- UFP Technologies exhibits the kind of equity premia we are seeking exposure to in FY22.
- A 5-year normalized ROIC of 9.2% coupled with a pivot into medtech look to have positioned the company well looking ahead.
- Investors have priced an above-market growth at the bottom-line for UFPT in FY23.
- We price the stock at $85 and look to re-rate to the upside come second quarter earnings.
Investment summary
As investors navigate the forward looking investment landscape factors of profitability, working capital management and earnings quality are paramount to separate alpha from the beta in FY22. Those names exhibiting high degrees of idiosyncratic risk premia have outperformed and look set to continue doing so for the remainder of this year.
The analysis then turns to UFP Technologies, Inc. (UFPT). We demonstrate the stock displays a tight affinity to the kind of equity premia we are seeking exposure to in FY22 and that recent divestments are accretive to $1.60/share of additional income for the coming period. Valuations are a challenge, however upcoming earnings provides an excellent opportunity to re-rate to the upside with an outsized result. We rate UFPT a buy with a price target of $85, seeking to re-rate in Q2 earnings.
Exhibit 1. UFPT 6-month price action
Data: Updata
Market mechanics pivot bullish
First we examined the market's expectations for UFPT and where it positions the company relative to the wider market. Ideally, we're after names that are strengthening against the benchmark whilst reducing equity beta as a display of idiosyncratic (or company specific) strengths – factors the market is rewarding in FY22 and beyond. Arguably, a stock that is outpacing the market whilst reducing covariances offers a greater probability to deliver true alpha that's separate from the market's influence.
Investors have dialed back exposure to high-beta and growth names in FY22 effectively exhausting that trade. In its place, low-beta, high quality names that exemplify resiliency look to be the standouts looking ahead. Investors are already paying a premium for value, low volatility and profitability in H2. As such, we advocate investors to follow the same line of reasoning when thinking of portfolio construction.
UFPT exhibits these qualities that investors are set to pay a premium for. As seen in Exhibit 2, UFPT caught a bid in March and has exhibited positive carry ever since, finding buyers at key trend levels. It also strengthened against the benchmark in that time whilst reducing its covariance structure, suggesting company-specific features might be responsible for the upside.
If investors are rewarding idiosyncratic risk premia in FY22 (instead of the index-like returns dominating these past 3-5 years), then it stands to reason UFPT exhibits a number of these, seeing as its bifurcated from the benchmark to the upside whilst reducing investors equity beta.
Exhibit 2. Bifurcating from the benchmark to the upside along with downshifting covariance structure
Suggests that investors have discovered and are rewarding UFPT's idiosyncratic risk premia
Data: Updata
Further evidence of this alpha genesis is seen in the chart below. UFPT has also been outpacing the medical devices and health care equipment sector since March without increasing correlation to the space. This is integral to the investment debate, seeing as ~82% of the company's revenue is now derived from its medical devices division. Again, we see UFPT stretching up ahead of peers on the chart, without displaying any evidence this is just sector beta. As such, we believe the market is rewarding UFPT's idiosyncratic properties and this forms a solid bedrock for continued upside in the forward looking investment landscape, by estimate.
Estimate 3. Also stretching up into strength of medical devices sector without evidence of this being just sector beta
Data: Updata
Molded Fibre sale to add ~$1.60 per share in accretive value
In late July UFPT announced the sale of its Molded Fibre Technology, Inc. ("MFT") business on a $32 million ($1.60/share) consideration. UFPT bought the MFT company back in 1993, growing it to be one of the largest of molded package solutions in the Americas. It recognized annual turnover of $21 million in FY21. The sale adds ~$1.60 per share in gross value to the company's bottom line and free's up additional capital to feed into the medtech business.
UFPT has spent great effort in consolidating its portfolio and end-markets and has shifted focus onto medtech given its higher margin offering, and longer-tail of asset returns on offer. As seen in Exhibit 4, taken from the company's recent investor presentation , the medtech portfolio now makes up ~80% of turnover as at Q1 FY22, with the remainder of sales dedicated to automotive, aerospace & defence and industrial applications. It's clear the company is set on focusing intently on growing its medtech segment, and that's where the money is. It has key differentials that insulate it from peers within the sector, including exclusive or semi-exclusive access to medical grade materials and in the design and manufacture of custom equipment.
Exhibit 4. UFPT's consolidated its portfolio towards a medtech weighting given higher margin/profitability
The move appears to have stuck well, with earnings holding steady across the pandemic and in-line with FY18 levels. Meanwhile, ROIC has tightened in line with the down-step in top-bottom income, but normalizes at a 5-year average of ~9% on a quarterly basis, as seen in Exhibit 5. That tells us that UFPT compounds capital at an average 9% each quarter on average, and therefore exemplifies the kind of quality we are searching for. It came in at ~7% last quarter, in-line with the WACC of 6.9%. In the environment where the cost of capital is increasingly prohibitive, a ROICC/WACC ratio of ~1x is a key resiliency factor.
Exhibit 5. UFPT compounding capital at normalized 9.2% over 5-years with ROIC/WACC ratio of ~1x
Meanwhile, the cash conversion cycle has widened by ~12 days since the onset of the pandemic. However, this has been substantiated by an average 5.5x TTM inventory turnover whilst average collection of receivables has held flat at 61 days. Turnover of receivables has also held tight at ~6x on a TTM basis each quarter since FY17 as well. As seen below, these trends are supportive of the company generating more cash from each dollar invested into its working capital cycle. There's less cash from the balance sheet tied up into working capital this way.
Exhibit 6. Working capital management sees higher return for each $1 invested into the cash conversion cycle
Valuation
Shares are trading at a pricey 38.5x trailing P/E, and trade at a 30% premium to the GICS industry peer median at 25x forward P/E. This suggests investors are expecting an above-market performance from the company at the bottom-line for FY23. Certainly, the stock has re-rated to the upside to price in a substantial increase in growth next year. Shares are also trading at a discount to book value relative to the peer median, and are in-line at ~3x sales.
Exhibit 7. Multiples and Comps
Data: HB Insights
At 3.1x book value there appears to be a slim value gap to the upside, as we'd be paying ~$81 at that valuation. In terms of corporate value, the stock trades at 3.55x book value and hence it looks overvalued by ~14.6% at this level. We price UFPT at $72 based on this adjustment.
Exhibit 8.
Data: HB Insights Estimates
At 23x FY22 consensus EPS estimates of $3.16 this has a price target of $72 adding validity to the price objective established above. Blending this with the technically derived price targets outlined below on an equal weight basis sets a 6-12 price objective of $85.
Technical Studies
On the daily point and figure chart there are clustered upside targets towards $99 with support as low as $66. The stock trades inside of three inner support lines and looks to break away to the upside from here once more. Price action is bullish on this chart and we see buyers all the way to $99 should this momentum continue.
Exhibit 9. Multiple upside targets to $99-$100, bullish confirmation and trading inside of 3x inner support lines
Data: Updata
On the 6-month daily cloud chart, shares have broken up through the cloud with the lag line also well above cloud support as well. On balance volume and momentum have also remained steady, with OBV in particular providing confluence on the longer-term uptrend. Shares are currently testing cloud support and if they were to break away from here we'd be heavily bullish and be working on sizing in all the way to our price objectives.
Exhibit 10. Testing cloud support
In short
Ongoing fundamental momentum and a background of compounding capital at a 5-year quarterly average of 5% are just two of the factors that have us trigger happy on UFPT. The stock has bifurcated away to the upside from both market and sector benchmarks whilst reducing covariances to each.
Meanwhile, it's recent sale adds ~$1.60/share to the bottom line and frees up capital for further allocation to the now portfolio-dominant medtech business. Whilst multiples-derived valuations are pricey, technical price targets are supportive of further upside. We rate UFPT a buy with a price target of $85.
For further details see:
UFP Technologies: Molded Fiber Sale Adds ~$1.60/Share To Bottom-Line