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United-Guardian: Supplier Woes

December 03, 2012 | About:
This is one in a series of articles where I will be covering most of the "30 Obscure, Profitable Stocks" listed by Geoff Gannon on his blog on Nov. 29, 2012. Many thanks to Geoff Gannon for the wonderful list of interesting stock ideas.

United-Guardian Inc (UG) a diversified company that conducts research, product development, manufacturing, and marketing of pharmaceuticals, cosmetic ingredients, health care products, medical devices and proprietary industrial products. Since its founding in 1942, the company has been granted over 30 patents, and now has a catalog of over 100 products in various stages of development.

Valuation

UG is currently trading at a trailing 12 months P/E of 18.62 and a trailing twelve months EV/EBITDA of 13.05. UG achieved a five-year average ROE of 26.5%.

Financial and Business Risks

UG is debt free with cash and cash equivalents of $12.9 million representing 15% of its current market capitalization of $83.7 million.

UG’s Renacidin products typically account for approximately 85% of its net sales of pharmaceutical products. Over the past two years, Renacidin experienced two disruptions in production at its third-party manufacturing facility, both of which led to product shortages. During the first disruption, in the last two months of 2010 and the first four months of 2011, UG was not able to fulfill all of the orders for its Renacidin product due to supply problems. Its Renacidin products have been manufactured for UG under a long-term contract with a major U.S. drug company that experienced regulatory problems in 2010 at its facility that manufactures Renacidin, which were unrelated to the production of Renacidin. The supplier resumed production of Renacidin in May 2011.

The second disruption began in May 2012 and is related to general production problems at the supplier’s manufacturing site, whch affects all of the products manufactured at that facility. UG's inventory of product was completely depleted by August 2012. UG will not be able to fill any further orders for Renacidin until production is resumed. The supplier has indicated it does not expect to be able to ship additional product to UG until May 2013 at the earliest. UG has notified the supplier that it considers it in breach of its supply agreement, and will seek compensation for all losses incurred. The supplier has also notified UG that it will no longer supply product to UG after the January 2014 contract termination date and UG is currently actively looking for a new supplier. UG is likely to be without Renacidin sales until 2014.

Business Quality and Capital Allocation

UG believes that the expense of testing and evaluating possible substitutes for its products that are already in customers' formulations, as well as the expense to the customer in relabeling its products, is a significant barrier to displacing UG's products in current customer formulations. Customers would only choose a competitor's product over UG, if there were significant cost savings.

In 2011, approximately 59.5% of UG’s sales were to customers in foreign countries, primarily sales of its cosmetic ingredients to customers in Europe and Asia. UG currently has six distributors for its personal care products outside the U.S., with ASI being the largest. UG is currently working on a new lower cost Lubrajel specifically for the India market with ASI, to enable it to penetrate the personal care market in India.

UG has paid dividends in every single year since 1997, and currently sports a dividend yield of 4.7%.

Conclusion

Some of the revenue lost as a result of the Renacidin shortage was offset by increases in sales of UG's personal care and medical products, such as the Lubrajel line of water-based moisturizers, and reduction in operating expenses and overhead costs. Despite the production problems UG is experiencing with Renacidin, EPS only decreased by by 6% from $0.82 per share to $0.77 per share for the nine-month period ended Sept. 30, 2012.

Double-digit ROEs, in addition to a debt-free balance sheet with a 4.7% dividend yields makes for an attractive investment. I think there is still significant valuation upside to UG, after the supplier woes are over.

Disclosure

The author does not have a position in any of the stocks mentioned.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap cigar-butts and wide-moat compounders. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website


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