UP7:FRA - United Power Technology

[Valueguy134]

As a disclosure, this is a company that I have looked at for a while and have taken a position.  What drew me to the company was that it was trading very close to Net Current Assets at the time (and has dipped to net cash), while simultaneously growing and making money.  After researching the company I really liked the products they sold and developed (portable power generators), along with the strategy of moving towards larger capacity gen-sets, given the higher margin and correlation to construction activity.  Furthermore, UP is one of the largest manufacturers of generators in China, and acts as an OEM for many large brands.

 

While approx. 60% of their invoiced customers are within China, the bulk of products are sold to Europe followed by China then North America, and emerging markets.  While the products are typically used for emergency situations in developed countries, emerging markets see them as a stable power source in a country with an un-stable grid.  The products are sold under the United Power brand and as an OEM for other major brands.  The products are also in major retailers (Canadian Tire as the brand Champion).  Secondly, the management has a very strong alignment with the company’s growth.  The founders/management own 60% of the stock with a venture fund owning 20% and 20% being free float.  The executive team has low compensation (about 80-120k per year) and is also awarded stock options.  While I typically dislike excessive stock options (given that you are playing with the house’s money) and the company is somewhat liberal in compensating management with options, they do come with strings attached.  The options vest after 4 years, disbursement is staggered and back-end loaded,  and the team must improve EBIT by 5% per year from the issue date.  Given the strings and the amount of options relative to the amount of shares they held, I viewed it as a mute point.  Thirdly, the management team is very transparent in their annual and quarterly reports, and conference calls.  Finally, I also liked how the company is moving towards higher automation given China’s rising wage rates, and increased quality and environmental regulations in Europe and N.A.  The only downfall I have seen with the management was an indication to pay dividends in 2013.  While this did not happen, the company did make an investment into more capacity and decided to keep extra cash on hand given the economic uncertainty.  Once again they have indicated to pay dividends in 2014 and seem to have held the line with regards to the statement.  In reading an analyst report, the dividend will most like be a 10-30% payout of earnings and equate to about 10% dividend yield.   

 

The industry is very much driven by economic growth (construction) and natural disasters (hurricanes).  While their most recent growth has slowed, and management’s guidance is for 5% less revenue for 2013, I feel that as the economy picks up (especially in Europe), the company will continue to grow.  In the meantime (1-2 years) I would expect flat to slower growth than the company has been used too, but margins should increase due to automation and a move towards commercial generators.  As for business risk, I would not rank it as being high due to a stable product which does not look to disappear anytime soon, continued R&D support, and a lack of reliance on a few customers (only 5 customers make up 5% of sales each).  While competitors from Japan (Honda/Yamaha) do have a superior product (according to customer reviews), they are also priced significantly higher and do not provide an equivalent increase in performance per dollar

 

The risks associated with investing in the stock, and the reason for it being undervalued come from three areas.  The first are liquidity problems, as only 1000 shares trade per day on average.  Second, they are a small cap company in an unsexy industry listed on the Frankfurt (Xetra) exchange. Finally, there is a stigma around Chinese companies.  While I originally saw this as the biggest sticking point, the management team has been very transparent in their annual/quarterly reports and their earnings calls.  Also, they have Deloitte auditing them, and not Deloitte China but rather Deloitte Germany. Second, the Lieutenant Governor of the State of Nevada is on their board, which was a bonus given that I would assume he would not risk his political career by being tied up with a fraudulent company.  Finally, they do have products in major retailers and customer reviews for their products.  All of this indicated that the company is trying very hard to wipe away the image associated with Chinese companies.

 

Another item which bothered me was the board has authorized the ability to issue 6M shares (50% S/O).  I really see it as being used for 3 items, M&A given consolidation in the industry, increase liquidity of shares, or as back-up in case they are unable to raise debt.  While it is a large amount of shares, they can only be issued with subscription rights (a positive for me), unless it is an M&A, equates to fractional rights, of if they issue less than 10% of share capital, most likely due to mgmt compensation reasons.

 

The company has grown revenues rapidly (10% CAGR), are close to net cash, they have about a 20% return on employed capital and at the time I looked at them about 30% return on EV.  The balance sheet is very strong with few intangibles.  The majority of their balance sheet compromises of current assets, giving them a strong financial position.  When I valued UP, I took a couple of approaches to see what my worst, base and best case would be.  At a liquidation value, I valued UP at approx.  2.20 euros per share.  On a normalized FCF with zero-growth and 10% discount rate, I see a max upside of 10.50 euros.  I received a similar valuation for 1x price/book an 10x P/E.  To come to my final valuation, I used 1x book with a 20% margin of safety for the illiquidity/ability to issue shares and another 20% for it being a Chinese company.  This provided an entry price of about 6 euros.  Given the recent share price I have taken a position.  The catalyst I really see for this stock taking off is a dividend (which should raise awareness of the stock) and the shares becoming more liquid which should come from an exit by the VC fund.  While the stigma of a Chinese company will be hard to shake, I feel the margin of safety I have taken is more than adequate.

 

[yadayada]

The problem is, you can't really say that margin of safety is adequate if they dont return cash to shareholders. And shareholders cannot really sue them if they run off with the cash. ALso an American on the board doesn't say a thing.

 

They donnt have good reasons to keep the cash, and if they haven't returned a meaningfull amount by now, they probably never will. Why are they holding 3.5 years of cash on the balance sheet?

 

"No dividend in 2013 due to uncertain economic conditions and investment plan, nevertheless intention to pay a

dividend in 2014 taking the general economic conditions into account''

 

Whenever you read this, get the hell out! The bullshit is just dripping off here. They dont want to pay a dividend because they want to invest, but in 2014 they will pay one! That doesn't make any sense. Why not pay one now, if they intend to pay one anyway? The economic conditions are also complete bs, they are growing revenue, and have a rock solid balance sheet. But they cannot pay a single dime in dividend? Not even like 3 million? They got almost 4 years of earnings on the balance sheet ffs.

 

Only 3 ways I would invest in those asian companies, one if management is known to be very ethical from previous ventures (and returned lots of cash to shareholders). Or 2, if they have shown to return good amounts of cash to shareholders already, or three, if I would know management personally very well. 

[Valueguy134]

Thought I provide an update.  The company has voted to begin paying a yearly dividend with an intent on increasing it each year.

 

http://www.unitedpower.de.com/en/node/619

[yadayada]

thanks for posting that update. A few issues. Capex is much higher then depreciation (15 mill vs 2.5 mill depreciation last H1), and now revenue is going down. Second, they are borrowing money, why? And why does that cost over 6%? Since their balance sheet is rock solid..

 

Seems like the massive capex and borrowing money while having 40 million euros on the balance sheet is just too  big of a red flag here.

[Valueguy134]

It would be expected that the CAPEX is higher than the depreciation given the continued investment in automation, capacity and complying with new environmental regulations for Europe in the generator segment, so CAPEX being much higher than depreciation should make sense.  Furthermore, the investment in automation should be seen as a positive development given the rising wage rate in China.   

 

As for the revenue decreasing, management has mentioned multiple times for the past while that this would be an issue.  The two regions seeing a drop is Europe and N.A.  It will probably be an on-going issue until Europe fixes it self, while NA is more dependent on natural disasters and is less predictable.  The upside with Europe is that monetary policy will most likely not fix everyones problem, causing investment by each country's government to help spurn economic growth (unless consumer demand greatly picks up).  Most often than not, this involves heavy investment in infrastructure/construction, which is an area UPT is active in.  With the anticipated easing in Europe, it would make it more likely that we will see increased infrastructure investment with the cheaper debt.

 

As for cash, it has been difficult for me to also see why they are holding it on the books.  My only idea is that the capital controls placed on the RMB make it unfavourable to convert and as such, it is better to keep it on the books and use it as working capital outside of the country.  Either way, they are returning cash to the shareholders rather than continuously accumulating it without any further distribution like many other Chinese companies.  This is most likely the reason for the increased borrowing, which is to fund the expansion.

 

While I agree people are hesitant in investing in what is essential a Chinese company, I would suggest looking into this company.  The management has been very upfront and transparent with all of their issues, their plans, and goals and have followed through with them.  Whether it causes a red flag or not is up to you.  The company is profitable and has decent returns justifying a higher valuations.  Moreover, the company has shown to be more diligent than some of the other NCAV companies in my portfolio.  Being close to net-cash justifies the investment for me and the risks I'm willing to take, but investing overseas is not for everyone.

[yadayada]

Either you are a promotor or you don't know much about investing. Id suggest reading a book on fraud and studying some Chinese frauds before you get burned here. Capex is out of control, 75% of business is outside China, yet they cannot pay any dividend because of capital restriction? 85 million invested last 4 years, yet no revenue increase. and they have veyr little personel costs so the automation argument does not fly here. Even if this is legit, they basicly pissed at least 30-40 million down the drain.

 

And then despite earning 75% outside China, they have to issue a lot of debt. The capital restrictions also is a bad excuse. Basicly all their excuses for paying no dividend are typical of Chinese frauds. Even all their websites sort of look the same. It is like one or two groups are behind most of these frauds trading at 2-3x multiples.

 

There is a reason why land ownership is very important for capitalism to function. You don't have that here. They can just run off with everything. And this thing has written fraud all over it.

[Valueguy134]

I'd suggest you read the annuals as revenue has grown until 2012 (from about 84m in 2010 to a peak of 111m) so i'm not sure the capex has been pissed away for the last couple of years.  I'm curious why you suggest capital spending is out of control, it is a capital intensive business and the business is expanding.  Construction of capacity takes time and would not equate to instant revenue recognition, also most of the recent investments have been to acquire a company and land/equipment for expansion so it makes sense with the numbers.  Given that such a huge chunk of revenue is derived from Europe, automation does make sense, you can only comply with increasingly strict environmental regulations using human capital to a point.  By not bringing technology to the manufacturing line, you begin to risk getting shutout of a large market with non-compliant products.  Replacing line workers is the side benefit.

 

I'd also suggest reading the update, as dividends have been paid (and received in my account) so cash is getting distributed to shareholders.  Additionally, I'm not promoting but rather bringing a possible investment to light (my position is only 2k euros, so no real benefit to promotion).  While the land might be in China, the investment is based on NCAV and provides me with downside protection. Either way I have done my due diligence and I am comfortable, especially since the management team has followed through with their promises and taken the steps to show they are legitimate.  If you don't like it, don't invest makes no difference to me, but I would back up accusations of fraud with some facts rather than general statements such as company X is a fraud therefore company Y must also be a fraud.