United-Guardian: It’s All Relative
“We will be actively seeking distribution partners to expand our reach in the medical field and introduce our medical lubricants into new medical markets. The medical field has many uses for lubricants, and we believe we have just scratched the surface of this potential market.” - Donna Vigilante, United-Guardian CEO, Q3 2023 Stockholder Letter
It has been no secret that United-Guardian, the small, uniquely positioned producer of cosmetic ingredients, medical lubricants, and niche pharmaceuticals, has recently faced immense pressure. Supply chain issues and dwindling demand post-pandemic for several of its core products have led to its income faltering, reflected in the company’s share price. My last two related updates, Caught in the Storm (June) and Patience Is the Game (August), covered these exact dynamics in detail and laid out scenarios in which an absurdly asymmetric opportunity may present itself. Those pieces opened with the following two quotes, respectively:
“A ship in port is safe, but that's not what ships are built for.” - Grace Hopper
“You don’t have to swing hard to hit a home run. If you got the timing, it’ll go.” - Yogi Berra
Ironically, I may have missed the boat to take my trivially small tracking position up in size—or at least for now. Assuredly, it’s worth revisiting parts of the core thesis and prior analyses alongside recent announcements to provide context on what may be to come.
What is it about United-Guardian that continues to capture my interest? Simply:
It is small ($37mn market cap) and obscure, ensuring limited eyeballs.
What was once its largest operating segment, Cosmetic Ingredients, has faced immense pressures, which may have a road to recovery.
Pharmaceuticals, now the company’s largest segment, is steadily growing, thanks to a mix of small volume increases and continued price take.
The company’s third segment, Medical Lubricants, has fluctuated in sales but remained fairly stable over the last decade and a half, and now sports a potential growth catalyst.
The company carries zero debt (and never has) and holds a substantial amount of cash and cash equivalents on its balance sheet.
The operating model is incredibly capital-light.
Prior to recent headwinds, margins were markedly and consistently high. Even currently, margins are respectable and due to the capital-light model, the company produces a fair amount of cash.
Overall, the business is far less correlated to the broad market than many companies, and, again, due to its capital-light nature, has returned significant cash flows to equity owners over its history. At a low enough equity price, the enterprise value, subtracting cash and cash equivalents, has the potential to be eclipsed by the value of Pharmaceuticals alone, providing a significant (full?) discount toward Cosmetic Ingredients and Medical Lubricants.
It’s all relative
Since November 3rd, United-Guardian’s share price has surged nearly 40% to $8.07. But it’s all relative, and the chart below captures its precipitous fall:
Previously in the year, a dreadful Q1 was met with an equally abysmal Q2, including the sudden departure of the newly appointed CEO. The 52-week low was reached following an additional announcement made by United-Guardian in which it was electing not to renew its exclusivity agreement with the largest distributor of its Cosmetic Ingredients, Ashland Specialty Ingredients—a conscious but concerning decision. The seemingly endless stream of alarming news reversed when UG published its Q3 2023 results, including sales of Cosmetic Ingredients, Pharmaceuticals, and Medical Lubricants increasing by 42%, 3%, and 73%, respectively. However, the cost of sales ballooned, and Pharmaceuticals, which have lower margins and are now a greater contributor, suppressed group performance significantly. The loss of operating leverage is immense.
While these net results appear far from stellar, there is a key point to note:
In the first nine months of 2023, United-Guardian generated EPS $0.01 lower than what my most recent model showcased for the full year 2023. At the same time, the model showed CI and ML sales for the full year close to what was achieved in the first nine months. This is the result of being conservative with inputs and, as always, using models to illustrate and understand potential outcomes rather than attempting to predict with precision. UG is now positioned to likely generate near $0.50 EPS for the full year—right between the June and August models. If Q3 does mark the beginning of the stabilization of LUBRAJEL sales in Cosmetic Ingredients and Medical Lubricants, hindsight shows that November presented an opportunity to acquire at a forward EV/EBIT of less than x8. If a more rapid recovery continues, the forward multiple a year or two out would have been conceivably less than x5. “If” is the operative word in both cases.
Below is a revised model which continues to apply the same conservative hand:
The above is less-than-impressive, as it should be. It implies brutally weak sales in Q4 across all three segments, continued elevated COGS, a tax rate of more than 100bps over the historical effective rate, and roughly double the requisite retained earnings for reinvestment without any additional growth for such reinvestment in the following years. Further recovery of Cosmetic Ingredients would help recover operational leverage, but the nixing of the exclusivity agreement with ASI, even if done in the best interest of the company, presents a considerable level of uncertainty, alongside the constant tension provided by the company’s bare-bones reporting. Conversely, there are several potential catalysts unaccounted for.
In October, U-G announced an agreement with Brenntag, a global chemicals and ingredients distributor, for a subset of LUBRAJEL products under the NATRAJEL line. This line of lubricant products is specifically designed for what UG has labeled Sexual Wellness. Launched at the California SCC (Society of Cosmetic Chemists) tradeshow, the initial overall response was said to be significantly positive. While almost certainly set to be a non-contributor in the near term, this marks a new channel to grow sales of the unique natural variants of LUBRAJEL.
United-Guardian’s Pharmaceuticals segment continues to be my priority focus. While lower margin, it has shown relatively stable growth and related sales occur in the U.S. The company’s primary pharmaceutical, Renacidin, has a fascinating history in which it has become a mini monopoly, but not without issue. The product experienced production issues related to contract manufacturers in the past. Additionally, new marketing efforts have supported a notable improvement in growth. Here we are, set for round two for both. UG will be commencing new marketing efforts in 2024 targeting doctors and healthcare professionals, as well as continued efforts to evaluate opportunities for international expansion.
Posing as a clear risk to the segment, in mid-October, United-Guardian informed the FDA of a potential supply shortage of Renacidin. Amsino Healthcare, the manufacturer contracted to produce Renacidin, will be temporarily ceasing manufacturing of the product due to required facility maintenance. This appears nearly identical to the Renacidin shortages of 2010-2011 due to issues with the previous contract manufacturer. Amsino has disclosed that due to the shut down two orders originally set for December 2023 and January 2024 will be pushed to early February 2024. This event will be partly offset by UG allocating current excess stock to distributors in December, but the total impact is uncertain. While clearly telegraphed by the company, would-be Q3 Pharmaceutical sales being pushed to Q1 2024, potentially paired with weak Q4 CI sales, may lead to a severe reaction by the market—one can only patiently wait, even if such a skewed opportunity does not materialize.
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Ownership Disclaimer
At the time of publishing this piece, I hold positions in United-Guardian.
Disclaimer
This publication’s content is for entertainment and educational purposes only. I am not a licensed investment professional. Nothing produced under the Invariant brand should be thought of as investment advice. Do your own research. All content is subject to interpretation.
Tags: UG 0.00%↑ ASH 0.00%↑
Just thinking out loud, what are the advantages of UG being a public company? They incur all the costs and headaches of being public, but they don’t seem to need to raise capital (they haven’t issued shares in decades and they have quite a bit of cash on the balance sheet).
Thank you for the update, Devin!