UPG: A Rare Net/Net Opportunity

 |  About: Universal Power Group, Inc. (UPGI)
by: Cigar Butts Investor

Note: The recent price decline of UPG is primarily what makes it so attractive, but it could reverse quickly. For that reason, this article will be short, and I will later post a full analysis if the price is still low. In addition, this is a micro cap company by market cap - 10.74 MM - with revenues of over $100 MM. Recognize that there are risks associated with small businesses that larger companies do not face.

Universal Power Group (UPG), a maker primarily of batteries, fell 17.69% on August 11 from a price of $2.60 to $2.14 on unusually high volume (about 10x the 3-month average). The asset valuation is as follows:

  • Net working capital (MRQ): $16.93 MM
  • Net working capital (MRQ) minus operating leases: $14.3 MM
  • Market capitalization (as of August 11 close): $10.74 MM

This company presents a rare net net opportunity in that not only does it sell below its net working capital1 ("NWC") minus operating leases, but it also has positive income and is even growing arguably. This is rare because the broad majority of "net/net" cases involve companies suffering losses of earnings or an earnings downtrend. The current price of $2.14 is lower than the cash the company received when had its IPO in 2005-2006, but as far as I can tell the company has gotten better over the past few years. Relevant financial statistics are below:

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(Note: All data is from the company's SEC filings. Net income adjusted in 2009 for a one-time charge.)

Another noteworthy piece of information:

  • The tax rate has averaged over 50% on both an accounting and cash basis. This is unusually high and the company is either understating its income, is over-paying, is subject to unusual tax laws locally or internationally that I am unaware of, or is due for a tax break in the future.

The company made an acquisition in Q2, announced on May 11 in an SEC 8-K form, of a smaller battery maker for $3.3 MM. It paid for this mostly in cash, but also with $1.4 MM in liabilities. The NWC calculations above are after this acquisition. NWC before the acquisition and on average in the past was higher ($18.19 MM - the average of the past 4 quarters, 2009, 2008, and 2007). The company gained about $1.39 MM in goodwill because of it, implying it paid that much for the acquisition over the fair value of its equity. There is a large risk in that the company could destroy the NWC position through further acquisitions, taking on more debt, etc. For that reason, I do not believe that UPG should be purchased except in a diversified portfolio. The large excess of NWC over the price, however, makes this probability of this low.

A major risk concerning this company, besides those already mentioned in Saj Karsan's articles, is that the company carries very little in cash on the notion that it will be able to draw from its Wells Fargo credit line in the event of a working capital crisis.2 This fails to consider the possibility of that credit line being taken away because of a major financial crisis or some other event. If the credit line falls, the company could face a major working capital problem.

A third risk is the company's declining inventory turnover and higher rate of inventory obsolescence. This correlates well to the general economic decline, but it may also indicate demand for the company's products has been falling. This is reflected also in a slight decline of sales since the financial crisis of 2008-2009.

As an aside, there was an interesting price spike minutes after I made a long position in UPG at $2.15:

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I attempted to sell on this rise (a 63% return within a few minutes is a very high number on an annual basis), but was alerted by my broker than all trading for the security had been halted.

[1] If you are not familiar with value investing, NWC is typically taken as a rough estimate for liquidation value. It is equal to current assets minus all liabilities. In theory, a company should never logically sell below its liquidation value unless it is worth less as a going concern than liquidated.

[2] Credit to Saj Karsan again for posting the management's responses to his criticisms and providing this information.

Disclosure: I am long UPG.