ULBI - Ultralife: Buy The Dip

2023-11-22 01:04:09 ET

Summary

• Ultralife Corporation shares have experienced a pullback of over 30%, making it an attractive investment opportunity.
• ULBI focuses on margin improvement and growing sales, with plans to pay down debt and evaluate further takeover targets.
• The company's range of new products and innovations is expected to drive revenue to new highs in FY2023 and beyond.

Ultralife Corporation ( ULBI ) shares have been on a tear in 2023; a recent pullback of over 30% combined with forecasts of increased revenues, higher margins, and a debt reduction make this an attractive opportunity. ULBI makes rechargeable and non-rechargeable lithium batteries primarily for military, Medical, and industrial use.

ULBI grows by acquisition, targeting closely aligned businesses that offer an already developed sales channel that allows ULBI to increase the sales of lithium batteries. A new CEO has focussed the company on margin improvement and growing sales. He has said he is already evaluating further takeover targets but will first use the company's increased profits to pay down the debt on their most recent acquisition.

A range of new products and innovations will drive revenue to new highs in FY2023 and much higher over the coming years. It looks like an excellent investment; a solid and improving balance sheet with EPS growing faster than its share price makes this look like a great opportunity.

The Volatile Share Price Movements

In 2023, the ULBI share price has risen from below $4 in January to more than $11 in mid-October; a significant and sharp pullback to $7 offers the chance to buy in at a potentially great price.

The big price jump in August followed the big Q2 2023 earnings beat ; revenue was $42.69 million compared to $32.13 million in Q2 2022. Net income was $3.34 million compared to $0.5 million a year earlier. EPS came in at $0.21 compared to $0.03 the previous year.

Q3 earnings ( released Oct 27th) arrested the sharp fall that began at $11.37 on Oct 16th. On the earnings release date, the shares were at $7.15 and bounced above $8 as the company reported revenue of $39.49 million compared to $33.23 million a year ago. Net income was $1.33 million compared to a net loss of $0.24 million. Basic earnings per share from continuing operations was $0.08 compared to a loss of $0.01.

Revenue guidance above $39 million for Q4 2023 suggests 2023 total revenue will be over $155 million, an increase of 18% over 2022.

EPS growth

A key element of my bullish thesis, using management guidance for revenue, margin, capex, and debt, my three-statement model forecasts the following.

An increase of almost 300% to EPS by the end of 2024 will profoundly increase the ULBI share price.

It has been a difficult 12 months for ULBI. They were hit by a ransomware cyber attack in January 2023 that reduced their ability to ship products, slowing revenue and lowering margins. It followed on from the Q4 2022 incident where the board dismissed the long-term CEO without giving any apparent reasons to the market.

The new CEO is a long-term ULBI employee; the go-forward strategy remains unchanged, except for an added focus on profitability. In the Q3 earnings call , management said the cyber attack is behind them, deliveries are back on track, and no ransom was paid.

ULBI Strategy

The competitive strategy of ULBI is its competitive advantage. It makes rechargeable and non-rechargeable Lithium batteries and looks to expand its revenue by designing batteries to replace existing non-lithium batteries in an already developed market.

ULBI enters new vertical markets by acquiring established players and integrating its existing technology into the newly acquired company and its products.

ULBI has successfully entered the Medical, Military, Oil and Gas, and Marine markets through its acquisitive strategy.

ULBI Born and Grown by Acquisition

The company began when it acquired the 9-volt battery technology of Eastman Kodak ( KODK ). The 9V standard-size battery found in smoke alarms is still a good product line. One online retail store has the ULBI (Ultralife) and competitive batteries with specifications. The ULBI battery costs almost three times as much as the Alkaline version but offers a shelf life of 10 years instead of 5 years and an operational life of nearly five times as long. The website also sells a competing Lithium battery with the same specification as ULBI but at a higher price. To maintain an advantage, ULBI will need to consistently apply new technology to their batteries and produce them at competitive prices.

(Note Author database: I keep a database on companies that I think can return 100% in the next 12 months; it includes tables like this, summaries, and a three-statement model used for following the progress of companies)

ULBI acquires businesses that offer new markets for its core battery technology.

A case study of the strategy

ULBI bought McDowell Research in 2006, paying $5 million in cash and $20 million in convertible notes. At the time, the CEO said :

We acquired McDowell to enhance our channels into the rapidly growing special operations area and to strengthen our presence in global military markets.

The purchase opened new vertical markets. ULBI is skilled at designing Lithium batteries of a specific size and shape to fit existing equipment.

An example is the BA-5390 Military battery. It is a lithium battery designed to fit an existing application, offering superior performance to the legacy tech.

our leading BA-5390 military battery, an alternative to the competing Li-SO2 BA-5590 battery, a widely used battery type in the US armed forces for portable applications." ( ULBI: 2022 10-K, 2023-3-31 )

The BA-5390 received an order from the US military for up to $40 million dollars for this battery in 2010 and a further $10 million order in 2021.

SAFT (owned by Total Energies) manufactures the competing BA 5590 and now has a high-capacity version, but its capacity is still 25% less than the ULBI alternative. With a solid cathode, the ULBI offers an improved safety profile and performance in all quoted areas, including as much as 100% additional mission time. The 5390 is an example of how ULBI develops its competitive advantage, using available technology and fitting it into a specific-sized unit with an already proven marketplace and selling the tech through an acquired vendor.

Paying for these acquisitions

The most recent acquisition was the 2021 $23.5 million all-cash purchase of Excell batteries. This acquisition has provided several new vertical markets, including Marine and Military applications of rugged computer equipment. ULBI has already announced large orders in these new channels.

The effect of takeovers on the ULBI balance sheet is above. ULBI has traditionally paid the cost of acquisitions in about three years. In the Q3 earnings call, the CEO said he wants to pay off current debt (for the acquisition of Excell) with operating profits and see a cash build-up over the next two years. He also clarified that ULBI is already looking at a future investment, saying they are constantly analyzing at least two potential takeovers at any time.

The organization is currently focused on margin improvement and is realizing impressive results. However, any investor should expect ongoing M&A activity that will make these improvements lumpy and will always raise the possibility of dilution.

They are naturally acquisitive and intend to return to this plan, buying competitors, brand names, and related new market opportunities.

Competitive advantages

Their USP is their people, skills, and reputation built up over many years. They are a trusted Military and Medical supplier that continues to grow its product range using battery cells and technologies invented by others. ULBI can fit a new technology into an existing application, significantly upgrading equipment performance. I expect to see ULBI selling different chemistry batteries as they become available. Other companies may develop solid-state batteries, but ULBI will integrate the tech into critical military and medical applications.

The strategy has led to significant military orders. The CEO said in Q3 earnings:

We won the largest contract award in history of the battery and energy business, the conformal wearable battery, with initial possible value of $165 million and additional option years that could add another $350 million

- (ULBI: 2023 Earnings call Q4 2022 Transcript, 2023-3-2 )

The scale of these orders will be transformative. This order alone could triple revenue in the next few years.

ULBI has acquired expertise in Thin-Cell batteries, flat, lightweight lithium batteries in various sizes, and designs marketed to OEMs for wearable and other applications. The Thincell product line will be a future growth area for ULBI, and they are installing a new production line to meet customer demand that will be operational in 2024. (Q3 2023)

Product development continues with chloride products, the 123A cell designed for IOT products, and the newly released X5 USB hot swap system received a $2.5 million order. Show the use of new chemistry being fit into existing products.

Communications Systems

This division was born with the two acquisitions in 2006 and 2009 and expanded with the Excell acquisition. Management guided to a significant upturn in US military orders in the Q3 2023 earnings call. Ground-to-ground and ground-to-air secure communications appear to be the main drivers of this business, and initial orders for the recently released ruggedized EL8000 integrated server systems have begun to arrive. The EL8000 devices are designed for harsh environments to bring computing power to military units in the field (the ruggedized computing came with the Excell acquisition).

In the Q&A section, the ruggedized EL8000 was a hot topic. The products developed with a strategic partner have enormous potential. The partner has a multi-billion dollar backlog for such servers. The CEO said:

We are the preferred and only real vendor in this space to package that equipment to get it to the edge.

- (ULBI: 2023 Earnings call 3 2023 Transcript, 2023-10-26 )

The CEO announced a ground fleet upgrade order of $6.9 million and guided to repeat similar-sized orders in 2024.

Financials

ULBI has a solid balance sheet.

Debt to equity stands at 21%, and the CFO said (Q3 prepared remarks), "With the dramatic strengthening of our balance sheet, we are poised to commence in the fourth quarter the paydown of our debt."

He referred to the dramatic strengthening of almost $13 million in working capital and the $13 million of EBITDA generated in the previous 12 months. The CFO said their financial performance in the previous trailing twelve-month period had been the best in their 15-year history.

Forecasts and targets

ULBI is not well covered by Wall Street and has only 1 Wall Street analyst following it. However, that analyst gives a 12-month price target of $12 ( Seeking Alpha ). The analyst forecasts revenue of $169 million in 2024.

Simplywall.st has created a DCF fair value using this single analyst forecast and derived the following.

I have set a technical price target of $22 (I will post a link to my charts in a comment following publication).

The seeking Alpha Quant rating is a strong buy with a score of 4.51, ranking it 4th out of the 71 players in its industry. The factor ratings from SA are:

The low scores come from Valuation and Profitability. Three ratios account for the low score in Valuation, Price/Earnings, Enterprise Value/EBIT, and Price/Cash Flow. The low score on profitability is related to margins, EBITDA, and free cash flow.

In truth, the low Profitability and Valuation scores relate to margins, and margins have not been trending in the right direction for the last few years.

The outlook for 2023 and 2024 looks very promising. In the Q3 earnings call, the CEO discussed his lean company strategy and its effect on margins. He guided to a margin improvement of 150 basis points this year over last and a similar improvement next year over this one. So we can expect to see a 300 basis point increase in gross margin by 2024, implying an improvement in margins from 22% in 2022 to 25% by 2024; this would address the fall in margins seen in recent years and have a knock in effect to EBITDA and net income. The Q3 margin was over 24%, suggesting the company is well on achieving this margin improvement.

The company is also improving its expenses in Q3 SG&A, which came in at 19.3% of revenues, up from the 22% reported in Q3 2022.

Conclusion

ULBI has worked through a difficult 12 months. The previous CEO was dismissed, and a Cyber attack reduced the ability of the company to operate at several of its sites; however, it has managed to increase volumes and margins over this period.

The company has given strong growth forecasts for the remainder of 2023 and has several large orders that will likely increase revenue again in 2024.

The share price has pulled back from its dramatic gains earlier in the year but with EPS forecast to move higher and management guidance suggesting improved full-year 2023 revenue and margins the pullback might be the share price catching its breath before another surge higher.

In terms of M&A, I would expect to see ULBI buy another company in 2025/6, and I expect that company to be an established manufacturer of electronic devices that need battery power. The military and Medical fields would appear to be ULBI favorites, but their commercial division is probably the one that offers the most growth. Perhaps a company that makes remote sensing and monitoring devices or remotely operated robots is already being analyzed?

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