UFP Technologies UFPT
October 03, 2008 - 1:51pm EST by
andreas947
2008 2009
Price: 6.75 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 45 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

Sign up for free guest access to view investment idea with a 45 days delay.

  • Multi-bagger

Description

 

UFP Technologies (UFPT)
Summary
We believe that UFP Technologies is attractive at its current valuation of 45% of LTM revenues of $106 million, 3.8x LTM EBITDA of $12 million, 5x LTM EBIT of $9 million, 7.5x LTM diluted EPS of 89 cents, and 7.5x free cash flow of $6 million. We think these valuations are even more attractive for a company that is growing: for six months 2008, the company was able to grow revenues by 25% from $45 million to $56 million, EBIT by 70% from $2.7 million to $4.6 million, and EPS by 69% from $0.26 to $0.44 due to organic growth and an accretive acquisition.  (While we don’t think these growth rates are sustainable, we do believe the company can continue to grow at attractive rates, even in this difficult economy).  Additionally, we like the fact that the company is basically debt free as a result of its strong cash flow generation.  The company has a market cap of about $42 million and net debt of about $3 million as of June 2008 for an enterprise value of about $45 million.  In our view, the company has revenue growth, gross margin improvement, reduced operating expense margins, increased free cash flow, an accretive acquisition, and an improving competitive position all working for it.  The company scores well on the Magic Formula criteria, with an earnings yield (EBIT to Enterprise Value) of 20% and a high return on invested capital (EBIT to net working capital plus net PPE) of 40%+. 
UFPT is a niche designer and manufacturer of interior protective packaging solutions using molded and fabricated foam plastics, molded fiber, and vacuumed formed plastics.  The company also designs and manufactures engineered component solutions using laminating, molding, and fabricating technologies.  The company is one of the largest foam converters in the U.S.  The company’s two segments are the component product segment (sales of $53.8 million and EBIT of $4.8 million in 2007) and the engineered packaging segment (sales of $39.8 million and EBIT of $2.5 million in 2007).  The company primarily serves the automotive, computers and electronics, medical, aerospace and defense, industrial, and consumer industries.   The company primarily manufactures products using polyethylene, polyurethane, cross linked polyethylene foams, and rigid plastics.   The company’s molded fiber products are made from recycled newspapers and have had strong demand recently due to environmental concerns.  The company has a network of 11 plants strategically located throughout the U.S. which gives it a strong competitive position against mostly regional smaller players.  The company focuses primarily on value-added segments of the foam packaging and component products businesses and does little commodity type work.

High Value Added, Service Oriented Business

We believe the company is more of a services business than a traditional manufacturer as it focuses on providing customized solutions to clients.  The company still does some commodity work but doesn’t make as much margin on it.  Due to this customized service focus, the company is much less asset intensive than a traditional manufacturing company.  The company carries a modest level of inventories and management says close to 90% of inventories are carried pursuant to firm orders.  The company is very much a job shop type manufacturer and there is often a lot of engineering work that occurs before an order is generated.  As of June 2008 inventories were $8.9 million and accounts payable were $5.9 million indicating a major portion of inventories are financed through trade credit.  Accounts receivable were $14.5 million as of June 2008 and management generally expects these to grow with sales.  Net PPE as of June 2008 was $11.7 million which is modest compared to LTM sales of $106 million and LTM EBIT of $9 million.  Capital expenditures have generally been close to D&A expense or about $2 million to $3 million per year.  So the company is not very asset intensive.  The result of this attractive business model is that management has been able to substantially improve sales and profitability while concurrently deleveraging the balance sheet.  Net debt decreased from $14 million at year end 2002 to less than zero at year end 2007 while, over this same period, sales increased from $61 million to $94 million and EBIT increased from $1 million to $7 million.

Competitive Position

The company believes there are about 200 to 300 small, primarily mom and pop, foam fabricators in the U.S.  The foam fabricating industry is highly fragmented.  Most of these foam fabricators offer only one type of raw material for packaging or component products.  The company believes its strongest competitive advantage is its ability to offer customers any type of foam or raw material which they want.  The company likens itself to an auto dealer with a large lot who can offer every model of car and doesn’t care which one the customer buys.  They feel this gives them a competitive advantage over their competitors who typically focus on just one type of raw material.  Many customers appreciate the flexibility which the company can offer them.  Furthermore, the three basic raw materials used by the company (urethane, polyurethane, and cross blended foam) are sold by their raw material suppliers to only 20 or 30 nationally authorized foam fabricators, which they rely upon to sell to end user customers.  The company is an authorized foam fabricator for each of these raw materials and believes its direct access to these raw material sources is a major competitive advantage.

A second major competitive advantage is the company’s national network of plants which allows it to service larger, national customers on a “one-stop-shop” basis, which these companies find very attractive.  The national network also allows the company to supply various raw materials from various plants.  Most of UFP’s competitors cannot offer this service as there are very few with a national network of manufacturing plants.

The company believes the following strengths are also important to its competitive position: 1) its engineering expertise; 2) its ability to combine foams with other materials such as plastics and laminates; and 3) its ability to manufacture products in a clean room environment.

The interior packaging products industry has several national companies but the company’s engineered packaging products segment competes primarily with smaller independent regional manufacturing companies which generally market their products in specific geographic areas from neighboring facilities.

The company’s component products segment also competes primarily with smaller companies that concentrate on production of component products for specific industries.  We believe the company’s national network of plants gives it an important competitive advantage in competing with these small regional companies.

We believe that the company is continuing to take market share from smaller competitors in both of its industry segments due to the competitive advantages discussed above.

Operating Strategies

The company has had strong growth recently despite the tough economic environment with solid improvements in sales and margins in Q4 of 2007, and Q1 and Q2 of 2008.  While total sales were flat in 2007 versus 2006, the quarterly sales trend throughout 2007 was one of consistent improvement (see quarterly financial results below).  We also think the recent Stephenson & Lawyer (S&L) acquisition (discussed below) could be significantly accretive and we think there is potential for other, similar such acquisitions. 

Management seems to be doing an excellent job of driving improved profitability by increasing gross margins and controlling operating expenses while also increasing sales.  A major reason for the improvement in gross margin is a focus on improving its book of business by replacing lower margin, less value added work with higher margin business.  The company has an engineering sales force of 20 to 25 employees who are basically focused on solving customer problems, the more difficult and complex, the better.  Many of these employees are specialized by industry and use their expertise to create customized solutions for customers.  Furthermore, these engineering sales employees have been incentivized by senior management to seek to grow gross margin dollars and improve the book of business by adding profitable sales, not just chasing additional sales.  Another factor contributing to improving gross margins has been reduced sales in the company’s automotive industry business, which is the lowest margin business among the industry segments, as lower margin automotive business is getting replaced with higher margin business in other segments.

Management has also incentivized plant operations management to improve gross margins.  These plant general managers are highly focused on reducing manufacturing costs through lean initiatives, etc.  There is a constant sharing of best practices type ideas among the 11 plant managers.  These plant managers are told to basically assume that sales are going to be flat (i.e., the sales and marketing people fall down) and they get paid to improve profits independent of sales growth by taking costs out of the manufacturing process.  Management estimates about 35 to 40 cents of sales dollars are represented by raw material costs such as foam (however raw material cost for molded fiber, made from recycled newspaper, is much lower at about 8 cents), about 30 cents are operating expenses and about 12 to 14 cents are labor related.  Since raw materials represent the largest component of the total cost structure, plant managers focus their efforts on reducing raw material costs through less waste, etc.

Packaging products are custom designed and fabricated or molded to provide protection for fragile and valuable items, and are sold primarily to original equipment and component manufacturers.  Molded fiber products are made primarily from 100% recycled paper principally derived from waste newspaper.  These products are custom designed, engineered and molded into shapes for packaging high volume consumer goods, including computer components, medical devices, other light electronics, and health and beauty products.

Component products are fabricated and molded from cross linked polyethylene foam and other materials.  The company also laminates fabrics and other materials to cross linked polyethylene and other foams.  Component products include automobile interior trim, athletic and industrial safety belts, components for medical diagnostic equipment, nail files, and shock absorbing inserts used in athletic and leisure footwear.  Cross linked foams have many of the same properties as traditional foams but include advantages such as ability to be thermoformed, availability in colors, better esthetics and abrasiveness, and enhanced resistance to chemicals and UV light.

The interior cushion packaging market has three primary sectors: 1) custom fabricated or molded products for low volume, high fragility products; 2) molded or die cut products for high volume industrial or consumer goods; and 3) loose fill and commodity packaging materials.  The company serves primarily the first two sectors but does not materially serve the commodity packaging market.

The company markets and sells its packaging and component products in the U.S. primarily through direct regional sales forces comprised of skilled engineers, but also uses independent manufacturers’ representatives.  The company’s sales engineers collaborate with customers and the company’s design and manufacturing experts to develop custom engineered solutions on a cost effective basis.

The company’s manufacturing operations consist primarily of cutting, molding, vacuum forming, laminating, and assembly.  The company does not manufacture any of the raw materials used in its products.   Raw materials are generally available from multiple suppliers but the company does rely on a limited number of suppliers of cross linked foam.  The company believes that it is one of the largest purchasers of cross linked foam in the U.S.

 

Industry Segments Served

The company serves six primary industry segments.  The medical segment includes customers like Johnson & Johnson, Depuy, and Biomet.  This is probably the strongest and least price sensitive segment.  The aerospace and defense (or military) segment has been solid but could be impacted by political changes.  The electronics segment has also been strong with the consumer side weaker but the corporate side stronger.  One example in electronics is the company makes the packaging for Blackberry units, sometimes using foam, sometimes plastic, and sometimes molded fiber.  The customer likes that the company can supply three different kinds of packaging depending on its preferences.  Automotive is most price sensitive segment and has the lowest margins.  Auto segment sales have been declining in the current environment.

The company’s top customer in its component products segment is Recticel Interiors North America which represented 18% of total company sales in 2007.  Sales to this automotive customer declined to about 14% of total sales for six months of 2008.  The top customer in the packaging segment was BAE Systems which represented about 5% of total company sales in 2007.  The company’s top 10 customers in 2007 represented about 44% of total company sales.

The company’s business with Recticel is related to a large, multi-year automotive industry contract based in the southeastern U.S. which the company secured in 2004 and which is contracted to continue through 2011.  The contract is for interior door panel foam related work for the Mercedes M and R class SUV vehicles worldwide.  The company bid on this business with Johnson Controls which is a tier one supplier to Mercedes.  The company makes rough interior foam door panels molds and supplies them to Recticel who finishes them for Johnson Controls.  The company maintains it has never had a pricing problem with this contract and is able to earn good margins on this business.  Management seems to have a high degree of confidence in the long-term viability of this program and the company’s position in the program, even in the current brutal auto industry environment.

The company’s remaining automotive industry business primarily relates to its Detroit operations.  These operations primarily specialize in supplying foam sunshades for automobiles.  While there have clearly been some headwinds in this area, one offsetting positive is that the proportion of automobiles using sunshades in moon roofs has been increasing.  We believe that while the company’s southeastern automotive contract business with Recticel / Johnson Controls is profitable, the company’s Detroit automotive business is not profitable but that its profitability has been improving markedly.  We believe sales for the southeast business have been declining modestly and sales for the Detroit business have declined more significantly.

Management does not give specific sales or margin data by industry segment but has stated its largest industry exposure is under 30% of total sales (this is probably automotive) and gross margin dollar exposure is likely well below 30% because the automotive segment has the lowest profit margins.

Strong Cash Flow Generation
The company has produced strong financial results and strong cash flow over the past five years, as the results below indicate.   The company has reduced its net debt position from about $14 million at year end 2002 to $0 at year end 2007.  Net debt has increased slightly to $3 million at June 2008 due to the $5 million spent to acquire S&L in January 2008, but is still close to zero.  We like the fact the company was able to make an attractive acquisition, adding close to $14 million to annual sales, and still maintain a near debt free balance sheet.
We think the strong levels of cash from operations of $12 million in 2006 and $10 million in 2007 are attractive relative to the company’s enterprise value of about $45 million.  The company’s strong cash flow continued into 2008 with cash from operations of $2.8 million for six months of 2008 as compared to $2.6 million prior year.  Six months 2008 capital expenditures were $1.1 million as compared to $1.3 million prior year.  Management expects capital expenditures to continue at about $2 million to $3 million per year with about $1.5 million related to maintenance type capital expenditures.
We think the company’s strong cash generating business model allows it to maintain a low risk balance sheet and to consider accretive fill in acquisitions such as S&L going forward, as well as share buyback and dividends as appropriate.  We believe a sustainable free cash flow number is close to net income, which adjusts for the non recurring working capital benefits in 2006 and non cash tax expense in 2007 and assumes D&A expense is roughly equal to capital expenditures.  LTM net income is about $5.4 million or 89 cents per share for an 11% free cash flow yield on the enterprise value.
We think the company’s customized make-to-order approach with customers is a key factor is its strong cash flow generation.  This customized approach results in inventory being carried on an as-needed basis, based confirmed customer orders.  This high value-added, make-to-order approach is a key factor that makes the company’s business model less capital intensive and lower risk in our opinion.  The company is selling its engineering expertise and broad product line capabilities as it relates to foam products rather than just selling a commodity type product off the shelf. 
Financial Results Year to Date 2008
Q2 sales increased 23% due to internal growth of 9% and gains from the January acquisition of Stephenson & Lawyer in Grand Rapids, Michigan.  Management stated the integration of S&L was going smoothly and that there should be further efficiencies as the process continues.  6 month sales were $56.5 million versus $45.2 million prior year, up 25%. 
On a segment basis, six months 2008 sales in the Engineered Packaging segment increased 28% to $23.6 million and six month 2008 sales in the Component Products segment increased 22.5% to $32.9 million.  Six months 2008 net income for Engineered Packaging segment increased 288% from $0.34 million to $1.32 million and six month 2008 net income for Component Products segment increased 20% from $1.17 million to $1.40 million.
Company sales for six months 2008 were $56.5 million, up 24.9%, versus $45.2 million in 2007.  Excluding sales of the S&L acquisition, company sales increased 9.9% for six months 2008.  The increase in sales for the company for six months 2008 were primarily due to increased sales to a key customer in the electronics industry (Packaging segment) of $1.8 million and increased sales of molded fiber packaging products (Packaging segment) of approximately $1.4 million, which the company believes are due to increased demand for environmentally friendly packaging materials.  

Company gross margin for six months 2008 improved to 25.7% from 23.0% prior year with improvement primarily due to continued manufacturing efficiency initiatives and improvement to the quality of the company’s book of business (about 1.1% improvement across both segments) as well as leveraging of fixed overhead costs with higher sales (about 0.8% improvement across both segments).  SG&A expense for six months 2008 increased to $9.9 million due to additional SG&A associated with acquired S&L operations (Component Products segment) of $830,000 and additional selling expenses of $595,000 (both segments) and normal inflationary activity.

As we have discussed, in terms of cost structure, raw material foam generally represents about 35% to 40% of sales in cost of goods sold. Foam prices are driven by oil prices and are generally passed on to customers.  Management claims to actually like price increases because they believe it gives them a chance to revisit pricing with customers and this is generally a successful discussion given the value added by the company for its customers.
Stephenson & Lawyer Acquisition
The company completed an add-on acquisition in January 2008 of Stephenson & Lawyer (S&L) which seems to be going well so far.  S&L did about $14 million of sales and was roughly breakeven at acquisition and the company paid about $5 million in cash for the acquisition (net of S&L’s cash).  S&L is basically a foam converter like the company but for a different type of foam which the company did not previously have access to.  S&L also does some work for the auto industry.  One of the company’s competitive advantages is that it is able to offer customers access to all families of foam and the acquisition of S&L gives it another type of foam to offer. 
S&L also came with a manufacturing plant and the company plans to consolidate its existing Detroit area plant into S&L’s 250,000 square foot facility to consolidate the entire Detroit operations.   Management estimates this move will cost about $1.6 million and save the company about $1.2 million per year once the project is completed.  We believe that due to this consolidation project, the company’s SG&A expense may be somewhat elevated for Q3 and Q4 of 2008, possibly by about $700,000 per quarter.  These higher expenses will likely impact earnings in Q3 and Q4 but hopefully the company will identify these expenses as non-recurring so investors can make the appropriate adjustments.  It seems to us that the Detroit consolidation project provides an attractive return on investment and good payback.
Financial Results 2002 to 2007
The company’s financial results show a steady improvement in gross margins and sales over the past five years and continuing through six months 2008.  Although sales were flat in 2007 the product mix changed as Component Products sales decreased 4.2% due to shrinking sales in the automotive market as certain programs in its Michigan plant ended and the company’s large southeastern automotive program matured.  2007 sales to the automotive industry declined $1.9 million.  This decline was largely offset by a 4.8% increase in Engineered Packaging sales due to about $1.3 million of increased sales of case insert products to key accounts.  2007 gross margin improved to 24.4% from 20.5% due to continuing manufacturing efficiency initiatives, especially in the automotive operations (Component Products segment) which improved gross margins by an estimated 2.0% in 2007.
SG&A expense in 2007 increased 9.7% to $15.6 million due to increased sales resources of $700,000 (across both segments) and equity based compensation due to SFAS 123 (both segments) of $250,000.
Sales increased 11.7% in 2006 to $94 million as Component Products segment sales increased 15.8% to $55.8 million due to increased sales from newly launched automotive programs and strong demand from customers in medical and military markets.  Packaging segment sales increased 6.4% to $38.0 million due to strong demand for electronics packaging products and fiber packaging.  2006 gross margin improved to 20.5% from 17.4% prior year due to fixed portion of labor and overhead leveraged by higher sales in both segments and reduction of labor from 2005 when company incurred excess labor due to launch of several automotive programs.
SG&A expense in 2006 increased 14.1% to $14.2 million due to equity based compensation, increased corporate governance and compliance costs, and incremental expense within automotive business unit (Component Products segment).
Quarterly Financial Results
The quarterly results below show the quarterly improvement in operating results for the company, driven by higher gross margins and, in the last couple quarters, also by higher sales levels.  The result of these two factors has been a steady climb in gross margin dollars:  gross margin dollars were up 32% in Q2 of 2008, 49% in Q1 of 2008, and 46% in Q4 of 2007 versus prior year results.  Higher gross margins are due to an improved mix of business as management has focused its engineering oriented sales force to grow both sales and gross margins.  Gross margins have also benefited as higher sales levels have leveraged some of the fixed cost components in cost of goods sold.
Risks
Clearly one major risk factor is the concentration in the customer base: the top 10 customers represented about 44% of total sales in 2006 and 2007.  The top packaging segment customer was BAE Systems which represented about 5% of total sales.  The top component products segment customer was Recticel Interiors North America which represented about 18% of total sales. 
Another major risk factor is the exposure to the auto industry.  If you think auto sales are going to continue to decline very steeply for a long period of time this investment is not for you.  We believe that the company has good niche positions in its auto business but we cannot make ironclad guarantees on this subject.
 
Financial Summary
Price per share
$6.75
Shares outstanding
6.4
 
Market value
$43
 
52 week range
$4.94
$14.63
Income statements
 
 
 
 
       6mos
       6mos
   FYE 12/31
2002
2003
2004
2005
2006
2007
2007
2008
Sales
$61
$61
$69
$84
$94
$94
$45
$57
EBITDA
$3
$3
$5
$5
$8
$10
$4
$6
EBIT
$1
$0
$2
$2
$5
$7
$3
$5
Net income
($0)
($2)
$1
$1
$3
$4
$2
$3
EPS - diluted
($0.05)
($0.34)
 $    0.17
 $   0.14
 $   0.45
 $     0.71
 $     0.26
 $     0.44
Cash flow statements
 
 
 
 
 
       6mos
        6mos
   FYE 12/31
2002
2003
2004
2005
2006
2007
2007
2008
Net income
($0)
($2)
$1
$1
$3
$4
$2
$3
Dep & amort
$3
$3
$3
$3
$3
$3
$1
$2
Non cash adjust
$0
$1
$0
$0
$2
$2
$1
$1
Working capital chgs
($0)
($1)
($2)
($3)
$5
$1
($2)
($3)
Cash fr operations
$3
$1
$1
$1
$12
$10
$3
$3
Capital expenditures
($1)
($1)
($2)
($1)
($2)
($2)
($1)
($1)
Dividends
$0
$0
$0
$0
$0
$0
$0
$0
Share repurchases
$0
$0
$0
$0
$0
$0
$0
$0
Acquisitions
($0)
$0
$0
$0
$0
$0
$0
($5)
 
 
 
Est. free cash flow
$2
$1
$1
$3
$6
$7
$3
$4
Balance sheets
   FYE 12/31
2002
2003
2004
2005
2006
2007
6/30/08
 
Cash
$0
$0
$0
$0
$1
$9
$5
Total assets
$35
$37
$40
$44
$39
$46
$49
Total debt
$14
$16
$18
$10
$9
$8
$7
Shareholder equity
$14
$13
$14
$15
$19
$24
$28
 
 
Valuation & Valuation Ratios
 
 
Market value
$43
Enterprise value / EBITDA
3.8
 
Net debt
$2
Enterprise value / EBIT
5.0
 
Preferred stock
$0
Enterprise value / Cash fr Ops
4.5
Enterprise value
$45
Ent. value / Free cash flow
7.5
Enterprise value / Revenues
0.5
 
 
 
       6mos
        6mos
2003
2004
2005
2006
2007
2007
2008
Net sales
$60.90
$68.62
$83.96
$93.75
$93.60
$45.19
$56.46
Gross profit
$10.72
$13.97
$14.60
$19.24
$22.81
$10.38
$14.52
Gross margin %
17.6%
20.4%
17.4%
20.5%
24.4%
23.0%
25.7%
Operating income
($1.51)
$2.14
$2.17
$5.05
$7.25
$2.71
$4.61
Net income
($1.52)
$0.87
$0.66
$2.52
$4.16
$1.50
$2.72
Diluted EPS
($0.34)
$0.17
$0.14
$0.45
$0.71
$0.26
$0.44
Weighted shares outstanding
4.49
5.00
5.26
5.57
5.86
5.79
6.25
 
 
 
Quarterly Financial Results
9/30/2006 12/31/2006 3/31/2007 6/30/2007 9/30/2007 12/31/2007 3/31/2008 6/30/2008
Net sales $21.74 $23.34 $22.01 $23.18 $22.94 $25.46 $28.01 $28.46
Gross profit $4.18 $4.89 $4.60 $5.78 $5.30 $7.12 $6.89 $7.63
Gross margin % 19.20% 21.00% 20.90% 24.90% 23.10% 28.00% 24.60% 26.80%
Operating income $0.88 $1.53 $0.99 $1.73 $1.55 $2.98 $1.97 $2.64
Net income $0.40 $0.85 $0.52 $0.98 $0.88 $1.78 $1.15 $1.57
Diluted EPS $0.07 $0.15 $0.09 $0.17 $0.15 $0.30 $0.19 $0.25
Wtd shs o/s 5.72 5.72 5.75 5.86 5.91 5.93 6.09 6.39
 
Segment Financial Results
      6mos        6mos
2003 2004 2005 2006 2007 2007 2008
Net sales
Component products $31.30 $36.10 $48.20 $55.80 $53.80 $26.80 $32.90
Engineered packaging $29.60 $32.50 $35.70 $38.00 $39.80 $18.40 $23.60
   Total  $60.90 $68.60 $84.00 $93.80 $93.60 $45.20 $56.50
Operating income
Component products ($0.50) $1.00 ($0.60) $2.80 $4.80
Engineered packaging ($1.10) $1.20 $2.80 $2.20 $2.50
   Total  ($1.50) $2.10 $2.20 $5.10 $7.30
Net income
Component products $1.20 $1.40
Engineered packaging $0.30 $1.30
   Total  $1.50 $2.70
Major Shareholders
Bailly, Jeffrey 676,000 12.60%
Estate of William Shaw 334,000 6.20%
Advisory Research 302,000 5.60%
California Public 227,000 4.20%
Bjurman, Barry & Co 226,000 4.20%
Lataille, Ron 173,000 3.20%
 
 
Disclaimer
Disclaimer:  We own shares of UFPT.  We may buy or sell these shares at any time without notice.  The information in the write-up is believed to be correct as of the date written but VIC members should do their own verification of this information and analysis of this potential investment.  We undertake no obligation to update this write-up if new information arises at a future date.

Catalyst

continued growth in sales and profit margins
impact of accretive acquisitions like S&L
service focused business model holds up better than the market expects in this economy
continued strong cash generation and potential dividend or share repurchase prgms
    show   sort by    
      Back to top