Value Investors Club / UNIFI INC (UFI)

Description

For those investors willing to accept some illiquidity risk of a micro-cap, I recommend an investment in

Unifi (“UFI” or the “Company”) with the potential to realize a return of 50% or more in two years or less.

My target is based on 6x EBITDA that I forecast in FY2023 (which incidentally at $65M is slightly below

what UFI delivered in FY2016 and FY2017). For some context, at $20, that would be ~50% below the 5-

year high (achieved October 2017 when UFI traded at over $39 and at ~10.5x LTM EBITDA), almost 30%

below the 52-week high (achieved in January), ~20% below the pre-COVID high achieved in February,

and ~25% above the post-COVID recent June high from which UFI’s stock has faded. Moreover, at $20,

that would be below the price paid for over 70% of the shares purchased by numerous insiders during

the past three years as well as below the $23.72 average price paid by the Company for $2M of its stock

(from 1/30/20-2/29/20) as part of the outstanding $50M buyback authorization.

The attractiveness of this longer-term investment opportunity is driven by numerous factors as

described below and although the recent COVID-induced challenges are real and will likely ensue

(though at a much more moderate pace) for at least the next couple of quarters, the balance sheet is

strong and the Company is well-positioned to further capitalize upon the sustainability trends in its end

markets that are likely to accelerate during the next few years.

UFI is currently trading at ~20% discount to tangible book value (inclusive of the losses estimated by the

sell-side for Q3 and Q4 of this calendar year) and less than 6x pre-COVID EBITDA that management

believed it was on a trajectory to achieve for the fiscal year that just ended in June but the virus created

severe setbacks across all of the Company’s markets (with the exception of PPE) as evidenced by the

52% decline in sales this past quarter and consequential decline to EBITDA by ~$27M. Assuming no

further significant government shutdowns, Unifi’s CEO noted on the recent earnings call that “we see no

reason why our run rate for revenue and profitability should not return to normal pre-COVID levels by

the end of FY 2021.” Based on that which I describe below, I am also confident that UFI will return to an

EBITDA level during FY 2022 that the Company was on a trajectory to achieve and drive further growth

in FY 2023 based on UFI’s position to capitalize upon sustainability tailwinds, the recent favorable

resolution of trade actions, and a more rigorous focus towards improving both profitability and FCF

generation.

Among the reasons to consider investing in UFI are the following:

1. The Company’s REPREVE Fiber (comprising 31% of sales) is the global leader in branded recycled

fibers which positions UFI well to capitalize on the growth trend for sustainable textiles. Unifi’s

REPREVE platform of recycled performance fibers has been adopted by more than 500 global

brand and textile partners. During the first two quarters of the past fiscal year, UFI’s REPREVE

Fiber business grew at over 3x the industry rate, by 33.5% and 32.2%, respectively, a rate which

declined substantially during the past two quarters primarily because of COVID but

demonstrative of UFI’s competitive advantage to meet both the scale and scope of

sustainability-driven textile objectives for some of the largest apparel brands globally. Industry

experts forecast that the recycled polyester segment of textiles will likely grow at 3x the industry

rate of ~3-3.5%. As customers like Nike, Zara, and PVH drive towards their sustainable

commitments, UFI’s REPREVE will greatly benefit as the mix of the supply chain shifts further

towards a recycled mix. In addition to its vertical integration and branding profile that

differentiates UFI in the marketplace for recycled fibers, the Company developed the U TRUST

verification provide to provide customers with transparency. I elaborate further about REPREVE

below but suffice it to say that the mix shift to sustainability will continue to grow and UFI will

continue to benefit from that growth.

2. The favorable resolution to unfair trade practices that was granted in December was gaining

“significant momentum” at Unifi as core textured polyester yarn sales volumes were reaching

expected levels but the virus severely altered that trajectory. I elaborate about this topic

further below but the good news is that Unifi demonstrated it can excel in the marketplace

pursuant to the domestic playing field becoming more “level” and such growth is anticipated to

resume once end markets normalize. Management had envisioned the ability to recapture a

minimum of $20M of annualized sales pursuant to the favorable ruling and it’s worth noting that

in addition to the incremental sales growth potential, the “level playing field” ruling would also

assist towards stabilizing the Company’s polyester gross margin which had notably declined by

over 600bps from FY2015 to FY2019.

3. Unifi has been in business for more than fifty years and is well-regarded within the trade for its

ongoing innovation. REPREVE is by far the most significant validation of this innovation but

historical innovation also includes yarn technologies that provide moisture management,

temperature moderation, stretch, ultra-violet protection, and fire retardation. As evidence of

the Company’s ongoing commitment to innovation, R&D expense grew by over 70% in FY19

from FY17. Approximately 5% of UFI’s employee base is noted to be focused on R&D. The

business composition characterized as PVA (or “Performance Value Added”) is the validation of

UFI’s ongoing focus towards innovation. Management’s goal is to increase the Company’s

global PVA sales by more than 10% per year which in turn should drive margin expansion (all

else being equal which has not recently been the case). Through much innovation, management

has grown the PVA mix to 53% of sales mix this past FY, which is up from 45% two years ago. A

recently introduced innovation by the Company which seeks to further capitalize on the

favorable trend towards sustainability is UFI’s new line “REPREVE Our Ocean” and management

envisions positioning UFI to capitalize upon the “circular economy” trends in the future. The

success of UFI’s innovation is very much evidenced in Asia which is almost exclusively PVA-

related products.

4. Business from the Company’s second largest business segment—the Asia segment (25% of

FY2020 sales)--has been very strong and management envisions an attractive growth rate in Asia

to continue in the medium-to-longer term as driven by UFI’s PVA offering and particularly from

its proprietary REPREVE. UFI’s business in Asia more than doubled from FY17 (when

management began segmenting Asia from international) to FY19 (pre-COVID) and grew another

15% this past FY (which included COVID for the last two quarters). During the first half of FY20

which was pre-COVID, the Asia business grew by 58%. This was also notably faster than the

overall REPREVE Fiber sales growth during that same period which grew by 33%. The Asia

segment is also attractive because it’s asset-light. The Company does not manufacture in Asia

but instead it essentially licenses its technologies and processes to a network of vendors and

suppliers to contract manufacture PVA solutions. This strategy is consistent with UFI’s objective

to serve global brands with consistency. For example, if Nike wants to integrate REPREVE into

apparel manufactured in the domestic segment (which includes in El Salvador) for product sold

in the U.S., Nike can also drive the same product to be manufactured in Asia with the REPREVE

process and brand for that product to be sold in Asia and/or Europe. In addition to the Asia

business requiring a minimal amount of capital expenditures, it’s notable that only 2% of the

Company’s overall employee base works in the Asia segment. The employee base in Asia is

primarily focused on serving its 590 customers in Asia. The Asia segment generated ~25% gross

margin in FY17 but that declined to ~12% in FY19. One main reason for the margin degradation

is the fact that beginning Q3 of FY18, management decided that the Company’s polyester

segment would earn a technology credit charged to the Asia segment for the rights granted in

Asia “to the use of certain manufacturing know-how, processes and product technical

information and design.” The other reason for margin degradation was management’s decision

to develop new customer relationships with lower-margin products as part of a strategy to

penetrate new customer relationships and then to elevate those new customers to higher-

margin PVA-related products like REPREVE over time. This strategic decision is evidenced by the

43% growth in the number of international (Asia and Brazil) customers from FY17 through FY19.

(note: FY19 was the first time that management broke out customers by Asia, at 590, and Brazil,

at 410, and the 10K for FY20 has yet to be filed to demonstrate specific customer unit growth in

Asia this past year)

5. Insiders are highly-aligned with ~26% ownership and Unifi’s owner-oriented management team

and Board have demonstrated substantial confidence for the equity’s potential by buying UFI

stock at much higher levels. During the past three years, eleven insiders have bought ~1.3M

shares at ~$23. This includes two funds with Board representatives: Impala Capital’s Robert

Bishop and Inclusive Capital’s Eva Zlotnicka. During the past three years, Impala has purchased

~$10.7M at ~$28 (including purchases above $35), and Inclusive has purchased over $11M at

almost $23. Director Ken Langone has purchased over $6.5M at ~$19 (including purchases near

$38). During Q1 (calendar) Chairman Al Carey purchased ~$500K and the relatively new CFO

Craig Creaturo purchased ~$150K at ~$20; the recently-appointed CEO Eddie Ingle has shown

his confidence with over $300K purchased near $13 in the past two weeks. I should note that

almost all Director compensation is in stock awards which resonates with me as a key barometer

of alignment versus the egregious amount of cash paid to Directors across many public

companies where Directors are not adequately aligned.

6. The quality of experiences of this Board are especially impressive for a company of this size and

as described above, the Board is highly-aligned (even though admittedly for some the purchases

can be deemed a rounding error). In addition to Home Depot’s co-founder Ken Langone (who

incidentally has been a Director for 51 years), Chairman Al Carey (who actively participates on

each conference call) served in multiple executive capacities with Pepsi for over 35 years

including CEO of both PepsiCo and Frito-Lay North America. As noted above, two Directors

serve with meaningful investments for each of their funds (based on recent 13F filings, Impala’s

8.9% UFI position is 2.4% of their fund, and Inclusive’s 7.7% position is 2% of their fund).

Impala’s Robert Bishop founded his fund in 2004 and previously was CIO for Soros, was a

Principal at Maverick, a PM at Kingdon, and MD at Tiger Management. Another Director James

Kilts was Vice Chairman at Procter & Gamble pursuant to the sale of Gillette where he served as

CEO; he also served as CEO of Nabisco and his Board experience includes Pfizer, MetLife,

Nielsen, Delta, New York Times, and Whirlpool. These Directors on any size Board are

impressive but especially so for UFI’s size. It can be deduced that Langone is the critical

influence in mobilizing such Board talent (e.g., Chairman Al Carey also serves on the Board of

Home Depot for over 12 years) but that doesn’t dilute the relevance of their experiences and I

would say reinforces the level of commitment from each Director as inferred by me after

reading Langone’s biography. The importance of relationships cannot be understated and one

can infer the magnitude of relationships from this Board is both broad and deep and with such

relationships, UFI has and will benefit from other business connections.

7. Management execution is the key to navigate the headwinds and there have been plenty

historically and there will be plenty in the future. Among the risks I share below is the

magnitude of management turnover and admittedly there is some leap of faith to assert that

this recently-installed executive team will more effectively execute UFI’s business plan.

However, after spending a couple of years closely following the Company, I think this is a

management team that can effectuate better performance on a more consistent basis and so

the “leap of faith” is better characterized as an informed judgment. Among the mistakes made

by previous management was excessive marketing spend, excessive management layers, and a

lack of attention ascribed to the legacy business. As noted, the Chairman is actively engaged in

working with the day-to-day management team. Al Carey became Chairman April of 2019 and

he has participated in each quarterly earnings call since his appointment. At first, I hesitated to

think that a veteran of a company the size of Pepsi for over thirty-five years could effectively

transition towards working with a company of UFI’s size but my primary insights confirm

otherwise. Al assisted with the implementation of a more “streamlined and simpler”

organization with SG&A at a level that “is more appropriate.” He is as comfortable in the Board

room discussing strategy as he is walking the manufacturing floor. The new CEO was with UFI

for ~30 years and his numerous roles included leading the REPREVE business. Employee morale

declined during the tenure of another CEO but has been quickly revitalized with Eddie’s return

to the Company as CEO. The CFO joined September of 2019 and he immediately seized upon

improving working capital and earlier this year led the monetization of the Company’s stake in

Parkdale. I should also note that the COO Tom Caudle has served as CEO twice in the past five

years including most recently before being replaced by Eddie. Tom will retire June of 2021 at

the age of 68 so there’s no management turmoil to be interpreted in that regard after what will

be ~40 years of UFI employment. Tom’s tenure as CEO can be characterized more as a bridge

for the Board to fill the CEO role as Tom’s experience is primarily in manufacturing.

8. The balance sheet is strong with leverage, at ~1.4x EBITDA, on depressed COVID-induced results.

Pursuant to the Company’s recent sale of its 35% stake in Parkdale America for $60M, UFI has

ample liquidity to invest and absorb the likelihood of some potential cash burn this FY as top-

line improves sequentially and therefore working capital increases accordingly. The Company’s

ABL revolver balance is zero and its ABL term loan doesn’t mature till the end of 2023. It’s worth

noting that even when net debt was 4.5x the current magnitude at the end of last FY, UFI’s

interest expense was just 3.3% including the effects of interest rate swaps.

9. The attractive investment opportunity exists partially because UFI is a micro-cap and therefore

doesn’t garner much research coverage from the sell-side (note: only two sell-side analysts

asked questions on the recent quarterly earnings call) but in recognition of the attractive longer-

term investment opportunity, the management team at UFI plans to be more pro-active with

investor relations and has already committed to attend (virtually of course) two conferences

during the next month. Having spoken many times with UFI’s VP of Finance who leads the IR

effort, I am confident that the current management team understands the mistakes that were

made in the past and that this team will execute its business plan to deliver more consistent

performance during the next few years. Since both the Board and management team recognize

the opportunity, they have committed capital from their pocket accordingly, and now aim to be

more pro-active to frame the investment opportunity to the market in a tailored approach that

targets the investor base that thinks longer-term and embraces “value.”

Summary Description

The Company manufactures and sells polyester yarns and related products in the U.S., El Salvador and

Brazil, and nylon yarns in the U.S. and Colombia. In Asia, Unifi manages a network of vendors and

suppliers to contract manufacture PVA solutions, including REPREVE, to direct and indirect customers

globally. As discussed further below, REPREVE is the Company’s branded recycled fabric primarily

derived from converting used plastic bottles and industrial fiber waste into polyester chips. The primary

source of growth for the Company has been from REPREVE Fiber sales which has grown to 31% of sales

mix from 24% two years ago. Moreover, pre-COVID, during each of the first two quarters of FY2020 just

ended, REPREVE Fiber grew by over 30%. This growth is quite notable given the acceleration that was

evidenced relative to FY2019 when REPREVE Fiber sales grew by ~9%.

Unifi typically sells directly to fabric and thread makers but its products are often specified by

downstream manufacturers, brands, and retailers for the unique qualities they bring to finished

products. The Company’s products are made for a variety of end-use markets but principally for

apparel, industrial, furnishings and automotive. The domestic apparel market, which includes hosiery,

represents ~58% of the Company’s domestic sales. The domestic industrial market, which includes

medical, filtration, ropes, protective fabrics and awnings, represents ~18% of the Company’s domestic

sales. It’s worth noting that for the period of April-July of this year, the PPE mix of sales in North and

Central America was 10-15%, up from 2-3% pre-COVID levels and management expects that PPE sales

are likely to remain strong for the near future although this won’t be nearly enough to offset the

ongoing challenges across other end-use markets in the near-term. The domestic furnishings market

represents ~8% of domestic sales and the domestic automotive market also represents ~8%.

During the most recent FY, the Company’s sales mix was segmented as follows: Polyester from the U.S.

and Central America (~51%), Asia (~25%), Brazil (~12%), Nylon (~12%). The Polyester segment

manufactures through eight plants, one of which is located in El Salvador and was notably shutdown for

most of the past quarter because of COVID. All U.S. plants are owned fee simple. The Asia segment is

primarily China and asset-light and is very well-positioned to accelerate from ongoing sustainability

trends for which customers in Asia are licensing PVA solutions and the REPREVE process for the

increasing demand driven by global brands.

The Company refers to fibers sold with specific rules of origin requirements under the Regional free

trade agreements and the Berry Amendment (legislation pertaining to the Department of Defense) as

“compliant yarns.” Approximately two-thirds of Unifi’s sales within the Polyester and Nylon segments

are sold as compliant yarns under the terms of those agreements. Unifi operates within a global and

highly-competitive industry although the Company competes with a limited number of foreign and

domestic producers of polyester and nylon yarns that are “compliant.” Among the major competitors

for polyester yarns are United Textiles Of America S De R.L. De C.V., O’Mara, and NanYa Plastics Corp of

America, AKHA, S.A. de C.V., C.S. Central America S.A. de C.V., and Avanti Industria Comercio Importacao

e Exportacao in Brazil. Unifi’s major competitors for nylon yarns are Sapona Manufacturing and

McMichael Mills.

Management believes the requirements of the rules of origin and the associated duty-free cost

advantages in the Regional free trade agreements, together with the Berry Amendment, and an

improvement in demand for supplier responsiveness and improved inventory turns, will ensure that a

portion of the existing textile industry will remain based in the Americas. There is also the potential

catalyst, as driven by political forces, for increased on-shoring of manufacturing to drive incremental

“Made in the USA” products. Nevertheless, the industry in which Unifi operates is global and highly

competitive and UFI and other domestic industry participants have incurred substantial pressure to

volume, pricing and margin from Asian supply chains. As described in the 10K from FY2019, through a

pattern of unfair trade practices, imports of polyester textured yarn from China and India increased by

almost 80% from 2013-2017 and continued to grow during 2018 and remained elevated during FY2019.

In an effort to reconcile the pattern of unfair trade practices, Unifi (along with other industry

participants) filed antidumping and countervailing duty cases with both the U.S. Department of

Commerce and the International Trade Commission alleging that dumped and subsidized imports of

polyester textured yarn from China and India were causing material injury to the domestic yarn industry.

Unifi’s petition for change was successful and therefore both China and India are being assessed

antidumping and countervailing duty rates that levels the “playing field”. As management noted, “The

positive development in our pursuit of relief from low-cost and subsidized imports are critical steps in

our efforts to compete against imported yarns that have flooded the U.S. market in recent years.” Pre-

COVID, the Company was expecting at least $20M of additional sales coupled with an improving margin.

The assessments will be in effect for at least five years and therefore for those evaluating UFI for the

longer-term, the positive impact from this favorable trade resolution will become more visible as end

markets stabilize.

Unifi is well-regarded for its innovation and the Company’s pivot towards the sustainability trend was

pursued far in advance of the growth trend towards recycled polyester. Sustainability is a megatrend

and has become a buzzword and there’s no dismissing that the ESG trend is evidenced by fund flows to

companies perceived or rated as meeting ESG criteria. UFI is likely too small to garner the passive fund

flow trade benefit from ESG ETFs but the Company did benefit from Inclusive Capital (previously called

ValueAct’s Spring Fund) making an investment based on UFI’s business converging with Inclusive

Capital’s mission which, in part, is identifying and investing in companies whose products, services, or

technology can unlock environmental or social value. Inclusive’s cost basis, at $29.55, is more than

twice UFI’s current price.Inclusive’s Eva Zlotnicka has served on UFI’s Board since August 2018.

The concept of sustainability is not new. The concept was elevated back in 1962 after the publication of

Rachel Carson’s Silent Spring. The textile industry creates one of the most significant impacts to the

global economy and to the environment. As a result of the environmental impacts created by the textile

industry, environmental sustainability has become a fundamental concern for textile manufacturers’

businesses and consumer’ product purchase choices.

Every hour, Americans throw away 2.5M plastic bottles and ~80% end up in a landfill. One plastic bottle

takes an average of 450 years or more to start decomposing and incineration produces toxic fumes. In

late 2007, the Company succeeded at producing a recycled fabric that management named REPREVE,

which is primarily derived from converting used plastic bottles and industrial fiber waste into polyester

chips. Management called it REPREVE as its recycled fabric would be a “reprieve” for the environment

and also hopefully a “reprieve” for the Company’s overall struggling business at that time. REPREVE is

the leading, branded performance fiber made from recycled materials. Over 21B bottles have been

recycled as part of the REPREVE process. The Company achieved its goal set in 2017 for 20B bottles and

is on track to achieve its goal of 30B bottles in 2022.

REPREVE has experienced significant growth in the past few years and increased commercial acceptance

has driven management to invest capital to accommodate anticipated ongoing growth of premium

synthetic and recycled products that are in demand. During FY2015, the Company began a significant

three-year capital plan ($135M) to increase its PVA/REPREVE capabilities and capacity. Among the

benefits from the REPREVE process is the energy saved (i.e., another ESG benefit) by recycling rather

than manufacturing the materials. Recycled polyester uses 30-50% less energy for production and

generates ~55% fewer carbon dioxide emissions than its conventional counterpart.

UFI’s first REPREVE customer was Polartec which was a buyer of Unifi’s polyester in fleeces it made for

companies like The North Face. Although REPREVE got off to a slow start, it has become the global

leader in branded recycled fibers and is now used by numerous well-regarded companies including Nike,

Toyota, Ford, General Motors, Patagonia, Haggar, Adidas, Target, Wal-Mart, H&M, PVH, VF Corp, New

Balance, Volcom, Levi’s, Roxy, Puma, Abercrombie & Fitch, Under Armour and CostCo. Three customers

have been awarded Unifi’s Billion Bottle Circle award for each having derived their REPREVE fiber from

over 1B recycled bottles each; those three customers are Nike, Polartec, and Target. The Olympics that

didn’t occur this past summer would have elevated the sustainability drive by Nike with their Olympic

uniforms. Much of that recycled content was derived from UFI’s REPREVE process and that visibility for

UFI could become a catalyst when the Olympics occur next year (hopefully).

If sustainability once seemed like a hobby for a group of eccentric businesses, it’s now viewed by many

corporations as mission-critical. Many consumers are increasingly basing their purchasing decisions, at

least in part, on sustainability. McKinsey recently published its fourth annual “State of Fashion” report

which highlights sustainability as both the single biggest challenge and single biggest opportunity facing

the industry in 2020 (this was pre-COVID). A survey of approximately 300 global fashion executives

demonstrates that a majority of apparel and footwear companies are seeking more responsible sourcing

practices. Among participating executives, McKinsey’s survey in 2019 highlighted that 55% of

companies wanted at least half of their products to be made with sustainable materials by 2025. Three-

quarters of companies are planning to include recycled polyester from plastic waste, whereas two-thirds

are aiming to include recycled polyester from post-consumer garment waste. Some more specific

examples follow:

• Zara owner Inditex pledged to use only 100% sustainable fabrics by 2025

• Adidas has committed to phasing out virgin polyester by 2024

• Ralph Lauren has committed to phasing out virgin polyester by 2025

• PVH established new supply-chain transparency targets

• Wal-Mart showcased REPREVE at a past sustainability summit and publicly committed to

numerous sustainability goals including increasing the proportion of recycled polyester content

in apparel to 50% by 2025 across its U.S. footprint.

McKinsey’s research leaves no doubt that sustainable sourcing at scale will be a must for apparel

companies over the next five years—and that consumer demand for sustainable fashion is growing

rapidly. Approximately two-thirds of respondents to a McKinsey U.S. cohort survey (and 75% of

millennial respondents) said they consider sustainability when making a fashion-related purchase. In

fact, on-line searches for “sustainable fashion” tripled between 2016 - 2019. Moreover, the consumer

concern for sustainability is evidence in the footwear segment as demonstrated by research conducted

by The NPD Group which showed that 40% of consumers said eco-friendly/sustainable materials are

important when making a footwear purchase. UFI is well-positioned to address the apparel industry’s

sustainable sourcing objective. This was reinforced to me by a primary research contact who said,

“There is no doubt that the apparel trade will continue to shift its mix of inputs towards sustainability

and there are few companies with the scale of a global brand like [XXX] to meet our objectives with

consistency.”

Below is a financial summary of UFI during the past seven fiscal years. I have excluded the contribution

from the unconsolidated affiliates like Parkdale which was recently sold.

Financial Summary

FY ending June; dollars in millions

FY2014 FY2015 FY2016 FY2017 FY2018 FY2019 FY2020

Net sales $688 $687 $644 $647 $679 $709 $607

Gross profit $83 $91 $94 $94 $86 $66 $39

Gross margin 12.1% 13.2% 14.5% 14.5% 12.7% 9.4% 6.4%

SG&A $46 $50 $48 $51 $56 $53 $44

SG&A % 6.7% 7.2% 7.4% 7.9% 8.3% 7.4% 7.2%

Operating income $31 $38 $42 $44 $29 $11 -$9

EBITDA $52 $60 $65 $66 $52 $36 $17

EBITDA Margin 7.6% 8.7% 10.2% 10.1% 7.7% 5.1% 2.7%

CFFO $43 $35 $51 $44 $25 $5 $42

Capital expenditures $19 $26 $52 $33 $25 $25 $19

FCF $24 $9 -$1 $11 $0 -$20 $24

Polyester net sales $404 $396 $383 $356 $364 $371 $309

Nylon net sales $149 $150 $132 $113 $103 $98 $67

Internationalnetsales$135$135$123

Brazil net sales $109 $111 $103 $73

Asia net sales $65 $97 $133 $153

Other net sales $0 $6 $6 $5 $4 $4 $4

Total net sales $688 $687 $644 $647 $679 $709 $607

Polyester gross margin 11.8% 12.8% 12.9% 11.3% 9.1% 6.4% 3.9%

Nylon gross margin 13.0% 12.7% 13.5% 10.7% 10.2% 8.0% -1.5%

International gross margin 12.1% 15.9% 21.9%

Brazil gross margin 24.4% 23.4% 18.1% 15.3%

Asia gross margin 24.7% 17.1% 11.8% 10.9%

There are numerous reasons not to own UFI and those risk considerations include the following:

1. Too much management turnover. The Company’s new CEO—Eddie Ingle--is the fourth during

the past four years. The Company has also experiencing numerous CFO changes with Craig

Creaturo as the fourth CFO during the past four years. This excludes the Treasurer having

served as interim CFO three times during that period.

2. The Company’s FCF generation has not been compelling. Excluding the distributions from

unconsolidated affiliates, FCF during the past three years totaled $4M, FCF during the past five

years totaled $14M, and FCF during the past seven years totaled $47M. Based on the past

seven fiscal years, that $47M amounts to only $6.6M on average or just 1.1% of sales. Some of

the lower conversion is definitely ascribed to a higher capital spending pattern during this

period to expand the capacity to accommodate growth across the recycling-driven part of the

business but there is also more opportunity to drive higher conversion at the CFFO line which

has ranged from 0.7-8.0% (5.3% average). It is worth noting that during FY 2012 and 2013, the

Company generated $26M and $27M of FCF, respectively (i.e., those two years exceeded the

past seven). Sales were generally higher than as well (except for FY2019 when it was roughly

equivalent) and capital spending was much lower. Management has communicated that

maintenance capital is ~$12-15M but this fiscal year is estimated at $22M which is inclusive of

new texturing machines that are exclusive to Unifi for two years. There will be some carry-over

of this capital to FY2022 as well. The payback on this machinery is forecasted to be roughly five

years. An investment in UFI is premised on growth resuming, an assumption I don’t think is too

far-fetched post-COVID given the substantial sustainability trends that UFI will continue to

capitalize upon but the FCF conversion does require ongoing monitoring given the absence of

consistency. During the latest FY, they did generate $24M of FCF to achieve the Company’s

highest FCF conversion (of sales), at 3.9%, during the past seven years but that was largely based

on the magnitude of benefits that were achieved from changes to working capital. It is worth

highlighting that the management team has become more vigilant about its cost structure (this

was pre-COVID) with a focus towards more FCF generation and they did exhibit such during the

first half of FY2020 when CFFO grew to $18.2M from negative $4.5M in the prior six-month

period that ended December. This trend of CFFO improvement was also exhibited during the

March quarter when CFFO grew despite lower sales. In my valuation framework, I have

assumed some cash burn this FY as working capital grows with sequential improvements to the

top-line but I assume FCF generation in both FY2022 and FY2023 although in FY2023 not

anything beyond the peak CFFO conversion that was generated during the past seven years

which might be conservative.

3. The equity has incurred substantial drawdowns that seem irrational to me but are nonetheless a

risk consideration that should be highlighted for those uncomfortable with volatility that I

rationalize is the painful turf that comes with investing in a micro-cap. For example, on January

28th, UFI hit a 52-week high but on the following day the stock was down by ~25% pursuant to

the Company’s earnings release and conference call. The Company did miss consensus

estimates and did lower its outlook but the $125M reduction to the equity seemed much more

than warranted for a change in guidance that totaled, at the midpoint, $2M in estimated EBITDA

less capital spending. After retreating another 8% the following day (i.e., ~$157M in total from

the $2M reduction in guidance) at the low, the stock finished to close positive from the

preceding day. During the COVID March flush, UFI declined by 40% (that is not a typo) from the

preceding day’s high of $12.41 on March 19th to the low of $7.48 on March 20th. The

capitulation low was made on roughly four times average volume and as we all now know in

hindsight, that period in March would mark the COVID-driven bear market low (at least for the

time-being). However, although UFI has indeed appreciated substantially from that low on

March 20th, the stock is not much higher than the preceding day March 19th

high of $12.41. One might not expect UFI’s business to return to the pre-COVID level of $44-47M until FY2022 but a

big difference is a much improved balance sheet from then. Net debt back in March was ~$91M

if one looked to December quarter-end or ~$100M if one looked to that quarter’s March

quarter-end. The latest net debt is ~$24M. This improvement to leverage is of course ascribed

to the monetization of the Company’s 34% interest in Parkdale America for $60M and one might

argue that the higher enterprise value in March was based on the Parkdale interest which now

serves to reduce UFI’s enterprise value because the monetized asset has been converted to cash

but I would contend that the market did not ascribe much likelihood for Parkdale being

monetized and the unconsolidated investment served only as a source of distributions. Given

that the Parkdale monetization improved the balance sheet while also simplifying both the

business and investment opportunity, I think the market is under-appreciating that

improvement.

4. The Nylon business has been severely challenged. Sales were down by ~35% in FY2019 from

FY2015. Hanesbrands was the Company’s largest customer and they decided to off-shore much

of their business so this is a business segment, with one plant in North Carolina and another in

Colombia, that remains challenged. Management recently introduced REPREVE Nylon which

could improve the business performance but my expectations remain low until evidence of such

improvements materialize. Management currently believes it remains of strategic importance

to its customers to offer nylon. During FY2019, the polyester segment served 390 customers

and the nylon segment served 140 customers and there is some overlap with the brands (i.e.,

the indirect customers).

5. Unifi’s business is impacted by the end markets which it serves so given that its largest customer

mix (the apparel industry) is being challenged with bankruptcies, liquidations, shutdowns, lack of

back-to-school, it should not be surprising that UFI would incur the collateral damage as

evidenced by the 52% decline in sales this past quarter. Other end markets currently confront a

host of challenges as well although there’s been some improvements across automotive and

furniture more reently but there will always be risks associated with each of the Company’s

end markets.

6. Significant price volatility of raw materials, especially rising energy costs, has challenged the

Company in the past. Although there is some index-based pricing and negotiated price

adjustments that mitigate the impact from such inflationary input pressures, there is a lagged

mitigation that often goes beyond one quarter.

7. Foreign currency fluctuations based on significant operations in China, Brazil, Colombia, and El

Salvador.

8. Trade policy issues always loom as a potential risk although it should be noted that the

Company’s business in China was not as much impacted by the “trade war” since its customers

are sourcing their business there for sales that are made within Asia and to Europe.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Continued growth of PVA segment and particularly REPREVE

Resume pre-COVID trajectory as forecasted by management (end of FY2021)

Increased recognition by equity market for magnitude of sustainability-driven growth

Improvement to FCF conversion

Benefit from potential resurgence of on-shoring of manufacturing for Made in the USA

Execution of outstanding buyback coupled with ongoing insider buying

show sort by

			2020	2021
Price:	12.56	EPS	0	0
Shares Out. (in M):	18	P/E	0	0
Market Cap (in $M):	232	P/FCF	0	0
Net Debt (in $M):	24	EBIT	0	0
TEV (in $M):	256	TEV/EBIT	0	0