Description

Thesis: Currently this $65mm corrosion chemical microcap is trading at close to its Net Working Capital + Cash value, which is obfuscated by a JV oriented corporate structure, with intermediate term 100%+ upside on recovery of cyclical end industries and continued expansion of its Nature Tec product line. Clean balance sheet, incentivized management and a decent risk reward with a decent margin of safety valuation.

Company Profile, via CapIQ: Northern Technologies International Corporation develops and markets rust and corrosion inhibiting products and services to automotive, electronics, electrical, mechanical, military, retail consumer, and oil and gas markets. It offers rust and corrosion inhibiting products, such as plastic and paper packaging, liquids, coatings, rust removers, cleaners, diffusers, and engineered solutions designed for the oil and gas industry under the ZERUST brand. The company also provides a portfolio of biobased and certified compostable polymer resin compounds and finished products under the Natur-Tec brand. In addition, it offers on-site technical consulting for rust and corrosion prevention issues. The company sells its products and services through a direct sales force, a network of independent distributors and agents, manufacturer’s sales representatives, strategic partners, and joint venture arrangements primarily in North America, South America, Europe, Asia, and the Middle East. Northern Technologies International Corporation was founded in 1970 and is headquartered in Circle Pines, Minnesota.

Some Financials:

Price $7.00 -$7.50 (nano cap spreads) … the company recently did a stock split and I’ve noticed not all financial databases have adjusted so be careful looking at the chart

Market Cap, with 9.1mm shares - $65mm

Balance Sheet/Margin of Safety analysis:

-        Visible cash: $12mm - $1.33 per share

-        Visible NWC, ex cash: $17.5mm - $2.00 per share

NTIC has 19 JVs and 7 subs (most of which were established prior to 2000) which it controls and has 50% economic interest in. It has a carrying value of $21.3mm which is $10.4mm ($1.15/per share) in cash and $11mm in NWC ($1.21 per share).  You can choose how to view this, but for purposes of this pitch, given that management has access and control over these liquid assets I will assign full value though you’re more than welcome to discount.

-        JV liquid assets: $2.35 – per share

Total Liquid Assets: $5.70 per share

Other Assets: PPE at about $7mm - $0.00 to $0.50 per share. NTIC owns a decent sized industrial facility in MN at 4201 Woodland Road, Circle Pines, Minnesota 55014. 

Patents: Company has been around for decades and spends $3.5-4mm a years on R&D which drives $150mm+ in global revenues. I am not a patent expert but I would imagine these are worth more than zero.

So that is all to say for $7.50 you’re getting $5.70 in liquid assets and probably $1-2 in other assets so providing the company doesn’t bleed cash (which it shouldn’t, or minimal about $1.00 in my worst case) during the recession your balance sheet margin of safety downside is about 20%.

EV, including the JV cash: $43mm – or $4.90 per share.

*additional financials note. It does not screen well on margins or EBIT/EBITDA profitability because it makes a significant amount from JV fees (7% of JV revenues) which is for some strange reason reported below operating expenses. Adjusting for those fees makes NTIC a significantly much more profitable company. For example this adds 10% of Gross Margin for TTM, from 33% to 43%.

Two product lines (total revenues, excluding JV fees, for 2019 $55.8mm)

1.      Zerust - rust and corrosion inhibiting products include plastic and paper packaging, liquids,c oatings, rust removers, cleaners, and diffusers as well as engineered solutions designed specifically for the oil and gas industry.  NTIC has been selling its proprietary ZERUST® products and services to the automotive, electronics, electrical, mechanical, military, and retail consumer markets for over 40 years and, in recent years, has targeted and expanded into the oil and gas industry. Zerust 2019 revenues were $35.5mm and $2.7mm for oil and gas sales or 69% of total. The O&G business was nice with good profits, oil drums is good business, but I would probably consider for the purposes of this analysis that those revenues are gone. Overall demand for ZERUST® products and services depends heavily on the overall health of the markets in which NTIC sells its products, including the automotive, oil and gas, agriculture, and mining markets in particular.

These are great products. I was able to talk to a customer who considers them top notch but not a lot of competition. Having said that these are the most consumer oriented cyclical end products such as automotive and electronics and retail. This is probably going to suffer a decent haircut globally, both from JV fees/global fees and from recognized revenues. But in the end that’s the point of this pitch, this is a bet on a microcap cyclical with a decent balance sheet. If you think the global consumer is coming back this is a good bet.

2.      Nature-Tec - Natur-Tec® biobased and compostable plastics are manufactured using NTIC’s patented and/or proprietary technologies and are intended to replace conventional plastics. The Natur-Tec® biopolymer resin compound portfolio includes formulations that have been optimized for a variety of applications, including blown-film extrusion, extrusion coating, injection molding, and engineered plastics. These resin compounds are certified to be fully biodegradable in a composting environment and are currently being used to produce finished products including can liners, shopping and grocery bags, lawn and leaf bags, branded apparel packaging bags and accessories, and various foodservice ware items, such as disposable cutlery, drinking straws, foodhandling gloves, and coated paper products. In North America, NTIC markets its Natur-Tec® resin compounds and finished products primarily through a network of regional and national distributors as well as 2 independent agents. NTIC continues to see significant opportunities for finished bioplastic products and, therefore, continues to strengthen and expand its North American distribution network for finished NaturTec® bioplastic products. 2019 Revenues - $17.6mm (31.5% of total revenues). These revenues did not exist a few years ago and have doubled from a 2017 base off $6.8mm, mostly through growing its revenues to over $8mm in India which did not exist a few years ago.

 This is a lower margin product, but obviously has a nice marginal contribution to the bottom line. A little less cyclical but obviously still cyclical. Big India exposure. So in general this is a hodge podge nano cap bet on the macro economy.

 Why I like it:

-        Aforementioned balance sheet/margin of safety allows you to ride out the wave of uncertainty over the next 12-24 months while the global economy recovers

-        Product is a high ROIC product, while accounting for little of overall cost of final products such as cars or oil drums etc.

-        Aforementioned JV accounting on balance sheet and income statements masks the true profitability of the firm

-        Simple and diversified business model. Sells across many verticals and end product segments, without too much commitment to a single product or country (though decent India and China exposure).

-        Very capital light/high FCF generating business model

-        Incentivized management with a significant ownership stake (though may also preclude sale) at 15.4% for CEO, and 20%+ including directors.

-        Good risk reward on current valuation with a long term horizon

Management

Decent management. They’ve done a nice job positioning this company for the long term. The oil & gas revenues and Nature-Tec revenues didn’t exist a few years ago and now they represent over one third of total.

From Risks in 10-k

One of NTIC’s principal stockholders beneficially owns a significant percentage of NTIC’s outstanding common stock and is affiliated with NTIC’s President and Chief Executive Officer and, thus, may be able to influence matters requiring stockholder approval, including the election of directors, and could discourage or otherwise impede a transaction in which a third party wishes to purchase NTIC’s outstanding shares at a premium. 

As of November 11, 2019, Inter Alia Holding Company, or Inter Alia, beneficially owned approximately 13.2% of NTIC’s outstanding common stock. Inter Alia is an entity partially owned by G. Patrick Lynch, NTIC’s President and Chief Executive Officer and director, as well as two other members of the Lynch family. Mr. Lynch shares voting and dispositive power of shares of NTIC’s common stock held by Inter Alia with the other owners. As a result of his share ownership through Inter Alia and his position as President and Chief Executive Officer and director of NTIC, Mr. Lynch may be able to influence the affairs and actions of NTIC, including matters requiring stockholder approval, such as the election of directors and approval of significant corporate transactions. The interests of Mr. Lynch and Inter Alia may differ from the interests of NTIC’s other stockholders. This concentration of ownership may have the effect of delaying, preventing, or deterring a change in control of NTIC, could deprive NTIC’s stockholders of an opportunity to receive a premium for their common stock as part of a sale or merger of NTIC, and may negatively affect the market price of NTIC’s common stock. Transactions that could be affected by this concentration of ownership include proxy contests, tender offers, mergers, or other purchases of common stock that could give stockholders the opportunity to realize a premium over the then-prevailing market price for shares of NTIC’s common stock.

 Valuation/Financials.

 For companies of NTIC’s size I usually have a 100%+ 3-5 year appreciation/20% IRR expectation with a bad case / base case risk reward of 5-1, usually at 20% downside. I believe NTIC meets this hurdle.

 With access to over $23mm in cash the liquidity aspect should be off the table. The aforementioned balance sheet values of $6.00-$7.00 provide a good downside for today’s margin of safety. I believe a sustained revenue 30% drop for two years will result in $4-5mm in cash bleed with some NWC capital reversal help and some cuts to the $24mm SG&A with worse case balance sheet value of $6.00 or 20% from today’s price.

 Hard to tell when the end markets will bounce back but lets say 2026 will be a peak cycle year again and the company can generate 30% more in revenues to over $75mm and produce over $1.20 in EPS (50% over last peak) on strength of recovery in Zerust as well as wider acceptance of Natur-Tec with 10-12x peak eps at $15+ $3-4 in additional cash, excluding any dividends to $19.00 or 150% from today’s price, giving me a pretty significant margin of safety for any error on my IRR.

Risks: I could probably be wrong in my worst case sce

Catalyst

-Global Economy coming back

- New products

- Any survival of domestic O&G industry would be a net positive given how the O&G revenue line is pretty profitable