Tuesday, June 14, 2011

Universal Security Instruments: In Disguise

Universal Security Instruments (UUU) has been hit hard recently. As a seller of residential smoke alarms and related products, its business is inherently tied to that of the housing market. Predictably, sales in this industry have been relatively soft with no optimism on the horizon as the US housing market continues its downward trajectory following the expiry of federal tax incentives.

As if that weren't enough, the company has been hit by a double-whammy as heavily concentrated customer The Home Depot informed Universal Security last year that it would no longer sell its products in store. The Home Depot has represented almost half of the company's sales over the last few years, so this was a big blow to the company. (Owning companies with high customer concentration can be a large downside risk, as discussed here.) The result is a company that struggles to break even in its operations.

But it's also a company with a healthy balance sheet that trades at a significant discount to book value. Universal Security has $28 million in assets against just $1 million in liabilities, and trades for just over $16 million. Furthermore, the company has what appears to be a flexible cost structure, with little in the way of property, plant and equipment requirements; it buys in Asia and sells in North America.

Book value as a measure of worth, however, can be pretty meaningless, so it's worth digging into the nature of the assets to figure out if it's worth paying $16 million for this company. Almost $13 million of its assets are made up of current assets, including $7 million of cash, a quarter's worth of inventory and half of a quarter's worth of receivables.

But what's most interesting about this company is a joint venture it owns which is also its overseas supplier. This JV is quite profitable, not just from purchases from Universal Security, but also from other customers. The JV has been pushing Universal Security into the black as an overall company despite the tough environment. This year, Universal Security's share of the JV is on pace to deliver earnings between $1.5 million and $2 million.

At the current price, Universal Security offers investors a piece of a profitable business (the JV) at a P/E of around 10. In addition, shareholders receive a public company with a significant amount of cash and other current assets that has hit some temporary problems for free.

Disclosure: Author has a long position in shares of UUU

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