A One-Trick Pony - But It's A Great Trick

 |  About: United-Guardian, Inc. (UG)
by: Richard Bulkeley

My name is Richard, and I am a recovering home run stock addict. I used to love trying to pick stocks that would double every year until I was sitting on a yacht sipping champagne and watching the sun set. The problem with that fantasy is that picking a stock that will double is very hard. Actually, I get seasick quite easily and do not really like the taste of champagne so there are three problems with that fantasy, but we are mostly concerned here with the first one. Picking a stock that will double is very hard and if you get it wrong, you tend to lose quite a lot of your money.

Fortunately, I updated my investing approach to trying to find companies that would churn out a steady stream of returns for me without much risk. I also updated my retirement fantasy so now I will be living on a small farm and sipping whiskey - the sunset can stay though.

Anyway, when I need to add a stock to my portfolio, I look for nice stable companies. Companies like United Guardian (NASDAQ:UG). UG manufactures and markets the extensive Lubragel ®line of water-based lubricants and a couple of other pharmaceutical products. I learned this after UG was one of just three real companies (as opposed to royalty trusts etc) that was left after I asked my favorite stock screener to show me companies with no debt, gross margin of at least 40%, net margin of 20%, a >10% return on investment , and paying a dividend of at least 3%.

I had to manually filter out companies whose inclusion might be to do more with corporate structure than operating quality (resource trusts and the like). This left me with three possible shares (including UG). One - Giant Interactive (NYSE:GA) - is a company I have already written about. It is a Chinese online game developer and operator.

The other was Garmin (the GPS company). I am less interested in it because I have some (admittedly crude) macro concerns about the industry it is in. A lot of big successful companies (Apple, Nike, Google) are moving into location-based businesses. It is very possible Garmin could keep its current niche and find new ones and go on to greater success, but I am looking for a share I can forget about and focus on sipping my whiskey. So that means I was left with United Guardian.

The initial screen looked promising but we should look at the financial statements in more detail.

Sales are slightly (3.5%) down on the previous year. This is because the supplier for UG's secondary product (Renacidin - a drug that keeps catheters clean) had to shut down temporarily because of unrelated problems. However, the supplier is paying UG monthly compensation for lost profits, so the impact on the company's bottom line is minimal until the contract ends (January 20, 2014). UG is working on obtaining FDA approval for an a different supplier, and the current supplier hopes to resume production in Q3. Sales without Renacidin were up 2%. Q1 sales are up 1.5% YoY and cost of sales down 9% so earnings are looking good so far this year.

Debt - UG does not have any debt. Its current liabilities (accounts payable and accrued expenses) are under half of their cash. This means that it is very financially stable and are likely to be able to survive short-term hiccups comfortably.

Assets - UG does not carry any goodwill on the balance sheet. This is always good to see because it means it has not been buying growth and that its assets are likely to be useful. Additionally, its plant property and equipment are nearly fully depreciated. It is unlikely to matter, but this means that in a worst-case scenario the breakup value of the company may be higher than the balance sheet suggests. It also suggests it is also not in a capital intensive industry (in fact, capex was about 5% of sales each of the last two years)

Return on Assets - UG achieved a 35% return on assets. This is nearly twice what it was 10 years ago and 5% higher than last year. That is a positive trend and even if it does not continue, maintaining this level of performance is not to be sneezed at.

The main risk factor for potential investors in United Guardian to consider is that it is a very concentrated business. Almost all the revenue (82%) comes from one product line and most of the rest is from Renacidin. It is quite a diverse product line (27 Lubragel products are listed on the company website) and it is working on both expanding / improving the Lubragel line and other possible products. However, there is always the possibility of a ground breaking lubrication discovery or a natural disaster in Hauppauge (where the company is based). The company's sales are also quite concentrated - two customers (both distributors) accounted for 62% of sales. Because the companies are distributors and many of the company's products are unique the risk is lower, but losing one of these customers would be a serious problem at least in the short term.

As mentioned earlier, UG currently yields 3.4%. This is very attractive, although the payout ratio is a little high at 82%. This is understandable and arguably even desirable given the stable and cash-generative nature of the business (if a company does not need the money it is far better it gives it back to the shareholders than sits on it). On top of that it paid a special dividend of $0.50 per share last year (another 2-3% depending how you measure it).

The P/E ratio is a little high at 24, especially considering the relatively slow growth UG is likely to experience. However, you are paying for quality and security. The beta is 0.33, which means that UG is a very stable (boring) stock. However, as I argued in another article - boring is good.

UG seems to have a relatively strong moat. It holds 32 patents for things like "the microemulsification of silicone into a clear, transparent, water-based gel" with more patent applications in process. It also benefits from being expert at producing water-based lubricants (the company was founded in 1942) so it has some non-patentable "trade secrets." Senior management has mostly been with the company since 1988 and holds a reasonable but not excessive numbers of shares Both of these facts are usually good for investors.

Overall, United Guardian seems to be a safe business (it seems unlikely there will be a revolution in the water-based lubricants market). Revenues are slowly and steadily growing, costs are slowly and steadily declining. The balance sheet is very solid. UG is unlikely to double in a hurry, but it should provide investors with a steady stream of dividend payments and if it keeps increasing dividends, the share price should go along for the ride.

Disclosure: I am long UG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.