UFP Technologies – Opportunities come in Small Packaging Companies

December 8, 2011

Hello all. Some of you may have noticed that I have not been posing as much as I normally do, and the reason for that is that I have been studying for the CFA examination. The test was last week, so I now find myself again at your disposal. I thought I would kick things off with a discussion of an interesting small cap called UFP Technologies, which I was referred to by a reader, Adib Motiwala of Motiwala Capital.

UFP Technologies is a small manufacturer of packaging for both bulk and fragile products, which it makes out of foam, plastics, and recycled fiber. Some time ago the company determined that the same technology to make packaging could also be repurposed to make actual components. The component trade now composes the majority of UFP’s net income, approximately 60% of the company’s total revenue for 2011 year to date. All of UFP’s physical locations are in the United States. The company’s revenue is somewhat concentrated, with four customers representing over 30% of all sales for 2010.

As a company that supplies packaging for businesses, and also produces components for other businesses, including the medical and automotive fields, the company’s results might well be considered cyclical. However, when the company’s current excess cash position is taken into account, UFP has produced a free cash flow yield that would almost be satisfactory even in 2008 and 2009. Furthermore, the company took advantage of the prices prevailing in 2008 and 2009 to make several attractive acquisitions which for the moment seem to be doing well. The company claims that further acquisition and joint ventures are integral to its current strategy, but it has not made any major acquisitions in 2010 or 2011, and in fact it divested one of its existing packaging factories in 2011.

Turning now to the figures, in terms of excess cash UFP has cash and equivalents of $30.7 million, receivables and inventory totaling $24.1 million, and current liabilities totaling $12.4 million. Current liabilities are therefore fully covered by noncash current assets and thus the entire cash holding may be considered excess. Based on the current market cap of $98 million, we thus have a value of $67.3 million for the market value of UFP’s  operations.

In terms of free cash flow, in 2010 sales were $121 million, operating income was $14.4 million, depreciation and amortization minus capital expenditures was -$0.1 million, producing $14.3 million in operating cash flow (not counting changes in working capital). Interest expense was $0.1 million, leaving $14.2 million in pretax free cash flow, or $9.2 million after estimated taxes of 35%. I should point out that UFP reports its interest expense net of interest income, and therefore I am using the company’s reported cash paid for interest to estimate total interest expenses for all periods. I believe this figure also to be reported on a net basis, so these figures may include interest income on cash that I have already separated as excess, but owing to the current low interest rates the effect should be fairly small. Based on the $67.3 million market value of UFP’s operations, this represents a free cash flow yield of 13.7%.

In 2009 sales were $99 million, operating income was $8.2 million, and excess depreciation was $1 million, which produces $9.2 million in operating cash flow. Interest expense was $0.2 million, producing $9 million in pretax free cash flow, or $5.8 million after taxes.

In 2008, sales were $110 million, operating income was $8.4 million, plus excess depreciation of $0.2 million, producing operating income of $8.6 million. Interest expense was $0.4 million, producing pretax free cash flow to equity of $8.2 million, or $5.3 million after estimated taxes.

As I said before, the free cash flows in 2008 and 2009 do not quite hit the 10% free cash flow yield on the market value of operating assets that many participants, including myself, consider a decent rule of thumb for an asset to be fairly valued. However, as these figures come from a fairly severe recession, and the UFP seems to have expanded its capacity through some acquisitions that it does not seem to have overpaid for, I believe that UFP is fairly robust at current prices.

2011, for which we have three quarters of 10-Q’s released, is shaping up fairly well. Sales are $96 million versus $89 million for the same period last year, but these figures include the automobile panel contract that has now expired. Capital expenditures for 2011 year to date have exceeded depreciation by $0.6 million, but UFP has also sold one of its packaging plants for $1.2 million. Operating cash flows are $10.9 million versus $11 million for the first three quarters of 2010. Cash interest paid was less than $0.1 million year to date, versus $0.1 million for the same period last year, producing free cash flows of $7.1 million for each period, not taking into the account the proceeds of the divestment of the packaging plant.

The company’s debt as a portion of its capital structure is almost negligible, with interest payments covered by operating cash flows many, many times. Furthermore, UFP has a credit facility with $16.7 million available on it. Therefore, the firm has plenty of leeway to return cash to its shareholders, and it is even possible, although the company has given no indication that it is likely, for the firm to expand its use of leverage for the further benefit of its shareholders.

I should point out, however, that UFP has a significant number of stock options outstanding, totaling  nearly 1/10th of the current shares outstanding and with a weighted average exercise price of $4.81, less than a third of the current price. The options that matured in 2011 were settled in stock rather than cash.

Based on a 10x multiple of 2010’s free cash flow to equity of $9.2 million, plus the excess cash figure of $30.7 million, we have an estimated equity value of $122.7 million. After taking the dilutive effect of options into account, this would translate to a share price of $17.56, a modest premium over the current price of $15.01. Thus, this stock is an interesting candidate for portfolio inclusion particularly in the event of any future drop in price.

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