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Seeing the Forest for the Trees

(Guest Commentary by Bill Rempel April 5, 2007)

Dear Subscribers and Readers,

For those who had wanted to learn more about individual stocks and the art of stock selection, it is again time to see what one of our regular guest commentators, Bill Rempel, has to say about his favorite picks.  Bill is a prolific writing on the stock market and individual stocks and is the author of a very active market blog at:

In this commentary, Bill is going to discuss a small cap in the lumber, wood production sector Universal Forest Products (UFPI).  While the margin of safety is not very wide for the stock, Bill lays out a great case for the outlook of the company.  In addition, the company has had outstanding management as exemplified by the steady earnings growth of the company over the last ten years.

Without further ado, following is biography of Bill:

Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see Air T Incorporated An Out-of-Favor Microcap in the Transportation Sector for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.

Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff."

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.

The "value stock" recipe isn't rocket science; it's one part beaten down over time, one part cheap valuation metrics, and another part "good company," adding up to a position that might just have a margin of safety at the current price.  One of the larger market-cap stocks to hit the value screener in the last few months has been Universal Forest Products, Inc (UFPI).  It's kind of a misnomer, the "universal" tag, because they don't do paper.  Oh, bother.

If you were to look at a chart of UFPI, you might notice that it's 20% off its price from a year ago, and about 40% off its 52-week high.  That might seem beaten down, and actually, my rough screener is only looking at performance over the last year.  A longer-term look, however, shows the beat-down is relative.

UFPI (Universal Forest Products, Inc.)

This stock has been on a four-year tear, and has only recently (relatively speaking May 2006) gotten ahead of itself and gotten beat down afterwards.  The monthly chart shows what looks like capitulation in October of last year, and about eight months of consolidation between $45 and $55, to a possible supporting trendline.  From a technical standpoint, this could present a low-risk entry, because the point of "thesis disproval" is close below.

UFPI (Universal Forest Products, Inc.)

That capitulation shows clearly on the daily chart, with October 17, 2006 standing out.  The regression line looks pretty strong from that point, apparently 10/17 was a pivotal event in the stock's history, likely the earnings "miss" on 3Q2006.

On the monthly chart, it looks like UFPI might be at support; on the daily chart, it looks like UFPI is right at trend.  Clearly, the "beaten down" applies recently, in the context of a much longer-term uptrend and a recent uptrend taking place since late last year.

A couple of other technical points probably should be looked at now.  First, of the 16.7 mil float, approximately 1.86 mil shares were short on March 12.  This is 11 days to cover based on the average volume over the last year, and about 16 days to cover based on more recent volume statistics.  Short ratio is up very slightly over the last report in February.  Second, the next earnings date is April 17, meaning that we may see some "tells" before earnings come out.

The following valuation metrics come straight from Yahoo!Finance's page on UFPI.

Market Cap (intraday): 960.73M

Enterprise Value (4-Apr-07): 1.09B

Trailing P/E (ttm, intraday): 14.05

Forward P/E (fye 30-Dec-08): 11.89

PEG Ratio (5 yr expected): 1.40

Price/Sales (ttm): 0.37

Price/Book (mrq): 1.89

For value stocks, I like to look at simplified 2- or 3-stage DCF calculations on EPS, with an eye towards the reasonableness of the P/E ratio and its implied growth.  The analysts' estimate for 5-year growth in earnings for UFPI is 10%, and the historical long-term average of S&P 500 companies is 6%.  Using those two numbers in a 2-stage calculation, the only thing missing is a discount rate.  Many folks like to use 11.5% as a discount rate, since it approximates the long-term gains in the stock market (dividends included).  Plugging in 10/6 growth and 11.5 discount, a "fair" P/E is roughly 22.  I will often do another check with a 15% discount rate; why 15%?  Because it approximates the sum of both long-term M3 growth (inflation) and long-term 10-Year Treasury yields!  Plugging in 10/6 growth and 15 discount, a "fair" P/E is 13.5.  Compared to today's trailing twelve month P/E of 14, the "fair" P/E range of 13.5 to 22 suggests there may be some margin of safety here.

Buying a stock for about 1/3 of revenues is cheap by any standards.  Less than twice book is not incredibly cheap, but is fairly cheap, especially considering it's in an industry where much of the book is likely to be tangible.  Dividend yield is not really a factor for this stock in terms of valuation.  Yes, there's a dividend, but it's inconsequential in yield, less than 1/3 of a percent.  Obviously, it's sustainable.

UFPI (Universal Forest Products, Inc.)

Of the stocks in its industry, UFPI is fairly cheap.  The earnings don't cost all that much by comparison, and while 1.9 times book isn't super-cheap, it's lower than most of those companies in the space.

Having established that the stock is beaten down and has cheap valuation metrics, the next step is trying to assess some measurements of company quality.  Several of these appear on the Yahoo!Finance statistics page on UFPI, but first, go back to the table above and note that UFPI achieved a rather high ROE for its industry.

Return on Assets (ttm): 8.66%

Return on Equity (ttm): 14.82%

Total Cash Per Share (mrq): 2.706

Total Debt/Equity (mrq): 0.33

Current Ratio (mrq): 2.472

One measure of a company's health could be the attitude of the insiders to the shares.  Given that I only see five transactions amongst the insiders in the last year (three buys and two sells), and none in the last six months, it's hard to say the insiders love it, but easy to say that they don't loathe it.  Considering which source you consult, between 10% and 16% of the stock is owned by "insiders" and about 10% is considered "off float," so if that many insiders own and nobody's selling, they might just be drinking the kool-aid.

MSN Money has some neat summary screens on fundamentals.  Over the last five years, the P/E has ranged from 7.7 to 22.9.  The five-year ROE, ROA, and Return on Capital for UFPI are all about twice the industry average, per those summary screens.

There is not much better endorsement for a "good company" than putting together ten consecutive years of increasing EPS and Book/Share value.  Only $50 million or so of revenues in fiscal 2000 kept UFPI from putting together a hat trick.  It's interesting to see that the company never has traded all that high in relation to book or revenue, however.

UFPI (Universal Forest Products, Inc.)

Other obvious checks for quality involve looking at the recent statements.  Over the last five years in total, and over each of the last four years, UFPI has had cash from operations that exceeded net income.  This is important because the "accrual anomaly" has noted that companies whose earnings are created by accruals (i.e. not from operating cash) tend to underperform.  Over the last five years in total, and in three of the last four years, UFPI has had net cash flow out from financing, primarily the result of paying down (retirement of) debt.  Again, companies with high cash inflow from financing, relative to assets, have tended to underperform.

Considering the technicals, valuations, and history of growth, it almost seems like a waste of time to read the filings.  Almost.

UFPI grew out of a company providing supplies to mobile home manufacturers.  Today, they provide to four industries,

  1. DIY/Retail including plastic products and fencing products

  2. Engineered products for site-built construction

  3. Specialty wood and alternative products for packaging and for industrial markets

  4. Structural lumber for mobile homes, modular housing, and RVs.

No paper, so "universal" is a misnomer.

The company managed to increase (INCREASE) their sales of site-built construction products in 2006, mainly because they provide engineered products that can speed construction and because they have a national footprint.  Think about builders increasing their use of UFPI's pre-manufactured structural panels and trusses, as opposed to using lumber and labor to build these things on-site, and the possibility of continued growth in a tough housing market seems very real.  Especially considering that Texas, a major building market relatively unaffected by the housing slowdown, is not a strong user of pre-engineered products yet.  If "housing" suffers enough to cause a resurgence in buying for mobile homes, then UFPI could see growth there as well.  A recent acquisition provides access to the RV market and UFPI is dedicating resources to that market.

I like the composite decking products that UFPI produces I may become a customer before too long, in addition to being a shareholder at the moment.  Regardless of the overall market for decking and railing products, the share of such products that consists of composite material will increase, as more customers realize the benefits of the material, which includes simplified fastening techniques (saving labor cost and materials costs).

Lumber costs are primarily a pass-through to the customer; only if the customer is unduly impacted will demand be reduced, but even then, UFPI might be able to gain share through value-added propositions like their engineered products.  In addition to the organic growth in the core business, there have been over a half-dozen acquisitions in the last year, all of them tuned to diversifying the product mix.  Their operating assumption is a tough housing market in 1-2Q 2007 with late-year improvement, and negligible growth in the DIY market overall (but an increasing share of that market).  Their strategy can be summed up as "value-added" rather than sell a commodity like lumber, they would prefer to innovate products that use (or even replace) traditional lumber-based ones.

The company has staggered directorship in three staggered three-year terms, and only one class of shares, one vote per share.  Directors are evaluated annually and there is a retirement age of 72.  The proxy for 2007 is pretty empty of voting items compared to some I've read, and directors and officers own about 12% of the company, with a max of 4.6% owned by one dude, a director since 1967.  The management has skin in the game, but not enough power to run the company like a fiefdom.  The company also has a frugal attitude towards executive perqs, severance agreements, and director compensation.

All in all, I am pretty high on the company at the moment, and currently am long the stock.

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