Description

Universal Power Group is a distributor (and soon-to-be manufacturer) of batteries and security system components.  The stock is very cheap-- trading at 8x ’07 earnings with double digit top and bottom-line growth.  In addition, there are a couple of opportunities to win new business as well as a new product launch which are not reflected in the company’s guidance and could be nicely positive.  I think the stock is worth 12x my F08 estimate of 70 cents or almost double the current stock price. New business wins and/or traction with new product launch would lead to further upside. 

UPG provides logistical services and supply chain management solutions.  Its services are cost effective and help to minimize working capital requirements for their customers, allowing them to focus on their core businesses.  Services include sourcing, warehousing, shipping, kitting, and distribution.  The company also private labels its batteries for customers like Home Depot, RadioShack, BassPro, and others.

UPG does have one significant customer, Brinks, which accounted for 48% of sales in 2006.  While this contract is up for renewal in November 2008, the relationship with Brinks dates back to 2002 and renewals have occurred every two years since. 

Competitors are numerous but fragmented and include traditional logistic services providers, overnight shipping companies like UPS and FedEx, as well as foreign manufacturers.

Why has the stock sold off?

• Does not seem as if the company’s IPO was handled very well
• Costs for the company’s primary two inputs (lead and copper) have been rising. 
• Most of Brinks’ business (~90%) is related to residential security, which has been impacted by the challenging construction/housing environment.  Sales to Brinks were down 4% in Q1 and were up a modest 2.4% in Q2. 

Despite these headwinds, UPG was able to grow revenues in Q2 by 12.3% while sales from sources other than Brinks grew at an impressive 26.1%.  Moreover, the company was able to pass through pricing increases to its customers and earnings increased by 15.3%.

On the cost side, the outlook for copper and lead prices appears to be more stable and there is no reason to think margins cannot be maintained.  If anything, Q3 and Q4 should be seasonally stronger quarters from a top-line perspective.

Management recently updated its 2007 guidance and announced that they expect to exceed previous guidance of 10% growth in revenues and operating income.  This guidance assumes that the Brinks business stays at its current rate (flattish) and does not incorporate 90% of the potential business wins management is currently pursuing.

Room for growth

On the battery side, the company has launched a cellular battery line, which is a more rapidly growing category with higher margin.  They are working on a battery search tool aptly named Battery Finder, which will eventually take the form of free-standing kiosks in retail stores.

More specifically, UPG recently announced a contract with Monitronics, a fast-growing alarm monitoring company.  Under the contract, UPG is supporting Monitronics conversion of its analog units to digital ones.  Revenues were quite immaterial to Q2 as Monitronics was testing out the relationship, but this is a $25-$30m opportunity (relative to an existing revenue base of about $100m) if things go well.  Basically, Monitronics would like to emulate the Brinks-UPG partnership.

Finally, the company is in discussions with at least 2 potential companies outside the home security industry to provide 3PL services.  One of these could close near term and the magnitude of each could be anywhere in the range of $500k - $20m depending on the ramp up of business.  This fits with the company’s articulated goal to further diversify its revenue stream.

Risks

• Customer concentration with Brinks
• Housing worsens (though it does not seem to negatively impacting Brinks as much as some other companies)

Catalyst