The single best thing about investing in microcaps is that there is almost zero competition for you as a stock picker. Just think about how many analysts are covering big companies like Facebook as their full time job. However, if you look at incredibly small companies, there might be just a few small retail investors like me, who don’t have any special insights.
One completely overlooked company is Universal Power Group (UPGI, Financial) with a market cap of just 10 MM. The company released their latest financial results, which turned out to be exceptionally good. The stock currently trades at ~50% NCAV, provides safety of principal and the company is operating profitable. But let’s go step by step and start right at the beginning.
The company was a subsidiary of Zunicom and went public in 2006 as a separate entity. However, Zunicom still remained the biggest shareholder of UPGI. When the company went public it also had to pay a “dividend” in the form of notes to Zunicom. Besides the notes UPGI also took on some debt, so the debt/equity ratio was over 100%. Why would some people even think about buying such a company at the IPO? Management kind of manages both companies simultaneously and they also own a significant amount of UPGI’s shares. However, the company delisted in early 2014 so it’s hard to get up to date details about insider ownership.
Operations
The company offers various kinds of batteries and supply chain services. However, the company doesn’t split up their two segments in their reports, so I can’t tell how badly well each segment operates. After the IPO the company faced many issues, so the stock declined significantly. In 2007 Brink’s Home Security accounted for 41% of the UPGI’s sales, however, when the financial crisis hit, sales to Brink’s Home Security fell. Brink’s also went through an acquisition and is now known as ADT Security Services. By 2011, customer concentration fell to just 16%.
Over the years UPGI also acquired some other companies, promising to “increase the value of the company”. Even though those acquisitions weren’t small relative to the size of UPGI, management didn’t publish any specifics regarding the newly acquired businesses. Therefore, it’s hard to tell whether these acquisitions were good or not, though declining sales and too much goodwill indicate the latter.
Another big problem turned up in 2011 when the Chinese government implemented a broad-based inspection program for manufacturing facilities. As a result of these inspections, the Chinese government closed more than 70% of China’s battery production fabrics. One of the closed factories was the principal supplier of UPGI. As a result, UPGI’s inventory sank significantly throughout the first half of 2012 and resulted in huge costs. In the subsequent year gross margins fell by almost 2%. However, the company now has a more diversified supply chain. The new suppliers mainly are from Taiwan, Malaysia and Vietnam.
Since the IPO the company is in steady decline, so management weren’t able to convert their options. Because of this, options were reset from an average price of ~3.50 to ~1.54. There are about 850k options at a price between 1.54 and 1.64 which could dilute shareholders dramatically.
Still interested?
So it seems like there have been huge problems in the past and management doesn’t seem to really care about minority shareholders. However, some changes in the recent past made the company more attractive.
Since 2012, the company is paying back it’s debt aggressively and I expect the company to have paid back its line of credit within the next one to two years.
My hope is that the company will pay a dividend after that which could be kind of a catalyst. Of course, management also could start “empire building” or other dumb things which wouldn’t be value enhancing. However, sometimes even a small sign of a better future brings net-nets back to fair value.
Even though Net Income doesn’t seem attractive, the company earned significant FCF in the last few years. The profit margins of the company are incredibly thin, so a small change in gross profit or reduced overhead costs can have a tremendous impact on the company. Even though Gross Profit declined slightly from 2013 to 2014, the company cut SG&A by 9% which increased EBIT by 276%. The decline in SG&A mainly was due to the delisting associated with lower regulatory requirements. Imagine how much the company could save if it would reduce management pay…
However, management mentioned in their 2014 report, that they lost one of their biggest customers – Radio Shack. It’s hard to tell how the loss of Radio Shack will impact earnings in the future, because management doesn’t report how much of the sales were made to Radio Shack.
Conclusion
The company trades at just 3 times 2014 FCF and a PE of 12. With a Price to Sales ratio of just 0.11, I think the company might be a good target for potential acquirers. Even though ROE is extremely low, ROIC represents the strong FCF (I use FCF instead of EBIT), so I think the company should be worth about NCAV.
| Ă‚ | 2014 | 2013 | 2012 | 2011 | 2010 | 2009 | 2008 | 2007 | |
| ROE | 3,5% | -0,2% | 0,7% | 0,9% | 13,0% | -0,7% | 6,6% | 12,6% | |
| ROIC | 11% | 13% | -4% | 19% | -8% | 18% | -1% | -30% | |
The stock has traded at a discount to NCAV in the past, however, bounced back to appropriate levels in 2008-2010. I really like how stable NCAV was in the past and the fact that it even grew slightly over time, which will give shareholders additional downside protection.
The 2014 financial results definitely were good news for investors, however, there is much more uncertainty due to the Radio Shack bankruptcy, which is the only reason why I don’t add to my position. With a current ratio of 2.7x, I don’t expect the company to bankrupt anytime soon.
Potential Catalysts
As with most net-nets, there are no clear catalysts. However, I don’t know how I could loose money on this one and the only way for the stock is up.
Take care of the downside and the upside will take care of itself.
