Eltek's 2015 And 2016 Are Like Day And Night

| About: Eltek Ltd. (ELTK)

Summary

Eltek has experienced a significant reduction in its profitability margins.

Sales for Eltek are slightly up, but do not offset the impact of smaller margins.

Eltek's CEO provided little reassurance of having a prosperous 2016.

Eltek Ltd. (NASDAQ:ELTK) is a printed circuit board manufacturer (PCB) headquartered in Israel. ELTK has been around for more than 40 years and serves customers in a plethora of countries worldwide. The majority of ELTK's sales come from Israel and the United States. ELTK had a profitable year last year, but the company is off to an unfavorable start in 2016. In the first quarter 2016 earnings conference call, CEO Yitzhak Nissan even expressed uncertainty with his belief that it is too early to tell if 2016 may be a profitable year for ELTK. While seasonality may cause some variation, this overall trend may continue in my opinion for a number of reasons.

Price competition in Israel is hurting ELTK's pricing power. The competitive environment is putting pressure on ELTK's margins. The company is making less profit despite making more sales. Nissan discussed the company's technology's ability to capture more sales and projects, yet the outlook isn't positive. With a gross margin that is significantly less than previous quarters, overall sales growth would have to be in the double digits overall in order to even offset this. ELTK's only bright-side is the North American market where sales grew double-digits. This market accounted for 51% of total revenues, compared to 48% previously. ELTK's penetration pricing enabled it to capture market share in North America; however, ELTK will have to maintain low margins if it wishes to keep sales growth up in a region not close to home.

Despite growing revenue 1% overall over last year's first quarter, ELTK experienced an unprofitable quarter. Gross margins for the quarter were 9.57%, compared to 16.35% for the prior quarter. This drop in per unit profit is not a singular occurrence. The second quarter of 2015 saw a stronger gross profit margin of 18.3%, while the third quarter witnessed a decline to 15.74%. Despite having some positive eps of .10, 2015's revenue was the lowest ELTK has received since 2010. From this data, it seems like ELTK's prospects are dim. Lower margins in Israel are due to an increasingly competitive environment in Israel, which is not expected to let up anytime soon. This represents an unfortunate trade-off. If ELTK increases margins in North America, it'll likely lose steam in its sales growth in the region. Raising margins in Israel forces ELTK to give up valuable market share. The net effect of lower pricing in Israel and greater sales in North America is a slight uptick in revenue and a plunge in earnings.

If shrinking profits weren't bad enough, ELTK's cash conversion cycle is widening each quarter. In the third quarter of 2015, the days it took to go from cash-to-cash was 217.15. The fourth quarter cash conversion cycle expanded by 6% and the first quarter of 2016's cash conversion cycle grew 1%. ELTK is becoming less efficient in terms of cash conversion. ELTK's working capital days of 17.19 also compares unfavorably to 2015's 5.09 working capital days. This suggests poor management of inventory, tying up cash in slow-moving products.

This, along with lower margins, suggests an ability to sell inventory swiftly, in volume and at favorable margin. While the company has sufficient current assets to meet short term needs, the reliance on short-term and long-term borrowing suggests an ability of operating cash flows to meet its current operating, financial and investment obligations. The trend suggests that liquidity may become an issue in the future in my opinion, as the operating cash flows struggle to meet the demands of financing. While ELTK has maintained a steady amount of common shares outstanding, further build-up of liabilities with insufficient cash flows may make equity financing an attractive option. It may take some time, if ever this were to happen, as the company has a decent supply of cash and cash equivalents.

Going forward, ELTK seeks to gain ground in North America and reduce its reliance on the Israeli market. The pricing in the Israeli market for PCBs will continue to be unfavorable for the foreseeable future. Too many competitors and a current inflexibility in manufacturing have hindered ELTK's progress. Nissan discussed improved flexibility and abilities to meet small volumes and customizable orders to improve profitability. A 6% decrease in sales to ELTK's home market was met with increased manufacturing costs. Given the need for smaller volume and customizable orders, manufacturing costs are expected to rise in the second quarter in my opinion, matched with similar margins and marginal sales growth. I expect another unprofitable quarter. Pricing pressure may eventually cause competitors to exit or consolidation to occur, but don't expect this happen immediately in my opinion .

When asked what ELTK could do if the share price drops below a threshold of $1, CEO Yitzhak Nissan discussed where the share price was then (slightly above $1) and when ending his statement about believing the share price will stay above $1, he said, "Lets' hope so." While it is narcissistic to be able to claim to know the future action of any stock, one would think the CEO, and current major shareholder, of ELTK would provide more reassurance than hope. Given the CEO's uncertainty and the downtrend in margins, sales, and sentiment, ELTK is a decliner and its share price should reflect this. I believe shorting ELTK to .89 (a price from which it consistently rebounds) could prove fruitful if initiated at current prices. As the trend suggests, at the expense of profits, sales may be minimally up at the next earnings report, but eps will likely be incomparable to last year's figure.

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I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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