A continued focus on efficient, sustainable business profitability.
As earnings season progresses, I was looking at some of the top movers, including Bel Fuse, an electrical components manufacturer. Shares are trading up 23% post-earnings release, reflecting the increased profitability stemming from gross margin expansion.
Bel Fuse is a multifaceted company specializing in three core product segments. In Power Solutions and Protection, they provide a diverse range of power conversion and circuit protection products used in servers, networking, industrial applications, and consumer electronics. Their Connectivity Solutions encompass a wide array of connectors and assemblies tailored for military, industrial, and IoT applications, while Magnetic Solutions offer integrated connector modules, power transformers, and components to enhance data transmission and power distribution.
Bel Fuse is a profitable business that has ~$450mm in backlog (orders placed but yet to be fulfilled), which has declined 20% as customers use their existing inventory. When thinking about operational efficiencies and margins, there are two main ways to drive margins: cost reductions or price hikes. However, as businesses scale, they may have a third option to expand margins. This includes shifting the product mix (amount of sales generated from the individual products) in a more favorable way.
In the case of Bel Fuse, this could mean shifting away production and sales from low margin businesses to focusing sales efforts on higher margin products. This third way is demonstrated in their recent quarter with the CEO’s remarks:
“The 600 basis point margin improvement was largely led by favorable product mix, with a higher volume of products going into aerospace and defense, eMobility and rail applications as compared to last year’s third quarter. Further, our low-margin expedite fee revenue was $1.0 million in Q3-23, down $8.4 million from its level in Q3-22.”
In their financials, we can see that the Magnetic Solutions products are low margin, but in Q3’23 sales from this segment fell by ~50%. This means from a weighted average perspective, the lower margins have a smaller effect on the overall margins of the business. Further extenuating this shift, sales of Connectivity and Power and Protection Solutions, high-margin products, increased 21%.
To better understand this concept, imagine the extremes. If Product 1 brings $100 of sales and 5% margins and Product 2 brings $1,000 of sales with 90% margins, then the margins will be more closely skewed to 90%, specifically, 82%.
