As originally posted at SeekingAlpha.com
UFP Technologies, Inc. (UFPT)
08.26.13
Current Price: $21.17
Fair Value: $25
Recommendation: BUY
Why UFPT?
• Best management team in the business
• Great research and engineering team
• Manufacturing consolidation will expand margins
• Medical market is now the largest and fastest growing
• Working off a large, older contract, comparables will look better
• High margins
• Reasonable valuation
• Strong balance sheet
• Large insider ownership
Business Description & Company History
UFPT manufactures high-tech, custom-molded packaging, components, and other products. They serve a number of different industries, including medical, automotive, aerospace, industrial, electronics, and consumer.
Founded in 1963 and headquartered in sleepy Georgetown, Massachusetts, UFPT is a geographically diverse company, with offices in eleven other states. Its other large fabrication and design facility is located in Grand Rapids, Michigan.
Although industry competition is stiff, UFPT differentiates itself by providing customized solutions and specializes in combining foams with plastics and laminates, which requires a specialized skillset. In essence, they manufacture packaging that is highly durable, light, breathable, protected, and available at a relatively low cost.
UFPT customer concentration represents 27% of revenues for the top ten clients, down from 31% two years ago. Management has made a conscious effort to diversify its revenue stream.
Medical (~23% of total revenue) is their largest segment, with approximately $32MM in revenue (FY12). This field also happens to be UFPT’s fastest-growing segment, with almost double-digit revenue growth.
Although some weakness in the aerospace and defense markets has largely overshadowed bright spots in other areas, such as medical, we believe medical will dominate revenue growth and percentage of sales for the foreseeable future, especially with the Affordable Care Act coming closer to reality.
Management
The management team is led by Jeff Bailly, CEO. He has worked for UFPT since 1988, having risen through the ranks. He’s a certified public accountant and well versed in operations, management, and acquisitions.
The company’s management team is probably its biggest asset and most important aspect of our thesis for UFPT’s long-term potential. I’ve rarely found a management team as astute as UFPT’s, and their capital allocation ability is second to none.
Much of UFPT’s recent success can be attributed to management’s uncanny talent in sheltering the company from the economic downturn and then having the wherewithal to engage in a series of acquisitions at the depths of the market downturn in 2009.
The following excerpt is from UFPT’s 2009 annual report:
2009 was a dynamic and exciting year for UFP Technologies. A difficult economic environment provided both challenges and opportunities for the company. I believe the events of this year also demonstrated our flexibility and depth, and validated the effectiveness of our strategy.
With customer demand significantly reduced in early 2009, we scaled back our business to ensure that we remained profitable, shifting resources within the company to minimize layoffs and cutbacks. We were careful to retain the resources we would need to capitalize on the new growth opportunities we believed would come our way in such a volatile environment. Once we identified these opportunities, we had the resources on hand to successfully negotiate and quickly close three important acquisitions, and efficiently integrate each business into UFP.
In March, we acquired certain assets of Foamade Industries, Inc. In July, we acquired E.N. Murray Co. Then, in August, we purchased certain assets of Advanced Materials Group (AMI). These were all exciting opportunities to increase market share and position UFP for long-term success. Together, the three acquisitions have been profitable, have added to our operating income, and have quickly made UFP a stronger company. We also recorded onetime transaction gains in each case, as a result of successful negotiations on purchase price. These acquisitions illustrate the growth opportunities that exist for UFP Technologies, as well as our ability to successfully integrate them. We will continue to search for companies that provide a good strategic and cultural fit, improve our position in our target markets, increase the value we bring our customers, and further differentiate us from our competitors. With newly acquired factories and changing market dynamics, we will also review our operating footprint to make sure our plant locations line up well with future opportunities, and consider changes where appropriate.
As you can see, acquisitions are a mainstay of UFPT’s value proposition, and unless more opportunities arise, UFPT’s stock should perform in line with that of its peers. If, however, such opportunities do occur, which we believe will be the case over the next couple of years, UFPT will be able to purchase companies at favorable times and prices to further solidify their dominance as a specialty packaging solutions company.
Valuation
We believe UFPT shares are currently undervalued when considering future growth prospects and a particularly astute management team.
UFPT has spent the past year and a half consolidating facilities in an effort to improve efficiencies, and margins have responded in kind. The company’s margins of around 29% are high for this industry, and we believe management has a clear plan to take those margins north of 30% within the next two years.
Return-on-invested-capital (ROIC) runs in the mid-teens, and return-on-equity (ROE) runs slightly higher than that. These high margins highlight UFPT’s value add within the industry, since most of their competitors struggle to simply earn their cost of capital, while UFPT more than surpasses it.
UFPT largely invests its earnings back into the business to improve operations and expand into new areas, so free cash flow is somewhat anemic. What is left over is used for opportunistic acquisitions, both horizontal and vertical.
Regarding an Enterprise Value-to–EBIT (EV/EBIT) perspective, UFPT is trading at a reasonable multiple below 8x, which is certainly acceptable for a company that has doubled revenue over the past ten years and increased earnings by a factor of 10 and whose management team is still young and hungry in their early 50s.
We particularly like to own companies such as UFPT, where a great operator who has a significant stake in the company is in control and has a track record of growing intrinsic value at a satisfactory rate. It makes determining the fair value of the company harder because the value of the firm seems to grow every quarter. So, while it’s a moving target, it’s moving in the right direction—up.
Risks
Acquisition Risk
UFPT’s ability to integrate acquisitions could hamper future performance if the transition is handled well or unforeseen circumstances occur.
Economic Risk
While UFPT’s revenue stream is relatively diversified, a prolonged downturn in economic activity may put pressure on the firm’s earnings.
Disclaimer: This discussion is for informational purposes and should not be taken as a recommendation to purchase any individual securities. Information within this discussion and investment determination of the author may change due to changes in investment strategy when warranted by changing market conditions, or if a security’s underlying fundamentals or valuation measures change. There is no guarantee that, should market conditions repeat, this security will perform in the same way in the future. There is no guarantee that the opinions expressed herein will be valid beyond the date of this presentation. There can be no assurance that the author will continue to hold this position in companies described herein, and may change any of his position at any time. We use or best efforts to obtain good data in our models, however it can’t be guaranteed that our inputs and data are correct. This is not a recommendation for readers to purchase shares in the above security without consulting your financial professional to discuss your own risk tolerance and objectives.
