Should we buy shares of a company known for its forest products when we appear to be nearing a recession, if we're not already in one, and home building is likely to slow?
UFP Industries Inc. (NASDAQ:UFPI) might be a case where we consider the idea since it has some attractive features and is available at a discounted price. It can be found on the Undervalued Predictable list at GuruFocus because of its earnings power and its current price.
First, though, the company changed its name at the beginning of the year, from Universal Forest Products Inc. to UFP Industries Inc., after a significant internal reorganization. CEO Matthew Missad explained the company no longer deals in just forest products or wood.
"Over the years, we have evolved from a lumber wholesaler to a mixed materials manufacturer and solutions provider serving thousands of business customers," he said.
In the new configuration, the 10-K for 2019 described its business this way: "UFP Industries is a holding company whose subsidiaries supply wood, wood composite and other products to three robust markets: retail, construction and industrial. Founded in 1955, the company is headquartered in Grand Rapids, Mich., with affiliates throughout North America, Europe, Asia and Australia."
In other words, the company has multiple revenue sources, including Home Depot (NYSE:HD), which represented 19% of sales in 2019. The construction segment is highly cyclical according to its 10-K, and investors are expecting it to take a hit from the Covid-19 crisis, as shown in this 10-year chart:
As we will see below, that sharp drawback was an overreaction because much of the company will continue to operate during lockdowns.
Note the growth over the past decade, albeit in bumpy fashion as the stock price increased from less than $10 to more than $50, while also paying a modest dividend. One of the reasons for that growth was acquisitions, with the company reporting in its 10-K: "Acquisition growth is one of the primary contributing factors to material increases over the period from 2015 to 2019." It bought three businesses in 2019 and seven in 2018.
For a focused look at UFP's fundamentals, we will apply the criteria of the Macpherson model, a set of initial screening tests used by Thomas Macpherson of Nintai Investments. The model is made up of tests for a competitive advantage (moat), financial stability, profitability and valuation.
To determine whether a company has a competitive advantage that will protect its margins and earnings, we look for 10-year medians of at least 15% for return on capital and return on tangible equity.
While UFP is getting close to the mark for ROC at 14.4%, it is coming up from a low of less than 2.5% in 2012. The trajectory is promising, but it will need some years to get to a median of 15%.
GuruFocus reported that UFP's median ROTE over the past 10 years was 13.48%, again below the 15% set in the model.
In summary, the company may not yet have a fully sustainable competitive advantage.
As a test of a company's financial strength, the model calls for a minimum cash-to-debt ratio of 100 and a GuruFocus rating of at least 9 out of 10.
UFP makes it on neither count, though it does come close on the rating, which is 8 out of 10. On the cash-to-debt ratio, it is 0.31, which is obviously far below 100. Regardless of the score, the company is in no danger given that its interest coverage ratio is 29.43.
The company does well on its profitability rating, although not quite up to the standard of 9 out of 10 in the Macpherson model. Once again, it falls just short with a rating of 8 out of 10.
Further, we note that the margins are both in the mid-single digits (operating margin 5.78% and net margin 4.16%). An orange bar next to the operating margin indicates it is slightly lagging its peers, while a green bar in the History column shows it is doing well in comparison to its own history.
In this category, we are looking for a company selling at a discount to its intrinsic value, so there is a margin of safety. That margin should be large enough to protect against the unexpected and our own errors.
That appears to be the case for UFP, which has a fair or intrinsic value of $84.84, while its share price is $41.09. This provides a 51.57% margin of safety based on the default settings of the GuruFocus discounted cash flow calculator.
Overall, the Macpherson model tells us UFP does not have a competitive moat, it is reasonably strong financially, it is profitable but not up to the model standard and has a good margin of safety.
At the end of fourth-quarter 2019, eight of the investing gurus had a stake in UFP. Jeremy Grantham (Trades, Portfolio) of GMO had the largest holding with 363,611 shares. The second and third-largest positions belonged to Pioneer Investments (Trades, Portfolio) and Jim Simons (Trades, Portfolio)' Renaissance Technologies.
And the gurus were doing a lot more buying than selling until the end of January this year:
The stock also was popular among institutional investors and insiders. The managers who run pension, mutual and hedge funds owned 63.27% of outstanding shares, while insiders owned 2.65%.
Response to Covid-19
UFP reported on March 26 that much of its work continues as usual, though some employees are working from home and new safety guidelines are in place. The "vast majority" of its employees have been deemed essential critical infrastructure workers because the company serves essential businesses, including health care manufacturers, food suppliers and infrastructure contractors. Those not serving critical sectors have been given temporary furloughs.
Financially, it feels comfortable with its situation, as it wrote: "In terms of existing capital availability, UFP Industries has a strong balance sheet with ample funding accessible under revolving lines of credit, which provide sufficient liquidity for expected capital needs. Total net debt at present is $123 million, with no significant debt maturing until 2022. The company is also closely managing working capital to maintain its strong balance sheet."
Management at UFP Industries made a good decision a few years ago when it broadened its scope to include non-wood products. That has given it a good buffer to help get it through the Covid-19 crisis, and perhaps a slowed economy.
It's a company with a good business model and its stock is currently selling at a significant discount. Up until recently, gurus were buying more its stock than they were selling. At the same time, though, it does not make the top tier in terms of competitive advantage, financial strength and profitability.
Thus, it may be worth watching, but, according to the numbers, there are more attractive stocks available at discounted prices.
Disclosure: This article is only an introduction to the company and investors must do their own due diligence. I do not own shares in it and do not expect to buy any in the next 72 hours.
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This article first appeared on GuruFocus.