up ~$70M of Bel Fuse's last 12 months sales, so only about 10% of total revenue. Growth in these markets is not going to move the needle much, even with the impressive growth rates. Management will still need to find growth elsewhere.

Growing Customer Share

Bel Fuse competes in highly competitive markets against behemoths like Amphenol ( APH , $12 billion annual revenue) TE Connectivity ( TEL , $16 billion) and Littelfuse ( LFUS , $2.4 billion) as well as smaller players (but still bigger than Bel Fuse) like Bourns, Artesyn, and Murata.

Can the sales team find new prospects and build relationships that lead to bids and proposals? Can the engineering team out-engineer competitors and build more cost-effective/high-performing products? Can Bel Fuse identify and capture niches where bigger players do not want to compete?

And if they can, what is the time frame? Bel Fuse's products are mainly components. The company make parts that go into bigger systems. If they successfully engineer and sell new products today, how long will it be before these "wins" impact the bottom line?

M&A

Management says that M&A is on their radar. Can they execute acquisitions successfully? The balance sheet is in great shape so no issue there.

But the company's recent move is a head-scratcher. In February, Bel Fuse purchased 1/3 of Innolectric AG. According to the press release , Innolectric is a German company working on fast-charging systems for the EV market. So far, so good.

The cost of the 1/3 stake was $8.8M, which can be found in the September 10-Q on p.8. The press release did not mention that Bel Fuse would also be loaning Innolectric money to meet working capital needs.

Also, the release says Bel Fuse has the "option" to buy the remaining 2/3 of the company if it meets certain milestones, but according to the 10-K, Bel Fuse has "committed" to buy the rest of the company upon meeting EBITDA targets. That's a big difference.

So Innolectric needed $1.9 million over the first 9 months of 2023 for working capital, and Bel Fuse loaned them the money at the low interest rate of 5%.

If Innolectric does not meet goals, Bel Fuse will end up with a minority interest of questionable value. Under this scenario, the capital could wind up trapped, with Bel Fuse having to make hard choices about putting more money into Innolectric, a company it does not control, or writing off the investment.

If Innolectric does meet goals, then Bel Fuse is obligated to buy the remaining 2/3 of the company. What are the EBITDA goals, and what is the price for the remaining 2/3? Would it be $17.6 million, or potentially higher? Candidly, I'm surprised this was the best Bel Fuse could do for their $10+ million. Management must be very confident in Innolectric's prospects.

The Bottom Line

Bel Fuse is Hold at 6.5x EV/OCF. Since Mr. Turweiq came on board, the company has turned a corner on profitability and become a consistent cash generator. This cash flow has strengthened the balance sheet and put the company in a position to invest for organic growth, make acquisitions, or even start a buyback program.

To earn a Buy rating, Bel Fuse will have to show it can grow the top line, as this is a key test for long-term compounders. Company leaders focused on growth at the Executive Offsite meeting in June, but until their efforts begin to show traction, there are better options for fresh capital, especially in the small cap space.

Additional Disclosure

I started buying Bel Fuse in September 2023. It's a 2% position in the portfolio (ranking #18 out of 20 stocks in the portfolio by current value) and my cost basis is $45.80.

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