UFP Technologies

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

UFP Technologies is a designer and custom manufacturer of components, subassemblies, products, and packaging, primarily used in the medical, automotive, aerospace & defense, consumer, and industrial markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: UFP Technologies (UFPT) is a specialized contract manufacturer that focuses on providing customized solutions to its clients. The company operates in a variety of sectors, where their products are used to:

  • MedTech: Components and devices for medical devices, sterile packaging solutions, and orthopedic equipment. This segment accounts for the largest share of UFP Technologies revenue.
  • Automotive: Components and subassemblies for interior and safety parts, noise and vibration control, insulation.
  • Aerospace & Defense: Specialized packaging, engineered components, and subassemblies with specific certifications for aerospace and defense.
  • Consumer: Packaging and components for personal care items, sporting equipment, and durable goods.

  • Industrial: Specialized foam and plastic solutions, components for industrial machinery and equipment, packaging, and filtration.

    The company provides a wide range of services from design and engineering to final manufacturing. They differentiate themselves by providing highly engineered products that meet very specific needs. They focus on complex, highly customized products that are made with advanced materials and fabrication techniques. In their annual report, they claim that their capabilities in molding, converting, fabricating, laminating, die cutting and foam expansion allow for specialized products with unique characteristics that are not easily copied by competitors.

Industry Trends:

  • Medical Device Sector Growth: Increased demand for medical devices due to an aging population.
  • Automotive Electrification: Focus on electric vehicles increases demand for lightweight, advanced materials and parts.
  • Aerospace and Defense: Strong demand for engineered materials and specialized packaging due to increasing commercial aerospace travel and defense spending
  • E-Commerce Growth: Increased demand for packaging and fulfillment due to increasing volume of online retail sales
  • Customization and Flexibility: Increasing demand for specialty products that meet specific customer requirements.

Competitive Landscape:

  • Fragmented: The contract manufacturing market is quite fragmented.
  • Competition on Service, Speed, & Cost: Key areas of competition include the ability to fulfill highly specific custom orders, speed of delivery, reliability, and price.
  • Barriers to Entry: High capital investment into advanced technologies can sometimes be a barrier to entry. However, the customization involved makes these products hard to be reproduced by competitors, making it easier to capture recurring business.

Margins

  • Gross margin: Stable at around 26% and 27% for the past 3 years.
  • Operating margin: Highly dependent on overall expenses of the company. Has been in a decline recently in the early 10’s%.
  • Net margin: Low. around 3 to 5%.

Financial Analysis:

  • Revenue Growth: The company’s revenue has been growing but at declining rates, in the period between 2020 to 2022 revenues rose from 243 million dollars to 321 million dollars. In the same period, profits went from 19 million dollars to 20 million dollars. 2023 growth was mostly flat for the 9 months ending in September (241 vs 244 million) compared to last year. This means a drastic slowdown for growth.

    • Net sales: In the last report ending in September of 2023, sales are only slightly up (4%) compared to previous year. 9-month sales were 165 vs 161 million dollars for the corresponding period.

  • Profitability: Profits have not grown as fast as revenues. Gross margin has been stable over time, however, operating margin and net income have varied significantly in recent times. The company is spending a lot on SG&A and other costs which are affecting profitability, but it doesn’t appear to affect long term business operations as they are not classified as costs related to core operations in their reports. This makes short term profits volatile and unpredictable.

  • Operating costs are increasing faster than revenue: In their latest 10-Q filed in November 2023, the selling, general, and administrative expenses for the company are reported to be 41.4 million dollars, compared to 39 million dollars in 2022 for the corresponding quarter.
  • Balance Sheet:
    • Assets: The company has increased its net property and equipment values by about 10% in the last two years, indicating continued investment in their manufacturing base. The total amount of tangible assets is 397 million dollars vs 362 million dollars. Also, a goodwill of approximately 44 million dollars can be seen on the balance sheet.
    • Liabilities: The long term debt amounts to 20 million dollars as of Q3 2023, and 30 million dollars as of Q4 2022, showing a decrease in their debt obligations. Total liabilities as of Q3 2023 were 165 million dollars versus 170 million dollars at the end of 2022, again, a reduction of liabilities.
    • Equity: Total stockholder’s equity has decreased slightly from 328 million dollars to 325 million dollars in the last 9 months of reporting. The company does not seem overleveraged and is maintaining appropriate financial health. The company is maintaining a low debt level and has a good current asset to current liability ratio.
  • Free Cash Flow: UFP’s cash flows from operations have generally grown from 16 to 25 million dollars, but have been inconsistent on a quarterly basis. In the last three months, they generated 11 million dollars.
  • Share repurchases : in the last 10Q report they note that they have repurchased some of their own shares which is a good thing if it can be done below fair value, showing a confident management.
  • Stock-based compensation: Stock-based compensation has been increasing year over year. This is something to be mindful of, and they should make sure they provide adequate compensation for the shareholders against dilution.
  • Guidance: It is concerning they do not give guidance to investors.

Moat Analysis:

  • Switching Costs Although the products made by UFP Technologies can appear simple, the relationships between the customer and UFP are deep, they involve close co-operation and integration. Once UFP products and processes are embedded inside the client’s processes, it will be too hard or expensive to switch to a new supplier, creating high customer retention.
  • Unique Capabilities and Intangibles: The company has developed expertise in customized engineering and high technology that is hard to replicate, along with patents.
  • Barriers to Entry: While manufacturing is not generally thought of as hard to get into, their relationships with customers, especially in MedTech have a layer of regulations which they have to adhere to to do business, acting as a barrier to entry for new potential competitors.

The combination of specialized products, and unique customer relationships give UFP a narrow economic moat. These products and processes are not easily copied by competitors, meaning UFP Technologies is better positioned to protect their profits. However, they do not have significant pricing power and have to work hard to protect margins by constant process improvement, and so they are at best a tier 2 moat company.

  • Moat Rating: 2 / 5

Risks to the Moat and Business Resilience:

  • Raw Material Price Volatility: The raw materials used by the company are sensitive to price and global supply, volatility in these prices could negatively affect margins.
  • Customer Concentration: While the company has a diverse set of customers, they may rely heavily on a few key customers, or a few sectors, which could be detrimental if those customers face any issues.
  • Loss of Key Personnel: The company relies on the experience of their engineering staff. Losing key personnel might harm their ability to innovate and deliver specialized products.
  • Technological Changes: Technology changes might make the expertise of UFP Technologies less valuable. This may also affect its product’s lifecycle.
  • Economic Slowdowns: Reduced discretionary spending on consumer, automotive, and industrial products would lead to a decrease in demand for UFP’s products
  • Over reliance on acquisitions: the company has been acquiring other companies recently, so they must make sure that the culture and strategies integrate smoothly. There could be a possibility of overpaying for their acquisition if they are not careful.

Understandability: UFP Technologies operates in many different sectors with a lot of specialization. Because of that it is hard to understand all aspects of the business. However, their core business model and source of competitive advantage is easy enough to understand.

  • Understandability: 3 / 5

Balance Sheet Health:

UFP Technologies has a fairly good balance sheet, with low debt levels, good liquidity and positive cash flow. They have a stable foundation and continue to invest into the business.

  • Balance Sheet Health: 4 / 5

Recent Concerns:

  • There has been a general decrease in net sales, which can lead to reduction of margins if they can’t keep the costs down.
  • Management has not provided any insights on future outlook of the company.
  • One of the bigger risks is increasing expenses, most of which are related to SG&A, this seems a recurring trend which is cutting into margins, something to be mindful of.

Overall UFP technologies has a narrow economic moat, but their reliance on custom specialized products in industries with high barriers of entry means that they have a fairly strong business and long term outlook. They have high customer retention which can only grow better in the future as they keep innovating and making their products more suitable for the customers. But there are risks to it as well, so they must be careful. The stock is a long-term holding that seems suitable for a more risk-averse investor with a large time horizon. However, they must manage costs well in the future to grow their profits further.