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Universal Securities (UUU): An Extremely Interesting Microcap Stock.

July 19, 2011 | About:

Universal Securities (UUU) is an extremely interesting microcap stock. They design and distribute safety products like smoke alarms, carbon monoxide alarms, etc. First, a little bit on how we got here. During fiscal 2007, Universal began selling their products through Home Depot. This resulted in a nice spike in revenue and profits. However, in the past year, Home Depot stopped selling their products in stores and now only sells Universal’s products through online and through their contractor desk. This has resulted in a huge decrease in sales (home depot was over 50% of their sales) and massive operating losses.

So that pretty much gets up to the present day, though if you look through their past ten years you will find a pretty colorful history.

What does an investment in Universal today get you? First, you get Universal’s main business, a business that is generating over $1m in operating losses right now. Second, you get a 50% interest in Universal’s main supplier, a joint venture in Hong Kong that sources (from CHina) the vast majority of Universal’s products. The joint venture sells to other companies, not just Universal.

So what are the value of these two separate parts? Let’s start with Universal’s core business. It’s currently generating losses, but it was generating huge profits just a few months ago. It’d be pretty shocking if this business was worth less than its net working capital (net current assets less all liabilities). Universal’s net current assets come out to ~$11.5m, or about $4.80 per share. If you take a slightly more optimistic view on valuation, the book value of their core business is $5.77 per share (tangible book value is just under this).

Then there’s the Hong Kong joint venture. The book value of their 50% stake is $13.15m, or $5.48, and this probably understates just how valuable the joint venture is. Earnings came in at $3.33m last year and just over $4m the two years before that. Both years resulted in returns on equity between 10-15%, and this was done with almost no leverage whatsoever. If the business was worth just 10x earnings (not an unreasonable assumption at all), Universals share would come in at $16.65m, or ~$6.95 per share.

So that puts a pretty conservative valuation range from $10.28 to $12.71, versus a current price of ~$6.30.

Are there risks involved? Yes, no doubt.

First, I’m always nervous of anything China related, given how difficult American’s have found it to secure property rights over there. So the joint venture is a bit troublesome, especially since it’s such a major source of value. But the joint venture has been running since 1989, which alleviates most concerns. Second, the core business generated huge losses last year. That’s concerning, but it’s tough to picture the business destroying so much value that it cuts through your margin of safety before management simply liquidates it.

Personally, I think the business will turn around in the next couple of years as the economy improves and housing normalizes, and there could actually be a bit more upside than the range I discussed above.

Disclosure: Long UUU

Rating: 2.0/5 (1 vote)


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GuruFocus has detected 4 Warning Signs with Universal Security Instruments Inc $UUU.
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