Description

UFP Technologies, Inc. (Nasdaq: UFPT) is highly undervalued.  If you are interested in investing in a situation that could generate 68%+ returns in the next twelve months, read on.  UFPT is a manufacturing firm that produces both packaging and component products.  The products sold by UFPT are comprised of fabricated foams, plastics, laminated composites, and natural fiber materials.  UFPT serves a variety of end markets including medical, automotive, computers and electronics, aerospace and defense, consumer and industrial.  We estimate that UFPT is the leading company in its market; however, its market share is under 10% of the total market.  UFPT has been a consistent acquirer of smaller competitors over time.

UFPT's shares are highly attractive at current levels.  UFPT generated $18.6 million of EBITDA in 2010.  In 2011, we estimate that UFPT will generate $22.5 million of EBITDA and have organic revenue growth of nearly 10%.  UFPT has grown EBITDA every year for the last ten years including during the recent economic downturn.  On a fully diluted basis the enterprise value is currently $107 million accordingly the trailing and forward EBITDA multiples are 5.75x and 4.75x, respectively.  Further, UFPT has minimal capital needs which equate to less than 2% of sales.  As a result of these favorable characteristics, UFPT generates free cash flow yields in excess of 10%.

UFPT has seen a transformation of its business over the last decade and its management team has done a nice job transitioning UFPT from a commodity part manufacturer with a unhealthy concentration in the automotive industry to a well diversified higher margin manufacturer that is focused on increasing margins and building long term customer relationships by offering its customers high quality (and high margin for UFPT) solutions.  A key area of focus during this transformation has been growing its high margin medical and scientific customer base.  Through acquisitions and organic growth this has become the largest end market for UFPT and now represents more than 30% of sales.  Further, the margins in this segment are higher than UFPT's average margins.  Also important for UFPT, is building a solid long-term business by targeting customers who produce products in the United States and who will not move their manufacturing overseas.  UFPT's products are competitive within a predefined radius of each of its twelve domestic manufacturing plants.  The lower margin products have a very narrow competitive radius from a given plant.

To give the reader a sense for the range of UFPT's products, the following are just a few examples: automotive interior trim, athletic helmet padding, shock absorbing case inserts, industrial safety belts, medical device components, air filtration, high-temperature insulation, abrasive nail files, anti-fatigue mats, and shock absorbing inserts used in athletic and leisure footwear.  UFPT also has more capabilities than its competitors such as clean room technology for producing medical device applications and an ability to work with a variety of materials that generally exceeds the capabilities of its competitors.  As a significant player in its industry, UFPT is able to buy foam and other materials direct from the producers.  Smaller industry players who lack UFPT's scale are incapable of securing direct purchasing relationships with key suppliers.  These smaller players must in turn buy their raw materials from the larger fabricators like UFPT.  From a competitive perspective, this puts UFPT in a very advantageous position as compared to its smaller competitors.

UFPT has done a nice job growing through acquisitions.  We review lots of companies in the course of our investing due diligence and rarely see as disciplined an acquisition approach as UFPT has demonstrated.  UFPT made each of its last four acquisitions at a discount to the net book value of each company.  These last four deals had a combined revenue base of $34 million and total consideration for the group of four was $8.9 million which produces an implied TEV to revenue multiple of 0.26x.  This compares to UFPT's TEV to revenue multiple of 0.8x.  Given its growing cash balance, there is a tremendous capacity to continue growth through acquisitions.  Since the end of 2006, cash has grown from $1.0 million to $24.4 million at the end of 2010.  Also, management has been thoughtful about continuing to grow its higher margin revenue streams.  Both the E.N. Murray and Advanced Materials acquisitions were focused on medical and scientific segments.

Once UFPT lands a customer relationship, they tend to maintain such relationships for long periods of time.  This is typically because UFPT supplies component parts and once they are designed into their customer's end products, it becomes difficult for a competitor to dislodge them.  Also, in many instances UFPT owns the tooling and designs related to its products and it becomes even more difficult for a customer to find an alternative supplier.

The single biggest perceived headwind in the near term for UFPT will be the loss of sales to one of its automotive customers.  For 2010, sales to Recticel were 9.3% of total sales.  UFPT supplies a component to Recticel that goes into the door panel assembly of two Mercedes Benz models.  Going forward, these door panels will be comprised of a different assembly and UFPT will no longer be a supplier.  The business is actually split into two parts, one part which was to end in 2011 and the other part to end in 2012.  As we have now moved into 2011, it has become more clear that UFPT will lose hardly any of the business in the current calendar year due to a slower than expected change over to the new door panel.  Further, UFPT had been considering raising the margins on the second part of the business when the first part is lost to keep gross margin dollars equal.  Also important in accessing the value of this customer is the fact that automobile margins are lower than normal margins.  We anticipate that gross margins on this business are less than 20%.  Accordingly, while the loss of a 9% customer relationship is never good, the sales to Recticel should continue for the immediate future and should not impact 2011 results at all.

We have noted that several investors in UFPT were concerned about the potential exposure to rising petroleum based inputs what comprise many of the raw materials that go into UFPT's products.  So far this has not been a huge issue for UFPT and management through good supply contracts and customer relationships has been able to pass on many cost increases related to raw materials.  Further, we get the sense that rising petroleum costs may ultimately lead to expanding profit margins as UFPT raises prices in the face of such cost pressures and then is able to maintain some portions of these increases after costs subside.

Organic sales growth at UFPT has averaged around 7% over the last fifteen years.  Management forecasts annual organic sales growth in the 6% to 10% range.  Keeping in mind that customer retention as measured in sales dollars is between 85% to 90% per year; this would imply that new customer relationships in the range of 16% to 25% of prior year's sales must be consistently generated to achieve the historical organic revenue growth trend.  This also highlights why losing a 9% customer over a multi-year period is not a monumental loss, especially given the lower margin nature of such sales.

Insiders own about 19% of UFPT.  The most notable change in the share base recently was the sales by both Dalton Griener and Hotchkis and Wiley when the stock was in the $12 range.  Clearly these firms missed the boat on 50% gains from where they sold and will miss the rest of the upside as UFPT continues to move higher.

We used a discounted cash flow model to arrive at a $30 price target for UFPT (68% upside).  The key unknown in our DCF is the size and rate at which acquisitions can be consummated.  We have heard that management has looked at several larger transactions which would add $60 million+ in top line revenues.  Given management's stellar acquisition track record, we view and acquisition as a potentially material value creating event.

Key catalysts:

• 1. Management considering doing quarterly conference calls
• 2. Research coverage increasing - recently added Sidoti and Singular Research
• 3. Management has discussed presenting at investment conferences
• 4. Utilize cash on balance sheet to pursue acquisitions or repurchase shares
• 5. Implement recurring dividend

Disclaimer:

We have from time to time been owners of common stock in UFPT, and may buy shares or sell shares, at any time.  We have no obligation to update any party of any changes in our views on UFPT.  The information outlined above is for information purposes only and does not constitute an offer to sell or the solicitation of an offer to buy any securities.  Readers should conduct their own independent analysis and investigation. We make no representation or warranty, express or implied, as to the accuracy or completeness of any of the information contained above or in any other written communication.

Catalyst

Key catalysts:

• 1. Management considering doing quarterly conference calls
• 2. Research coverage increasing - recently added Sidoti and Singular Research
• 3. Management has discussed presenting at investment conferences
• 4. Utilize cash on balance sheet to pursue acquisitions or repurchase shares
• 5. Implement recurring dividend