Description

Background:

Northwest Pipe (NWPX) has been written up twice previously. Once back in 2001 and more recently in August 2019. I direct you to Dr1004’s terrific writeup of the company from 2019 as it provides a good history and background of the company and explains the compelling prospects for the core, legacy steel transmission pipe.

As a quick summary, Northwest Pipe is the largest manufacturer of engineered steel water transmission pipeline systems in North America. It has historically operated in the water-transmission pipe business (except for a short period when it operated in the oil & gas pipeline industry). In 2018, Northwest Pipe acquired its main West-Coast competitor (Ameron Water), and now occupies a dominant space in the steel-pipe water-transmission market share of 50% of the market for steel-water pipe. It has two competitors in this space (Thompson Pipe and American Spiralweld) and the three companies pretty much represent an oligopoly in the industry.  Northwest Pipe dominates the west coast and American Spiralweld dominates the east. Thompson Pipe focuses on the center of the country though does work on either coast. Accordingly, Northwest Pipe has an incredibly strong market position (bordering on monopoly) for West Coast water-transmission jobs. It currently has a robust backlog of projects throughout the West Coast while also maintaining a large market share in Texas and other central regions.

As mentioned in the previous write-up, Northwest Pipe has a Project Tracking System that it relies on to track all major jobs at various stages--conceptual, approved, in-bid, and in-construction. This system allows Northwest Pipe to keep a clear view on the project pipeline and allows for early discussions with contractors and water authorities at each stage of the process.

Both times Northwest Pipe was written up previously, it traded at ridiculously low multiples. This write-up continues that trend in recommending Northwest Pipe when it is trading at a bargain.

Opportunity

Northwest Pipe remains dirt cheap, particularly for a company with 50% market share, massive barriers to entry, and only 2 material competitors. Northwest Pipe has remained inexpensive, in part, because of its industry limitations. Northwest Pipe has a two-prong growth strategy of (1) improving margins in its steel-pipe business and (2) expanding beyond its traditional legacy market into other, complementary channels in the water-delivery space.

Northwest Pipe is making progress in its first prong, but the prong has limited legs. At 50% market share, there is not a ton of space for organic growth or acquisition. Recognizing this limitation, Northwest Pipe has increasingly implemented lean manufacturing and has improved its internal cost structure. While welcome, these improvements are not going to materially move the needle for the company. As a going concern, however, Northwest Pipe is cheap; it has a tremendous backlog of work (over $200M in backlog); lineup of upcoming projects that are either in the bidding or procurement stage; and the potential for industry expansion through increased focus on long-neglected and failing water-infrastructure projects. Indeed, we think that the recently passed stimulus bill and infrastructure aspects could start up some nice catalysts for Northwest Pipe.

On January 31, 2020, Northwest Pipe began to execute on this new strategy and acquired Geneva Pipe Company. Geneva is Northwest’s first entrée into the precast concrete pipe sector. Precast pipe is another vertical in the water-delivery ecosystem. Whereas large-diameter steel pipe is used in water transmission, smaller-diameter precast concrete pipe is used in municipal storm water, storm sewer, irrigation, and similar segments. Although fundamentally different products, municipalities and water authorities are the largest end purchaser of both segments (though different contractors--steel pipe--and subcontractors--precast concrete--are direct purchasers of the products).

The goal of the precast pipe business is to expand into an area where end-purchasers (municipalities and water authorities) are familiar with the company and allow Northwest Pipe to further integrate along the water-delivery ecosystem. The precast pipe market is dramatically larger than the transmission steel business. Transmission steel market is between $450M-$600M (of which NWPX has 50%); whereas the precast concrete market is $3.5B-$5B.

The precast market is also a more fractured industry making it an area that is ripe for a well-capitalized participant with know-how to begin geographically consolidating the industry. There is only one analogous competitor in the space--Forterra (FRTA).

We think that Geneva is a strategic play to kick off Northwest Pipe’s concrete pipe and precast operations. Geneva has three manufacturing facilities across the state of Utah--Salt Lake City, Orem/Provo, and St. George. These are each rapidly growing markets, and St. George provides a strategic access point into the Las Vegas market--which is just a 90 minute drive down I-15. These growing population centers have contributed to the 4-4.5% CAGR within Geneva, and we believe that should continue for the foreseeable future. Indeed, Geneva’s primary market (Utah) leads the country in both organic growth (number of babies) and relocation growth. This natural market growth provides a nice backdrop for continued organic growth at Geneva. 

Northwest Pipe paid $49.4M for Geneva which was based, in part, on Geneva’s 2019 revenue of $43M and based on EBITDA margins in the “mid-teens.” Thus, Northwest Pipe paid a multiple of about 1.15 TTM sales and around 7.5x TTM EBITDA. We now have 9 months of operations to begin to analyze Northwest Pipe’s strategy and whether this is indeed a transformative strategic extension into a new product offering that can grow, or whether the concrete pipe play was merely a poor allocation into an area that will merely add in a conglomerate discount overlay.

According to the Q3 10-Q, Geneva contributed $32.9M in sales for the first 3 quarters of 2020. This is consistent with our estimates of Geneva’s 2019 operations and was a key contributor to Northwest Pipe’s success this year. Northwest Pipe’s steel business was hampered by COVID (due in part to a mandatory shutdown of its Mexico manufacturing facility), but the precast business continued along in pretty much the same manner as pre-COVID. Margins have also expanded this year which further evidences the accretive nature of the Geneva business. The legacy business operates at around 20% gross margins; whereas the precast business has been a few bps above that.

The next step in bearing out the thesis will be seeing whether Geneva proves to be a one-off business that is a nice addition to the company, or whether Northwest Pipe will be able to use Geneva as a base platform for additional acquisitions. Northwest Pipe is financially poised and unlevered to allow it to add market share in the precast market even after the Ameron and Geneva acquisitions. Northwest Pipe has $14.6M in outstanding debt. It has robust liquidity, however, with $30M of cash on its balance sheet and immediate borrowing capacity of another $55M under its existing borrowing lines--giving it $85M of immediate liquidity. This liquidity would allow Northwest Pipe to acquire two more Genevas without having to source additional debt or amend its existing debt covenants.

Valuation

Direct comparisons are challenging given that there are no public competitors in the legacy steel-transmission pipe business (see again the persuasive write-up from Dr1004 on this point). Although not a perfect analog, Forterra presents the closest competitor--though its precast business is significantly further along than Northwest Pipe’s. Forterra also makes for an interesting comparison because although it does not compete in the steel pressure pipe business, it does produce ductile iron pipe (“DIP”), which is also used in water transmission (and with similar market dynamics to the transmission steel business) and thus not a bad proxy for Northwest Pipe’s steel business. Forterra’s precast business in more developed, however, and it has a product mix more evenly split (44/56% DIP/precast concrete, respectively) than Northwest Pipe’s current split of roughly 85/15% steel/precast.  

Across every metric, Forterra (which is a bargain) makes Northwest Pipe look like an absolute steel. As an aside, Forterra was also written up recently and persuasively in October. We agree that Forterra remains undervalued and is attractive. We think, however, that Northwest Pipe is even more undervalued and presents a compelling growth opportunity with similar margin-expansion opportunities. The following table demonstrates the TTM multiples of NWPX v. FRTA:

Northwest Pipe is also carrying significantly less leverage than Forterra. Forterra has leverage ratio of around 4.0x EBITDA (which has been coming down); whereas Northwest Pipe has de minimis leverage--with long-term debt less than cash on hand. Indeed, we would like to see Northwest Pipe take on some additional debt as it builds out its precast business.

Northwest Pipe generated TTM EBITDA of $43.1M. Using an EBITDA multiple of 10.2 would give a valuation of $440M (or 161% above the current EV of $272M). Again, this is based on trailing earnings and does not price in any of the growth catalysts, margin expansion, or external catalysts.  

Northwest Pipe also printed money over the past year generating free cash flow of $52.46M over the trailing 12 months for a cash flow yield of 18.16%. We are not optimistic that Northwest Pipe will be able to continue a yield at that rate (its legacy pipe business is notoriously lumpy), but it provides a sense of the business’s potential cash flow generation.

Finally, we believe that 2021 is set up to be a banner year for Northwest Pipe. Many of the legacy projects scheduled for 2020 were delayed and pushed back into 2021. Northwest Pipe had forecasted a solid 2021 before these projects were pushed into 2021; with these delayed 2020 projects and the existing scheduled 2021 projects, 2021 may produce legacy production not seen for many years. Additionally, Geneva Pipe continues to grow and should be able to continue to produce improved margins; thus, 2021 (without any other catalysts) could have record sales, margins, and profits.

Management Team

Northwest Pipe has an impressive management team led by CEO Scott Montross. He has 20+ years’ experience in the steel business and was a key driver for the Ameron acquisition and in seeking out Geneva Pipe. Aaron Wilkins took over the role of CFO after Robin Gantt chose to retire. Aaorn was the VP of Finance and Controller until he took over from Robin. Robin remained in an advisory role, and we think that Aaron will continue in the same vein as Robin but with perhaps some additional encouragement to take on some strategic leverage.

We’ve spoken with the management team and are impressed with the group and are also impressed with the Geneva Pipe team and believe that they are a good fit. Mike Wray heads up the precast operations and is a legacy Northwest Pipe employee but with some history in the precast business. He also has deep ties to the Utah marketplace, which allows for a smooth transition for Geneva Pipe. The Geneva Pipe team largely came over during the acquisition and seem to be happy with the direction of the company. From speaking with management, the existing precast team seems well positioned to take on material acquisitions and could see additional synergies and margin expansion with acquisitions.

Additional Catalysts

In addition to a general re-rating, the potential for strategic West-Coast roll-up of the precast concrete pipe business, there is significant opportunity as long-awaited, long-needed, and long-promised infrastructure bills continue to come to fruition. We view these as increasingly likely with the Biden administration. As with any small-cap there is also the opportunity for increased analyst coverage and institutional buying. Currently, only two sell-side analysts cover the company--D.A. Davidson and Northland Securities. The company is looking to increase its coverage and could certainly improve its investor relations. As it stands now, Northwest Pipe does not have any contact on its website for investor relations questions.  

Bear Case

·         The primary bear cases is that its legacy business will be disrupted by a competitor outside the oligopoly. We do not view this as a likely event, but it is possible.

·         Dramatic slowdown in the precast concrete business or failed M&A in the precast space.

·         Failure to fund water-infrastructure projects in the future (extremely unlikely).

Catalyst

• General re-rating based on existing multiples
• Increased sell-side coverage
• Margin expansion from new industry of focus
• Continued M&A
• Long-awaited and promised infrastructure bill