2023-10-12 10:00:00 ET
Summary
- UFP Industries has seen great growth over the last years.
- UFP Industries is actively working to reduce its reliance on commodity sales and maintain strong cash flows.
- The company has strong management with well aligned incentives.
- At current prices, UFPI looks fairly priced.
UFP Industries ( UFPI ) is a leading manufacturer and distributor of wood products, with the bulk of its operations in the USA.
Three business segments
UFPI split its business into three main segments: Retail Solutions, Construction and packaging. It also has a small international export business.
Retail Solutions
Retail is the company's largest segment, providing products like decking and railings. This segment is my least favorite because it has the highest percentage of commodity sales with over 50% in most of the last four years. Product development is a big focus for UFPI, so the company always provides figures on the percentage of new products in the sales mix. This can come either through acquisitions or internal development. The retail segment has a strong track record of new product growth but is a lower-margin business with an AEBITDA margin in the mid-single digits.
Packaging
Packaging provides products like wooden pallets, crates or custom skids. We can see that packaging has a much higher percentage of value-added sales than retailing, which also shows in the mid-teens AEBITDA margin.
Construction
Construction provides products for wooden construction and manufactured housing. This segment also has a high percentage of value-added sales and a low-teens AEBITDA margin. Over time, UFPI aims to drive the rate of commodity sales down in all of its segments, currently at 36%. While this doesn't work for every year, we can see a trend over the long term. M&A is supposed to speed up this process by searching for products that fill the gaps in the existing product portfolio, drive value-added sales and increase scale with the upside of improving the acquired business.
The lumber risk
With lumber still a sizable part of the company's sales, knowing the cyclical lumber risk is essential. Over the pandemic, lumber prices saw incredible volatility, rising from $300 to $1600 trough to peak. UFPI claims that the lumber market does not impact its margins much due to its balanced mix of variable and fixed-price products. We can see that the AEBITDA margin stood around the 10% range over the last five years. As value-added products become an increasing part of sales, this risk should be further mitigated.
A focus on capital allocation
UFPI produces healthy and growing cash flows, so we should consider the firm's capital allocation priorities. We can see strong growth over the pandemic. This was partially due to a favorable commodity pricing environment, strategic reinvestment, and M&A. Most cash flows are reinvested into the business via Capex and M&A. In the last two years, M&A outpaced Capex. A modest dividend is also paid out and there are occasional share buybacks.
A Focus on return on invested capital
UFPI openly talks about its Return on Invested Capital, which has seen steady growth over the last few years. While I don't think they can maintain 34% as their end markets normalize a bit, their hurdle rate for new projects is 20% and they are disciplined in keeping a high ROIC. The company runs a decentralized management style where every plant is a profit center and each manager must own stock. Management is compensated based on the returns on capital of the profit centers and the average senior manager has a tenure of over 22 years at UFPI. This drives a strong incentive to drive profitable and resourceful growth.
The long-term goal...
Over the long term, UFPI wants to achieve unit sales growth between 5-7%, including bolt-on acquisition, an AEBITDA margin above 10% and to earn an incremental return on new investment above its WACC of 10%. It wants to maintain a conservative capital structure. Over the last decade, the net debt/EBITDA ratio was at 0.7 times as a median. This is well below my 2 times maximum I like to see. Interest coverage has averaged 30 times. Currently, UFPI sits at a $353 million net cash position, as the company used the great cash flow generation over the last years to pay down some debt and increase its cash position meaningfully. Debt maturities are spaced out nicely and at interest rates between 3-4%.
....and short-term headwinds
The short-term outlook doesn't look rosy, with sales as much as 24% depending on the segment. The last three quarters saw accelerating declining sales and profits, with a 29% sales decline and a 27% net income decline previous quarter. Over the long term, we should see modest growth in UFPI markets. I'm most excited about the packaging market, as sustainable packaging is an increasingly important topic for customers.
UFPI looks fairly priced
To value UFPI, I'm using an inverse DCF model. I recently started to use higher discount rates for companies with cyclical components, so instead of my usual 10% discount rate, I'm using 15% for UFPI to account for the added risk. I also used $125 million of growth capex, as UFPI is investing a lot of money into increasing capacity and automating its manufacturing footprint. We can see that UFPI currently has an overstated FCF due to high changes in NWC. Still, UFPI trades at a high Owner Earnings yield of 9.8% and requires 5% growth over the next five years, followed by five years of 4% growth. This is below its long-term growth guidance of 5-7% unit sales growth. I believe that UFPI trades at a fair price right now and is a high-quality business that is increasing its revenue quality (reducing commodity sales) and with the right alignment between management and shareholders. UFPI is a 2% position in my portfolio.
For further details see:
UFP Industries: Growth With Strong Management Incentives