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We love Richardson Electronics, Ltd. (NASDAQ:RELL). It’s one of our favorite stocks – one of our Top 5 Faves for that matter. Our research, which includes analyses of the company’s operations, conversations with management, and on-the-ground due diligence, has led us to believe that we have a solid stock on our hands with multi-bagger potential.
However, we won’t shy away from holding management’s feet to the fire during our live chat events. That is kind of what one of our GeoInvesting Premium Members did in a February 23, 2022 Fireside Chat we had with 2 members of the senior management team, Ed Richardson and Wendy Diddel, CEO and COO, respectively.
Sometimes, management of public companies need to answer tough questions to satiate investors’ appetite for transparency when it comes to the reasons they make certain decisions, or for accepting things as they are. They want executives to be pragmatic.
Most investors will agree that addressing concerns head on is the best approach management can take.
The member brought up the subject of Selling, General and Administrative expenses (SG&A), and why the line item comprised 30% while the Earnings Before Taxes, Depreciation and Amortization (EBITDA) margin ran low (as of 2021, 3.57%). He made the point that RELL was not so much a contract manufacturer, but more of a technology company. Companies performing well in the tech sector can typically garner EBITDA margins of near 10%, and that even contract manufacturers often get bought out at EBITDA margins of 7 to 8 percent.
So, we do see the angle that he was trying to take. Ultimately, he wanted to know if, in light of infrastructure buildout to meet increased customer demand, RELL could eventually bring those margins up. And would it make sense for the company to consider the prospect of seeking suitors?
“You talk about building out the infrastructure. But if you look at your SG&A, and you guys talk about gross margin a lot, but you look at the real EBITDA margin numbers. I mean, obviously, they’ve been quite low. And earlier, Wendy mentioned you’re not a contract manufacturer – it would seem as if you have more technology than a contract manufacturer – but even contract manufacturers that are getting bought in the public market have 7% EBITDA margins or 8% EBIT margins. Has that really been the story? The reason the EBITDA margins aren’t 10% or 9% is because you’ve been building out this infrastructure? Because it seems like over the last five years, the EBIT the EBITDA hasn’t really been there and SG&A is running like 30 something percent.”
“So from that perspective, we’re not investing as much in additional equipment, because we’ve already built the factory. So that’s going to be something we grow into. And that’s going to help that bottom line number that you’re asking about.
In general, our SG&A increases – about 3 to 5% is what we always estimate – year over year, and a lot of that, as Ed said earlier, has to do with merit and employee increases. We are very stingy when it comes to adding a lot of people, although certainly right now, we’re adding engineers, and we’re adding manufacturing folks. So this year is a little bit different. But our SG&A is still below what we had planned and in line with our expectations. So as we grow that top line, there’s not a lot of additional SG&A.
When we are successful with improving the CT to production [for medical scanners], with the manufacturing of some of these new products that Ed mentioned, including the ultra 3000 and more products that are in the ultra capacitor range, those all carry higher margins. So our gross margin should improve over time and with our SG&A staying fairly low, I won’t say flat. but you know, a 3% increase. You do the quick math and about 60 to 70% of the incremental gross margin drops right to that bottom line. “
Looking at the historical gross margins, they have been within a few percentage points of 30% for the past 5 years, so at face value it might be hard to believe that the increase in margins Wendy is talking about will make a substantive difference.. Where will the margin blend ultimately be across all of the company’s segments?
When the subject of $15 million in headquarter management costs was brought into the conversation, it could be inferred that the member’s concern included how the top 5 key executives wrangled in a decent collective pay of $3.45 million in 2021.
To be honest, we don’t think it’s unreasonable to bake a 3% raise into employee compensation year over year. If everything that RELL is saying is true about the massive growth opportunities in front of them and if the company hits its targets we may not have to worry about a debate about salary or hiring more employees.
Overall, while we think Wendy and Ed could have given higher level answers to the members’ questions, their bird’s eye view wasn’t so bad. In our opinion, it was enough to help investors appreciate the nuances of the company’s current endeavors. However, if the company starts to falter on its growth plan, it will be interesting to see if activists will circle the company.
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