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QUALIPORT
Ultraframe: A Missed Opportunity

By Maynard Paton (TMFMayn)
December 6, 2001

Carburton Street, London -- No doubt about it. Ultraframe (LSE: UTF) is a missed opportunity. The company reported its annual results on Tuesday and the statement defied the Qualiport and all the group's other doubters. Since November 5th, Ultraframe shares have surged 70%. Is it now too late to jump aboard?

Business

To recap, Ultraframe is Europe's leading conservatory roofing specialist, designing, manufacturing and supplying a comprehensive range of products and components for this niche industry. Sales are made to third-party conservatory installers, retail outlets, other branded conservatory manufacturers and house builders.

Ultraframe's business strength comes in the form of dominating a fragmented market (the company has been said to be ten times as large as its nearest competitor), a raft of patents, all-important industry accreditation (which very few competitors have) and a management team that effectively created the marketplace for specialist conservatory roofing.

The financials

Ultraframe floated in late 1997. Until the latest set of results, the financial record had been without problem.

Year to 30 September         1997    1998    1999    2000    2001



Turnover (m) 53.6 61.6 69.1 81.8 100.7
Operating Profit (m) 12.6 17.2 20.9 26.4 25.3
Pre-tax profit (m) 12.8 18.5 22.3 27.6 25.7

Earnings per share (p) 9.5 13.9 16.4 21.0 18.9
Dividend per share (p) - 5.4 6.6 9.0 9.4

The year ending September 2001 was characterised by two events:

* A slowdown in domestic sales growth. After reporting high double-digit growth in previous years, revenues at the group's core UK residential conservatory operation edged just 4% higher to 84.1m. Additional infrastructure investment caused Ultraframe's overall pre-tax profit to slip 7% to 25.7m

* The 88m purchase of Four Seasons, a market leading 'glazed enclosure' business based in the US. Generating an additional 50m of sales and 8m of operating profits, it was a relatively ambitious purchase.

Four Seasons

While the slowdown in domestic turnover was unfortunate (due, in the main, to bad weather), Ultraframe no doubt continues to dominate its particular market place. Even in a disappointing year, UK operating margins were a stunning 28%.

However, the US venture looked circumspect. As mentioned before, aggressive moves by UK firms into the States typically lead to costly retreats. And although just five months have passed since its purchase, so far, all seems to be going well at Four Seasons.

Ultraframe stated on Tuesday: "The events of 11 September had a minimal impact on the [Four Seasons] business, with sales orders at our expected levels by the end of September. Our customers report good enquiry levels and our sales and orders in the current financial year are consistent with last year."

That's a great performance, especially given conservatory sales are supposedly sensitive to a deteriorating economic climate. The only continuing niggle with the Four Seasons business is the recent change in its top-level management. How will the business fare with its founders now taking a back seat?

Cash flow

Ultraframe's great cash flow record continued with the latest results.

Year to 30 September         1997    1998    1999    2000    2001

Operating Profit (m) 12.6 17.2 20.9 26.4 25.3

Working Capital Change (m) 1.7 (0.9) (0.6) (4.7) 0.1

Depreciation (m) 0.8 1.8 2.0 2.2 2.7
Capital Expenditure (m) (2.3) (1.4) (6.2) (6.1) (2.7)

Over the past five years, just 7% of operating profits have been absorbed into working capital. And although capital expenditure did rise during 1999 and 2000 (the company expanded its production facilities), Ultraframe still requires little in the way of tangible fixed assets.

The group generated operating profits of 25m on fixed assets of 27m during 2001. As this study shows, that performance indicates Ultraframe having relatively more difficult-to-replicate intangible assets than most other businesses.

The lack of tangible assets means Ultraframe produces a high return on shareholders equity. Over the five years ending September 2001, Ultraframe's equity base increased by 57.4m while earnings improved by 12.7m. The incremental return on shareholders' equity thus comes to a robust 22.3%. (Note: this calculation is somewhat conservative, as it includes just a part-year profit contribution from Four Seasons, although the division's assets are fully accounted for in the company's balance sheet.)

The Four Seasons purchase meant Ultraframe exchanging a 29m cash pile for net debt of 39m during 2001. I estimate a net interest bill of some 3.5m in fiscal 2002, with the company's prospective interest cover a comfortable 9 times. Future returns on equity won't be aided by substantial borrowings.

Valuation and summary

When Ultraframe shares touched 156p a month ago, those who could see beyond the doom and gloom would have made a mint. But for the Qualiport and everybody else, how do the shares stand at today's 263p?

Using these assumptions for the enlarged group...

* Operating profits at the group's continuing businesses remain flat at 22.4m;

* Four Seasons produces annualised operating profits of 8.0m (the division generated 1.8m in the 11 weeks ending September 2001);

* A full year depreciation charge of 3.5m and annual cash capital expenditure of 4.6m;

* Net interest payments of 3.5m (net debt at September 2001 was 39m), and;

* Tax is charged at 31% (as per 2001).

...Ultraframe's prospective free cash flow comes to 18.52p per share. To get a 7.5% free cash flow yield, an entry price of 248p is required.

Overall, Ultraframe remains an attractive business. Conservatory roofing may not be the most glamorous of activities, but the company's fat margins and cash flow profile should make shareholders drool.

Certainly there seems to be no further problems in the company's UK market. Domestic sales in October and November were 10% ahead of last year. The only worry stems from operational hiccups in the US. If none occur, then Ultraframe will be almost unique amongst UK companies with its ambitious US expansion. All things considered, a sub 250p share price will tempt the Qualiport to part with its remaining cash balance.

More: Ultraframe: The Conservatory Cash Cow