UFP Technologies (NASDAQ:UFPT) is a producer of innovative custom-engineered component products and specialty packaging. Founded in 1963, the company has pioneered a long list of processes and applications, has a large portfolio of active patents, and holds proprietary positions on many advanced materials from leading global suppliers. Currently, the company serves more than 3000 customers from facilities across the United States and has more than 600 employees. The company’s strategy includes organic growth and growth through strategic acquisitions.
The company’s vision is to become its customers’ most valued partner and first choice for engineered solutions involving fabricated or molded foams, plastics, and natural fibers.
In order to achieve that, the company key areas to focus on are:
· Market insight
· Creative problem solving process
· Cutting edge processing techniques and quality systems
· Knowledge of latest and most innovative materials
· Continuously increasing organizational velocity
UFPT’s customers include leading companies in six target markets: Medical & Scientific, Automotive, Computers & Electronics, Aerospace & Defense, Consumer, and Industrial.
Medical & Scientific
UFPT services numerous segments within the medical industry including custom medical device packaging and components, orthopedic implant packaging and product solutions, components and products for wound care and infection prevention, and branded products used in biopharm manufacturing.
In this segment, the company provides, among other products, interior trim, door panels, sunshades, sound dampening, engine filtration and molded foam componenets. Packaging solutions include material handling and dunnage.
Aerospace & Defense
For this market, UFPT manufactures uniform components to improve soldier safety and comfort, cases and inserts to protect vital combat equipment. tool control to prevent damage to aircraflt engines, etc.
Computer & Electronics
Some of the types of solutions UFPT brings to the electronics industry include: specialty packaging to prevent static and vibration, material handling solutions to protect fragile products in the factory and components to maximize performance.
Strong packaging for fragile items like wine and glass candles, creative beauty products for the home and spa and rugged athletic components that enhance safety are examples of the innovative products and solutions that the company offers.
UFPT provides numerous engineered solutions to the industrial market including foam protective packaging, molded fiber packaging, protective cases, material handling, industrial safety components, gaskets, filtration and many more.
Needless to say, the company has a great deal of ISO certifications for most of its products. For a company of this size, I believe that it is very well diversified and that will help mitigate potential bad news in any of the markets it competes in.
According to the company both the packaging industry and the component products industry are very competitive.
Regarding the packaging industry, the company has identified that the primary competition comes from small independent regional manufacturing companies. In addition, the company’s foam and fiber packaging products compete against companies that produce substitutive products such as expanded polystyrene foams, die-cut corrugated, plastic peanuts and plastic bubbles.
With respect to the component products industry, the company faces competition primarily from smaller companies that concentrate on production for specific industries. In this area, the company also competes with other manufacturers who use rubber, leather and other foams to make their products.
That said, the company believes it can effectively compete with its competitors due to:
· Its access to a wide variety of materials
· Its engineering expertise
· Its ability to combine foams with other materials
· Its offer of reliable, good performing and price competitive products
· Its excellent customer service
Because the company manufactures and sells very specialized products they need to work very closely both with their suppliers and their customers.
The company does not manufacture any of the raw materials utilized in its products, however these raw materials can be obtained from multiple supply sources.
The company is one of the largest buyers of cross-linked foam in the US which has allowed it to establish strong relationships with this small group of suppliers.
Apart from the raw materials, the company is able to work together with its suppliers to manufacture special machinery that allows them to produce cutting-edge component products, which can be sold at premium prices.
Even though the company’s size is not huge, the growth in the last 5 years has allowed the company to have greater influence over its suppliers, this added to the fact they have to work together very often has helped the company build a good and strong relationship with them which has translated in lower raw material prices.
The company has more than 3000 customers (pretty good for its size). However the company depends on a small number of customers for a large percentage of its revenues.
In 2009 and 2010 UFPT’s top ten customers represented approximately 31% and 32.1% of its total revenues .
In 2010, a single automotive program accounted for 9.3% of its total sales. This program was scheduled to phase out beginnning in the 3rd quarter of 2011. Since the company only markets its products in the US, another recession will adversely affect the company’s results
While it is true that there’s some risk of customer concentration the company has improved a lot on this issue.
· In 2007 the company had over 1000 customers vs +3000 in 2010.
· This is the lowest top customer concentration the company has had since it went public. From 2005 to 2009 the top customer sales averaged 15%.
· Many of its customers have been clients for more than a decade.
I think UFPT has a narrow moat. Its competitive advantage in my opinion is product differentiation. Playing in the commodity industry, the company has been able to differentiate from its competitors by offering unique components and very customized solutions.
For the company to remain successful, they’ll have to quickly respond to any new market trends or customer preferences. The company has been able to do this in the past by retaining the best professionals in the field, sharing new know-how between facilities and Investing in R&D and training programs.
The company has managed to double its revenue in the last 10 years from $61.6M in 2001 to $120.8M in 2010. The TTM revenue is $127.4M. The 10-year CAGR is 7% and the 5-year CAGR is 5%.
As we can see in the graphics, the company has been able to grow revenue steadily in the last ten years although it has not been able to grow at spectacular rates. However, as we can see the company has been suffering to maintain its sales level in its Packaging segment.
The company realized organic growth wasn’t good enough so it decided to deploy most of the excess cash in acquisitions. This would normally mean a red-flag for me but digging deeper we can see that the company has fulfilled the two requisites I ask for when dealing with an acquiring company:
1. Paying a fair price for the company/assets
As you can see on the table, in 2009, taking advantage of the weak economy, the company was able to acquire 3 companies at bargain prices buying them at a discount of their net asset value. As the company says, they are always looking out for good opportunities and, in this case, when the opportunity came up they didn’t hesitate and took the plunge.
Source: UFPT 10K
1. Disclosing information about the different growth obtained with or without the acquisition.
As management says:
“Net sales increased 21.7% to $120.8 million for the year ended December 31, 2010, from net sales of $99.2 million in the same period of 2009, driven primarily by the 2009 acquisitions of Foamade, ENM, and AMI (all within the Component Products segment). Without sales from these acquisitions for the portion of 2010 in which they were not owned in 2009, sales would have increased 10.0% to $109.1 million. The increase in sales excluding these acquisitions was largely due to increased demand for interior trim parts from the automotive industry of approximately $6.6 million (Component Products segment), as well as an increase in sales in the Packaging segment of approximately $2.3 million, due largely to the impact of the improved economy on demand for our customers’ parts.”
Although it is a little bit worrisome that the company has majorly grown via acquisitions, the fact that they are good value investors makes this look more like a strength rather than a weakness to me. They don’t buy companies for personal or professional recognition, they do it to add value to the company, hence, the shareholder.
Looking forward, I would like to see greater organic growth or a good acquisition specially in the stagnant packaging segment. If they don’t, they have plenty of cash to reward shareholders with a special dividend.
One of the things I really like about this company is its ability to generate free cashflows. Over the last 10 years the company has been able to grow owner earnings from - $2M to $9M. The 5 year CAGR is an impressive 18%. I am always looking for companies with a nice upward trend in owner earnings and this one looks really good.
The company has averaged CapEx of $1.6M from 2001 to 2007. Since then, the company has increased CapEx averaging $3M for the last 4 years.
The main reasons for this increase in the last few years have been the purchase of new manufacturing equipment, the acquisitions we just commented and the purchase of previously leased real-estate.
On the other hand, the company has been growing the pie for shareholders at spectacular 10-year and 5-year CAGRs of 19% and 29% respectively.
However, although at a slower rate, management has been increasing shares outstanding mainly though stock options which has diluted a bit the value for shareholders on a per share basis.
Despite the dilution, since 2005 the company has been able to grow tangible equity per share at +20% year over year.
It is very important when analyzing profitability the fact that the company can maintain or grow its margins. As the table below shows the company has done a great job in terms of profitability.
The company has experienced tremedous growth in margins which shows that management knows quite well the enviroment and the industry the business is in and are taking the steps towards greater efficiency and greater profitability.
Looking back further, we can see that the improvement the company has achieved is even greater. In 2001-2003 the company struggled to make a profit.
This improvement in margins can be attributed primarily to the following reasons:
· Improvement the quality of its book of business: The company knows the group of markets and customers with the highest potential to bring profit to the company and acts accordingly.
· Reductions in manufacturing costs: The company is always striving to become more efficient in every aspect of its business.
· Abilty to leverage sales growth the fixed component of cost of sales (overhead).
· Repayment of debt.
ROA – ROE - CROIC
When analizing this ratios I always try to find companies that are able to maintain or grow figures at or above 10%. Normally companies that can do that for a long period of time enjoy some kind of competitive advantage
Companies with returns over 10% tell us that they can extract value of its assets (ROA), that the shareholder stake is being very well take care of (ROE, low debt) and that the business generates strong free cashflows related to the invested capital (CROIC).
In this case, because UFPT is a small company I don’t have 10 years ROAs, ROEs, and CROICs above 10%. However, since the company is doing a great job and has been able to score above 10% in all of these in the last 3 years and will do so in 2011, I believe the company will be able to maintain this good figures in the future.
For 2010 the company returned:
· 13 cents of profit for every dollar of its assets.
· 19 cents of profit for every dollar of equity
· 16 cents of excess cash for every dollar of invested capital
Since UFPT manufactures very innovative products they need to sell its products quickly because what can be innovative one year it is obsolete the next one. So we have to be watchful for significant and prolonged decrease in this number.
UFPT has been turning its inventory between 8 and 10 times a year for the last 9 years which is pretty good. For now I don’t see problems in this front.
Receivables & Payables Turnover
UFPT has turned receivables 6 to 8 times a year from 2002 to 2010 which means the company collects money from customers in less than 2 months which is not bad but isn’t great either.
However, they have a pretty high payable turnover (14-18) which means the company pays its supplier on average in 20 to 30 day period.
I think the company should try to extend this period a bit longer when possible, although it is true that the company is not going to suffer a liquidity problem any time soon.
The company has been growing its working capital very aggressively in the last 5 years. This is just another example of how well the company has done lately.
Looking at the Balance Sheet there is nothing to be worried about since 1/3 of total assets are Cash & Equivalents and inventory and receivables are growing at at lower pace than sales.
Debt to Equity
As we saw the company has increased its net margins amazingly. This is the result of great operational efficiency and lower interest expense. As the graph shows the company has come from having a debt-to-equity ratio of 2 to 1 to having a ratio of 0.35 to 1. In 2010, for every dollar in debt the company had 3 dollars in equity. The interest coverage ratio (operating income / interest expense) for 2010 was 144.
In this very difficult times we live in, I am specially interested in companies with very low debt to equity ratios and high interest coverage ratios and this company fits in perfectly.
UFPT vs Competitors
Now it is time to compare UFPT’s growth, profitability, efficiency and financial health with those of its competitors. According to Google Finance, UFPT’s competitors are:
|Aptar Group (ATR)||$3.45B|
|Greif, Inc (GEF)||$2.31B|
|Sealed Air, Corp (SEE)||$3.82B|
|Bemis Company, Inc (BMS)||$3.25B|
|UFP Technologies (NASDAQ:UFPT)||$99.87M|
Although its competitors are much bigger, with the following matrix I’ll be able to quickly assess how the company does compared to its major competitors.
*Data from Morningstar.
As we can see, UFPT has the best metrics in terms of growth, profitability, efficiency and financial health. Even though the yield in FCF/ Sales is only average, the company has been improving it and the yield for 2010 is 7.7%.
Another metric where UFPT is average is Operating margin. However, due to the improved efficiency and the strategic acquisitions the company enjoys now a 11.9% operating margin which is better than the 3-year-average operating margins achieved by its competitors.
I liked the company data before looking at its competitors but after looking at this matrix I am convinced that UFPT is a great company.
· The CEO and Director, Jeffrey Bailley is the the son’s founder and has been working in the company since 1988, and before reaching his CEO position he served as a Division Manager (1989-1992), General Manager Northeast Operations (1992-1994), Vice President of Operations (1994-1995). He is the owner of 11% of the company stock.
· Honesty. Reading the Annual Reports, I have followed what they said about creating value, selective acquisitions, targeting most profitable sectors...and they fulfilled the promises they had made.
· Operational efficiency as I’ve explained throughout the analysis
· Compensation in line with shares appreciation
· Dilution through stock options
· Insider sales in 2011 between 15-18 $.
· Very high compensation when compared to net income
Valuation ratios and yields
Fair Value using Owner-Earnings (DCF)
When valuing companies I am always ultra cautious. Because of this, I normally miss out on some companies but it helps me sleep better at night. But because I think we are not close to solving this economic mess we are in, my projections are very conservative.
· Growth rate: 6%
For this company, even though we have seen in the last 5 years Owner earnings growing at a 18% CAGR tangible equity at 29% CAGR and Sales at 5% CAGR I have decided to choose a 6% growth rate because the operational efficiency will reach its top soon, and the company will need to grow sales to generate bigger profits and because sales have been a little stagnant in the last 5 years a 6% growth rate seems fair.
· Discount rate: 12%
It is the current long-term rate of return I look for when when investing in stocks and it is more than double what I can get on “risk-free” investment alternatives.
· Starting Owner Earnings: 9.3M
It corresponds with Owner Earnings for 2010.
· Terminal Growth rate: 0%
· Estimated Fair value: 19-22 $
· Buy Price: 15$
· Current price: 15.07$
While I have been writing this the stock has been priced between $14 and $15.50. All those prices represent an attractive entry point based on my conservative DCF model valuation. This represents a 30% potential return.
Fair Value using EPS
· 2010 EPS : $1.37 (TTM is $1.51, but i’ll be conservative)
· 10 year EPS growth was 18% so we’ll use 2/3 of that as our growth rate 12%
· Current PE is 10. Because it is lower than 18, we’ll use a projected PE of 12.
· So we’ll be using initial EPS of $1.37, a projected 5-year growth rate of 12% and a P/E of 12 to find out the net present value of the stock.
· Fair value: 24$
Both models seem to indicate that the company is undervalued and because the company earns high returns on capital, has little debt and has an easy to understand business model I think this is a very good opportunity for a value investor.
As much as I like the company, there are some risks that we’ll have to monitor closely:
UFPT’s strategy includes the potential acquisitions of businesses as we have seen above. In my opinion, this is one of the company’s strenghts and even though there are always risks when acquiring companies the company’s has done a great job in the past, so I’ll trust them on this one.
Fluctuations in the supply of components and raw materials
The company purchases raw materials pursuant to purchase orders placed from time to time in the ordinary course of business. Failure or delay by such suplliers in supplying these materials coulde affect UFPT’s ability to manufacture and deliver products on a timely and competitive basis.
The company has secured alternative sources of these materials but that can not assure that any delays or loss of quality happens.
Cost of raw materials
The cost of raw materials, including petroleum and petroleum-based raw materials such as resins, used in the production of its products, are subjetct to rise in prices, which may materially affect the business, its financial conditions and margins.
To fight this, the company has provisions in most of its sales orders that allows them to pass on to its customers certain price fluctuations.
Customers shifting manufacture offshore
The company has lost customers in the past and may lose customers again in the future as a result of customers moving their production facilities offshore, then hiring competitors that operate closer to them which increases shipping efficiency and decreases costs.
I think this is a very good opportunity to buy a high quality company. I think UFPT’s strengths more than make up for the potential risks. I bought shares last year at 15$ and I was able to sell them at 19$ a few months later. I see no reason why this shouldn’t happen again, even if it takes some time. I am looking forward to see what happens.
Disclosure: I am long UFPT. I bought shares at 15.01$ and I’ll increase my position if it drops to 13$. If there are no significant changes I will sell my shares in the 20$ range.