UFPT - UFP Technologies: Exceptional Durable Economic Characteristics

2023-06-21 00:16:57 ET

Summary

• UFPT Technologies has caught another strong bid in FY'23.
• The company's MedTech business, particularly its robotic surgery sales, is driving its success, with the potential to capture market share in the future.
• Despite a possible short-term correction, I've revised up the long-term target for UFPT to $342/share.
• Reiterate buy.

Investment summary

The investment thesis covering UFP Technologies, Inc. ( UFPT ) continues to vindicate itself with a 109% return on capital since the original buy recommendation in August FY'22, and 66.7% return since I urged to size up the long account back in January. You will note in Figure 1 UFPT's market performance is backed by robust fundamental, sentimental and valuation data.

This report will convey the latest developments, and highlight the company's durable economic characteristics, factors the market is paying higher values for over time in my view. A couple of points I will add here, regarding price visibility looking ahead:

1. On a technical basis, the stock has broken the upper line of the ascending channel that's extended for 14 weeks now.
2. Given that, there is a chance of a pullback in the company's market value in my opinion.
3. Second, the "guts" of the trend have also extended for around 12 months now, meaning large accounts can now take profits and avoid incurring short-term capital gains tax. This should also be factored into consideration.

The point being, I wouldn't be surprised to see a short-term correction and liquidity grab over the coming weeks to months– but I want to clearly say that doesn't change my investment view on UFPT. Here I will outline the economic reasons why I remain bullish on UFPT, rating it a buy in doing so. On earnings power and asset factors, I reiterate UFPT a buy, looking to a revised long-term target of $342 over the coming years.

Figure 1. UFP Long-term equity curve

Critical facts for further price change

It is no secret the investor of today does not get paid for the results of yesterday's market. Indeed, the performance shown in Figure 1 has already ''happened'', and the question is what's in store from here. Based on this analysis there is good reason to believe a bolus of UFPT's growth lies ahead of us. There are fundamental and econometric reasons for this, reasons that will be discussed in detail here today.

Fundamental factors

1. UFPT is a long-term "growth company"

Long-term and near-term performances are worth a mention for UFPT. Looking at its latest numbers of Q1 FY'23 , reported in early May, UFPT clipped 37% YoY sales growth to $97.8mm, on 98% YoY earnings growth to $1.27 (fully diluted).

Looking to the divisional highlights, growth percentages are superb here and illustrate the current sentiment:

• The MedTech ("medtech") business, driving the bolus of the company's successes, is the key set of numbers to look out for when analysing UFPT. It was up 59.5% in Q1 to $83.8mm, making up 86% of turnover.
• The segment's growth was underscored by a 112% advancement in robotic surgery sales. This is a domain undergoing quite the expansion within broad surgery, whereby a combination of artificial intelligence, software and engineering are producing innovative surgical robots to maximise surgeon and patient outcomes.
• Aerospace & defense turnover was up 430bps YoY to $4.2mm, but the company booked YoY losses in its Automotive and Industrial segments.

Taking the medtech segment on its merits, the growth is attractive and sets a firm platform to work from into the coming decade.

The term "growth company" is one spread too thinly throughout the universe of high and low-quality stock issues. Commentators will apply the term with little regard to the long-term growth performance of a firm, instead looking at the YoY numbers. UFPT is in fact a long-term purveyor of growth, as shown in the below record:

Table 1. UFPT long-term top-line growth record

You'll note two key facts from the record above– one, is that revenues have grown at an annual compound rate of 11% since 2013 and 17.6% since 2017, tremendous numbers in my view. Two, is that the cumulative growth rates are increasing over each long-term period. From 2013–2017, the cumulative gain was 6% in sales, 2017–2021 up to 40%, not from 2021– 2023 in the last 12 months, you're looking at 84% growth in turnover.

The divisional record is equally as telling (in the medical segment) of these same statistics:

Table 2. UPFT long-term segment performance

2. Recent fundamental momentum

Moving down the Q1 P&L , results were widespread. Namely:

• Gross profit was up another 530bps to 29.4%. In a time of inflationary headwinds, higher labour input costs, and raw material shortages, the upshift in gross margin is telling. It indicates to me UFPT's ability to navigate these issues. To get there, the company has focused intensely on improving operating efficiency, followed up by price adjustments to pass through the raw material and labour cost increases.
• It pulled this to core EBITDA of $15.5mm– up 65% YoY, on operating income growth of 102% to $13mm and earnings of $1.27 as mentioned earlier.

These are attractive growth numbers in my view. That it is pulling the top-line growth down to the operating line is an illustration of the robust fundamental momentum underlying UFPT's intrinsic value.

As support for the company's ability to attract further investment, consider the company's exceptional numbers in robotic surgery. This presents a compelling investment opportunity in my informed opinion. The segment was up 112% in Q1 as mentioned, and at those rates, UFPT demonstrated its ability to capture market share early on. The surgical robotics market is projected to grow at 16.6% annually to reach $18.4Bn in 2027, strong momentum itself. As the adoption of robotic surgery continues to increase, if UFPT keeps the pace up in its robotics business, it could capture a good portion of the future market share in my view.

Economic factors

Readers of this investment channel will know of the eternal quest to uncover high-quality names with the most desirable economic characteristics. UFPT displays an extensive list of these. This is precisely why the market has generously rewarded the company over an extended time frame in my view, and also why it will continue to pay justified higher market valuations into the future.

1. Return on tangible and intangible operating assets

Along with the financial advancements listed earlier, there are deeper, more critical drivers of UFPT's value.

On a company level, UFPT has demonstrated an exceptional ability to appreciate capital over time. Take Figure 2 to show this. The firm has committed c.20% annual growth in investment to its capital base per year since 2013. In recent years, this has ramped up substantially to ~25% increase in investment per year.

Critically, the firm has produced an incremental gain in post-tax earnings to accommodate the capital employed. The return on capital is now back at the long-term range of 10–14%, albeit at a 106% wider capital base compared to December 2020. I would surmise this is one very important factor underlying the market's ongoing reward for the company.

Figure 2.

2. Market return on investment

The points raised above are exemplified in Table 3 and Table 4. The former shows the company's incremental investments made each year into the last 12 months, along with the incremental profits generated. The rolling 5-year incremental return on capital is calculated from 2013, along with the incremental return between periods shown.

What's clear is this– UFPT does not have any difficulty in meeting its cost of capital when making new investments for business growth. In particular, from 2020–2023 in the TTM, incremental returns have been stellar. Up from 2% in 2021, lifting to 71% and then 42% in the subsequent periods (note: TTM figures). This trend is observed in both the rolling 5-year return on invested capital and incremental capital returns.

Table 3.

With UFPT allocating capital at tremendous rates of return, it would be no surprise to see the market's reactions. Checking the market's return on UFPT's investments, the results are astounding. The change in market value is calculated as the annual change in market cap from December each year, scaled against the periodic investment made each year, and growth in profits between each period. So December 2020, for example, shows the change in market value from December 2019–2020, next to the extra investment/divestment UFPT made in that year. Note that:

• There's nigh been a period where at least a triple-digit return has occurred from the market.
• Apart from 2019, the momentum on this is actually building over time, as the company generates even greater market ROI.

To me, this is absolutely telling. The market is an accurate judge of intrinsic value over time. An extremely accurate judge in fact. It recognizes the earnings power and asset factors on display from UFPT, and justifies the higher market value as the company compounds its intrinsic value, justifiably so.

Table. 4

Valuation

Based on the economic factors discussed above, it is no wonder to see UFPT trading at 5.7x its book value on the market. This is absolutely justified in my view, as, since 2013 the company has generated $5.97 in market value from every $1 invested into additional growth. Since 2018, that figure is $6.30 per $1 of capital invested.

It can be deduced the market values the capital UFPT invests extremely high, because it generates quite healthy returns over such a long period of time. This is evidence of a durable competitive advantage that protects the returns on capital. I would surmise this comes from the company's standing in the med-tech arena, where it produces highly engineered customized products for surgery and other domains.

Hence, I am not deterred by the 5.7x multiple, and believe this is actually underserving the company's forward earnings power and asset utilization. The stock also smashed my last price target of $128 based on these factors.

The company trades at 33x forward earnings, however, which makes me wonder if the market is a bit stretched. My numbers have the company to do $49mm in earnings in FY'23, or ~$7 per share– above consensus estimates of $5.43. Projecting the owner earnings out to 2030, the NPV on my growth assumptions at a 12% discount rate and 2% terminal rate pull to $342/share, an indication of the growth potential on offer. I am not surprised by this, given the market's strong reward for the company to date. With my FY'23 growth assumptions and valuation estimate, this comes to an intrinsic value of 52x forward P/E, ahead of the market's expectations.

In short

Based on the culmination of factors presented in this report, I remain bullish on UFPT and am looking to a revised long-term target of $342/share, signifying the upside potential in my investment view. Critically, as discussed, I wouldn't be surprised of a near-term pullback based on technical findings. In terms of the company's economic characteristics, it is poised to create tremendous value going forward, with UFPT appreciating capital at rates higher than the market return. Net-net, reiterate buy.

Appendix 1. UFPT forward-estimates and earnings assumptions

For further details see: