Higher margin business masked by legacy business

So just a quick overview on UNIFI. UNIFI is the maker of REPREVE, fiber/textile manufacturer with operations in North/Central/South America and Asia. North comprises the United States, Central comprises El Salvador, South America comprises Colombia and Brazil. These are consolidated as The Americas, Brazil, and the other is Asia. The past few years they have been hit hard. Revenues down from all-time highs from 2022 with revenues up as much as $800m. Now revenues latest FY was around $650m. A big contributor to this was super high inventory level at the retail level in apparel which is their main sales channel coupled with increased imported goods into the Americas and Brazil which has been a big contributor to the decrease in margins in the past 2 years. The lower volume, specifically in America, caused weak fixed cost absorption as they are asset heavy in this region. Volume is a key driver for this investment.

Why the investment will yield a positive return.

The company is priced very low due to the weak economic environment in a commoditized industry. What people fail to realize is the upside the company has in leveraging their REPREVE brand to enter new markets beyond apparel. First off, as consumers become more conscious of the impact apparel has on greenhouse emissions and the overall health of the planet, demand for REPREVE is going to keep increasing as the years go by. It’s a matter of time for consumers to be educated on this topic and brands are forced by regulations and consumer demand for recycled products. Repreve has an extensive brand reputation and sophisticated tracking system that serves as an advantage for their brand partners. Their brand partners will benefit from REPREVE by having a certificated and trackable fabric that eases the consumers mind on its authenticity. Second of all, REPREVE is able to expand into new markets, “beyond apparel”, which is margin accretive and orders and interest are starting to come in FY24. Demand for REPREVE will always be there, it’s just a matter of time recycled products become the norm. Repreve is a higher margin business and it still has not penetrated the Brazil market. Plenty of upside in Brazil with the adoption of REPREVE. Local advertising is taking place to increase awareness of REPREVE fibers.

Inventory levels looks like it has bottomed and is set for a rise as retailers will start purchasing again in the next calendar year 2024. However, I do expect retailers to purchase more slowly as they made big mistakes with inventory management the last few years due to supply chain issues. They saw they overstocked, and it became a big problem paired with weak consumer spending and created huge drags on cash flows for them. I see that easing in the near future based on management’s comments and industry trends. 

Americas set for an uptick in volumes

Biggest competitor in the US exited the market, leaving UNIFI with the majority of the business left. Around $30m worth of business they are confident they will capture. This should improve volumes and fixed cost absorption in the Americas and be margin accretive coupled with general increase in demand from decreased inventory levels and resuming of inventory purchases. Volume is extra important for the Americas as its asset base is very heavy and needs increased volume to absorb all this overhead. The last 2 years the Americas had negative gross margin due to weak volume caused by dumping of imports. 

Last quarter, Q1 2024, Americas operations posted negative gross margins not due to volumes, but due to lower selling prices caused by lower input costs coupled with increased imports. Now with increased volume from business revamp and the capture of market share, they should be able to pump those margins back up by year end. 

Brazil Operations

Brazil is one of their segment/geographies with the most potential for growth excluding Asia. The thing with Brazil is that a small number of sales are REPREVE, so REPREVE has not penetrated that market and Brazil has higher margins without the REPREVE mix. They are getting REPREVE out there, advertising it to gain traction in that area as it is a growing segment and REPREVE would expand margins even further. Plus, investments in equipment have been made for efficiency and cost savings so that should drive margins even further there. The roll out of REPREVE in Brazil will be a part of the growth story of the company and part of the margin accretion as well.

In Brazil, volume remained strong with 90%+ capacity utilization in Q1 24. However, sales decreased due to extreme competitive pricing caused by dumping imports from China which caused the Brazil segment to lower its prices and cause revenue decrease. Margins suffered greatly as well. As the Asian market improves, they see imports from China in Brazil decreasing which should help Brazil operations improve margins and grow revenues. 

Asia Operations

The Asian operations are different from the other geographies. This one operates on an asset light model which has benefited them greatly as they don’t have to rely on volumes to absorb fixed costs and margins are relatively stable when sales decrease. This is a big part of the REPREVE business as they sell their recycled products to manufacturers that manufacture for these big brands all over the world. The growth of the Asian market is essential for UNIFI’s growth, they have been experiencing increased interest in REPREVE and their “textile take back” program. Management have said that they plan to copy the Asia operations business model and apply them to other markets like in Europe, India, and Africa.

In Asia, Q1 volumes were significantly down, the Chinese economy has been weak and most of the REPREVE sales demand is from Asia. However, margins were able to increase due to increase in prices.

Capital Allocation

Capital spending has been paused due to an uncertain economy which I think was smart from management. Why invest in growth when there is no growth, and it is very foggy looking forward because no one can predict when the economy will improve. They also focused on working capital management and cost control, implementing activity-based costing to find true unit costs. These initiatives generated positive cash flows in the last quarter during a really tough environment. So props to them. They also have $38m remaining on their share repurchase program, however they should prioritize debt service, especially in this environment. But the buyback program should be a catalyst in the long term as right now that buyback program if executed would remove 34% of the shares outstandings. That is a significant reduction, especially for a business of this size.

One of the board of directors, Kenneth Langone, increased his position in the company from 10% to 13% in December. He was the co-founder of Home Depot. The board of directors is also composed of very good businessmen. The former CEO of PepsiCo is on the board of directors.

In conclusion, you are buying this stock at a market cap of $113m, at cyclical lows when no one is watching it due to negative earnings while the environment is improving coupled with a good business inside of its ecosystem that will help the company move into a higher margin norm as volume on that business increases. Also worth reemphasizing, they were able to generate positive cash flows in horrible operating conditions. It also has downside protection with it trading at 40% of tangible book value, so margin of safety is very wide.

Disclaimer: This is not investment advice