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Micro-Cap Valuation: United Guardian Inc.

August 18, 2011 | About:
Ameya Pandit

Ameya Pandit

0 followers
ABOUT ME

Stumbling on Graham's "The Intelligent Investor" 12 years back changed my perspective on investing. Before that, I had never ventured into the stock market in particular. Over the years, I have read books on different areas of investing: its origins, risk and probability. I am of the opinion that if anyone is doing serious investing, then it has got to be value investing. It is the perception and probablistic evaluation of the true value of business that makes this game so enjoyable.

PHILOSOPHY

In search of stable business with a high growth potential (domestic or international), I stumbled across a company called United Guardian Inc. (UG). UG is categorized as a small-cap business. The screening criteria was strict enough since venturing in the mid- or small-cap world has its share of adventures and pitfalls.

Further, I made it a point to look at businesses that are established, have demonstrated growth through earnings and cash flows and, importantly, are in easy to understand sectors of the economy. In order to provide a safety net, considering the size of the company, dividend payout was taken into consideration to understand management diligence in returning cash to the shareholders for returns below the cost of capital. UG fitted the criteria beautifully. UG, established in 1942 started publicly trading in mid-80s, is into the consumer non-cyclical sector and manufactures products in the Personal and Household industry. I particularly like this sector and industry as it is a easy to understand, repetative, and has fairly predictable cash flows.

Numerical snapshot

- ROE (5 yr. avg.) >= 20%

- ROE (TTM) = 29.12%

- zero debt

- 10 yr. EPS growth >= 5%

- high dividend payouts

- NPM = 27.69%

ANALYSIS

United-Guardian Inc. ("United") is a diversified company that conducts research, product development, manufacturing and marketing of pharmaceuticals, cosmetic ingredients, health care products, medical devices and proprietary industrial products. A lot of details about the nature of the business are given in 10-Ks, however, I will touch on some important points. It operates as a single business unit with products in personal care, medical, pharmaceutical and industrial. All of these products are marketed through marketing partners and distributors. ISP is one of their major distributors. Per their latest 10-K, pharma products are sold through major full-line drug wholesalers; personal care products are sold outright to the marketing partners; and the medical and industrial products are directly sold to the end users. What is interesting is that the company claims to have a pipeline of products ready to be marketed that are currently under various stages of development. With a pipeline of products being developed, the company has a chance to diversify into those.

Here is a brief description and segments of products the company is involved in.

Personal care -- ingredients used in moisturizers, skin creams, cleansers, makeup and body lotions

Medical -- lubricants for catheters, prelubricated enema tips, pre-lubricated condoms

Pharma -- prescription drugs to prevent calcifications in urethral catheters and the urninary bladder infections, which have received regulatory approval in the U.S.

Industrial -- Products that are used in detergents and water insoluble materials

Economics of scope is prevalent since the know-how is spilled over to different sectors, e.g., the lubrajel variants in the personal care are also used in the medical sector. The company has two major product lines: LUBRAJEL and RENADIN. Together they accounted for 95% and 96% of revenues for the years ending December 2010 and December 2009 respectively. Breakup is below:

2010 2009
LUBRAJEL 78% 78%
RENADIN 17% 18%


Revenue decomposition

Domestic 45%
International 55%
The company's international sales are primarily the sales of its cosmetic ingredients to customers in Europe and Asia. The international revenue increased by 5% compared to 2009. There is a significant impetus and potential (per the company) for its Lubrajel line of products through product modifications in developing markets as mainland China, India and Eastern Europe. The international expansion is something that can add value to the stock over the long run. The company is actively working on it based on 10-K reports and other sites.

Segment revenue breakup

2010 2009 Increase/(Decrease) %
Personal care $8,391,156 $7,976,819 5.19%
Pharma $2,699,467 $2,823,152 (4.38%)
Medical $2,612,088 $2,682,739 (2.63%)
Industrial $169,209 $124,899 35.48%
TOTAL $13,871,920 $13,607,609 1.94%
(Less Discounts) $(148,846) $(330,625) (54.98%)
NET SALES $13,723,074 $13,276,984 3.36%


Geographical revenue breakup

2010 2009 Increase/(Decrease)%
United States $6,068,696 $6,612,165 (8.22%)
Canada $1,995,510 $1,828,981 9.11%
China $1,549,551 $1,415,533 9.47%
France $1,323,875 $951,241 39.17%
Other Countries $2,785,442 $2,469,064 12.81%


To put things into perspective about the nature of international growth, the table below identifies the growing revenue base for the company in international markets from 2001. From 2009 onwards the company released China and Canada breakups as given above. Since the numbers for these countries were not given before 2009, for comparison's sake, in 2010 and 2009 they are coupled in the Other* section.

Table 2001-2010 (in millions)

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
US $5.11 $4.66 $5.67 $5.63 $5.89 $5.83 $5.06 $5.22 $6.61 $6.07
France $1.22 $1.17 $1.33 $1.27 $1.57 $1.48 $1.26 $1.35 $0.951 $1.32
Other* $3.25 $3.27 $4.14 $4.21 $4.66 $4.88 $5.55 $5.71 $5.71 $6.33


CAGR for international growth is a decent 7%.

Ratios and Other Numerics

Further, these numbers have little value if they do not result in profitability and cash flows. The company is profitable and, as can be seen the overall return on equity, has been very healthy with free cash enough to pay for the dividends. Dividends have consistently increased at a CAGR rate of 18.59% from 1997. The FCF has been growing at a CAGR of 6% starting 2001. With a high dividend payout, the management appears to be conservative in doing incremental investments for capex. Further the company has been able to slowly increase its margins from 22.1 in 2003 to around 27.7 in 2010, signifying improving operating efficiencies. Another point to note is the ability of the company to be a zero debt company which enforces our view of the management being conservative. The company's TEV/EBIT is at 10.46 with EBIT and EBITDA at $5.513 million and $5.968 million respectively.

2010 2009 2008 2007 2006 2005 2004 2003
ROE(%) 29.12 25.6 21.6. 24.7 20.7 20 19.4 21.2.
NPM(%) 27.7 29.2 25.7 28.8 22.4 21.6 22.3 22.1
% Long term
Debt/
Capital - - - 0.1 0.1 - - -
EPS $0.80 $0.78 $0.64 $0.69 $0.55 $0.53 $0.50 $0.50
Dividend/Share $0.63 $0.60 $0.55 $0.55 $0.47 $0.47 $0.43 $0.15
Net income (millions) $3.80 $3.88 $3.16 $3.43 $2.74 $2.62 $2.48 $2.47
FCF (in millions) $3.58 $3.90 $3.18 $3.33 $2.84 $2.66 $2.48 $2.55


CAGR growth for dividend is 18.59% starting in 1997 when the company started paying dividends of $0.06

CAGR. Growth for FCF is 6% starting in 2001 when FCF was at $2.

Dividend Discount Model

I am applying the DDM here (could have applied FCF as well). Since the company has been in existence from 1942, going concern is not a problem. Although the limitations of DDM (or FCF) are well known in terms of estimation of discount rate and so on, this analysis is necessary to get an idea as to where we stand assuming that the current conditions for the company continue. Applying sensitivity analysis will give a broader picture on the range of investment opportunities for this company.

Inputs:

· Starting dividend = $0.63 (2010 dividend paid)

· Cost of capital = 17% (a very established business since 1942 hence the only premium is the liquidity premium. Selection is random)

· Initial growth rate = 18.29% for 5 years followed by 17.29% for next 1 yr. and then followed by 16.29% for next 4 years (note : These are based directly from CAGR with 1% drop every random interval)

· Perpetual growth rate is set to 5% and we use the H model for the growth to be slowed down to this 5% in 15 years.

With this the value of the stock is $16.25 — that is 16% at the discount with the price at the time of this writing.

Selective Sensitivity analysis is given below for a sample set:

g1=18%, g1=12%
g2=17%, g2=11%
g3=16%, g3=10%
g=5%, g=5%
H=7.5 yrs H=7.5 yrs
k = 15% $20.95 $11.88
k = 16% $18.36 $10.58
k = 17% $16.25 $9.51
k = 18% $14.51 $8.62
k = 19% $13.04 $7.86
k = 20% $11.80 $7.22


With the current market value of $13.73 the stock appears to be fairly valued for a discount rate of 18% and going concern assumption. Since the investment is longer term, the CAGR growth rate matrix is used.

SUMMARY

A steady business, good financial position, high dividend yield and a fair price is a compelling reason to consider United Guardian (UG) for investment. Although per DDM, the stock appears to be fairly valued at specific discount rates, accumulation of the stock on any further downside may be a good possibility. The heavy yield and fewer price fluctuations make it a safe investment with an upside potential driven by international growth. Further heavy insider ownership (approximately 45%) suggests that management has confidence in the business.

In 2010 the RENACIDIN product line suffered a setback because of some regulatory problems with a major drug company. These problems were unrelated to RELACIDIN; however, there was a temporary suspension of RENACIDIN production in August 2010. But his did not have a significant impact on the earnings. This is what the CEO had to say in the latest 10-Q: "We are very pleased that we were able to attain this level of revenue and earnings despite the fact that our most important pharmaceutical product, Renacidin(R) Irrigation, was in very short supply for the entire quarter due to production problems experienced by our outside supplier. Fortunately, the drop in Renacidin sales was offset by very strong sales of our cosmetic ingredients line, which enabled us to attain these strong sales and earnings. Now that the production problems have been resolved we expect Renacidin sales to rebound strongly in the second quarter."

In 2008 the original founder, Dr. Alfred R. Globus, died at the age of 88. His nephew, Ken Globus, heads the company. It is possible that if the management cannot find means to grow, the company's reputation may suffer. However, it also sparks the speculation of a potential take-over now that a new CEO is in charge. With the small size and a tight control by the insiders buy out is a possibility. The company also terminated the DB pension plan thereby recovering from any future pension obligations. This is a great news now that the pension expense is clearly expensed out in the income statement.

As can be seen from the analysis, it looks a great investment to accumulate on the downside considering its potential for growth (capital appreciation), very low fluctuations to the market, or safety of income (dividend yield about 5%).

Mario Gabelli's GAMCO owns 4% of shares outstanding.

DISCLOSURE

I own shares of United Guardian Inc.

This article does not constitute any investment advice.


Rating: 2.6/5 (15 votes)

Comments

ranjitsudan
Ranjitsudan - 3 years ago
Do you know if they have expiration of product patent anytime soon - esp LUBRAJEL and RENADIN?

Any competition from generics?

value_shishya
Value_shishya - 3 years ago


Patents expiry range is from 2013-2019.

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