Reader Question Regarding Unifi Inc.

Timm wrote:

What do you think of UFI a textile company selling at approximately 0.36 times book.  Current price is $2.55 wit 0.69 in cash.  Assets are mostly tangible with recent divestment selling for more than 70% of cost.  Mgmt is trying to unlock value.

I took a few moments today to look into Timm’s question regarding Unifi Inc. (UFI). The first thing that caught my attention was the fact that Timm mentioned that UFI is a textile company.

A textile company to me signals that this is likely to be a commodity producer. Commodity companies tend not to have economic moats and end up facing heavy competition. The only way a commodity producer can build a moat is to become the low cost producer. Without a moat or a special situation opportunity, a fat pitch investor should wait until a better “pitch” comes by since there are no strikes called in investing.

Unifi Inc is a producer of yarns. It sells its products to other yarn manufacturers, knitters and weavers. The company has tried to brand its premium products but none of the name were recognizable to me (however, I don’t use yarn).

In its 10-K, Unifi mentions that it uses advanced production processes to manufacture its high-quality yarns cost-effectively. Even given that, if I’m not mistaken, many foreign companies in the textile industries often receive support from their governments in order for them to remain competitive enough to continue to provide jobs. As I continued to read the 10-K, Unifi confirmed my suspicions that they are facing intense competition when they stated, “The North American synthetic yarn market has contracted since 1999, primarily as a result of intense foreign competition in finished goods on the basis of price.”

Let’s take a look at Unifi’s financial numbers to further see what is going on with this company.  Sales have gone down from $1.1 billion in 2001 to 739 million in 2006.  Net income has been negative over this whole period.  Gross profit margins were less than 6 percent last year. None of these numbers look good.

It is interesting to note that the company has been free cash flow positive over the past five years, but free cash flows have also been declining.  It looks like the only reason that Unifi has been free cash flow positive is that they have been spending much less in capital expenditures than they are depreciating.  This might mean that their equipment is getting old. There might be a need for major capital expenditures to replace plants and equipment in the next few years.

The company only has a market cap of $137 million but it has long term debt of over $200 million. Even if the company has lots of valuable assets that could be sold off, if it takes too long to realize the value of those assets and its business continues to deteriorate, the debt holders could end up owning those assets. (Hmm… maybe this company’s debt is worth looking into.)

Without going any further into this company, this stock looks like a “cigar butt”.  Just like Buffett, I tend to shy away from cigar butt opportunities.  Benjamin Graham was a big fan of cigar butts, but Buffett moved away from these type of stocks after working with them for several years early in his career when he worked for Graham. As Buffett learned, there are often much better opportunities in excellent businesses and short term special situations.

While I wouldn’t short Unifi’s stock, I am definitely not interested in researching this company any further.