Description

Northwest Pipe Company (NPWX) offers good current value and an exceedingly bright future. Their business is manufacturing welded steel pipe through two businesses: Water Transmission and Tubular Products. Although their business may not sound that exciting, they are entrenched comfortably in an industry in which their customers (namely municipalities and water districts) desperately need and are going to require a massive amount more of the company’s products for a very long time to come.

A lot has been written about the state of the water crisis that is occurring not only in the US but also worldwide. Water infrastructure is dilapidated in many parts of the U.S. and according to a recent article in Barron’s, ”In the U.S. alone, some studies suggest, as much as $1 trillion is needed over the next 20 years to upgrade and replace the nation's aging and deteriorating water infrastructure. While the Bush Administration is unlikely to treat proposals for $50 billion a year in spending kindly, there's no doubt that, over the long term, the country will have to improve its crucial water systems and undertake some big projects. And in many areas of the world outside the developed lands, the need for improved water systems is similarly pressing, and sometimes far worse.”

I encourage everyone to read the cover story from Barron’s dated March 5, 2001, “Precious Liquid.” Investment in the water industry has proven to be very lucrative over the years. What other industry has such a profound and captive client base? Fresh water is an essential natural resource for which there is no substitute. As such, demand is highly inelastic - history has shown per capita consumption to steadily expand regardless of price increases. Simple economics therefore tells us that exponential population growth across the globe will result in consistent, substantial price and demand increases in the foreseeable future. Moreover, what would be the last thing a consumer would stop purchasing if we hit a severe recession? Water, of course. If you think the energy and oil crisis’ we have experienced recently are bad, it would be nothing compared to a situation where people’s water sources were cut off.

The leader and ONLY national manufacturer of pipe for water transmission is Northwest Pipe. The primary customers for Northwest Pipes’ products are installation contractors for projects funded by public water agencies, including states, municipalities and water districts. The Company's plant locations in Oregon, Colorado, California, West Virginia and Texas allow it to efficiently serve customers throughout the United States, Canada and Mexico. Most of the Northwest Pipes’s water transmission products are fully engineered, large diameter, high-pressure water transmission lines. Other uses include pipe for piling and hydroelectric projects, wastewater transmission and treatment plant piping. The pipe business is not an ease of entry business. Large capital outlays and expertise are required to commence business. In that regard, Northwest Pipe has built a rather sizable moat around it. If a larger company wanted to penetrate the water infrastructure business in a quick and big way, they would have to go through Northwest Pipe to get there either through partnership or takeover.

On a valuation basis, the company looks very compelling. At $13.875 per share, the stock is trading at 8.5x TTM Earnings, 0.85x Book Value, 4.7x Cash Flow, and 0.33x Sales. With TTM earnings at $1.62, the analyst’s forecasts for 2001 and 2002 are $1.77 and $2.10, respectively. Their historic EPS growth rate has been 26% and the profit margins have averaged about 10.5%. They do however have a notable amount of debt with a D/E ratio of 1.21; however, if you look under the hood and see why they have that debt, it is justified. They secured the credit agreement a few years back in order to get the capital to become the dominant company in this space. Solvency has not been an issue since securing the credit agreement. The annual operating income for the 12 months ending 09/30/00 was $30.0 million while the amount due (principal and interest) on the note was only $15 million. This financing has led to the largest contracts in the company’s history and the contracts continue to get larger and larger. On January 31, 2001, Northwest Pipe Company reported that it has received a letter of intent to supply approximately $30 million of steel pipe for the City of Irving, TX, project, and their largest to date.

Insiders own 43% of the company and 71% is owned by institutions, almost exclusively value funds.

Catalyst

Northwest Pipe is the only national company in the manufacturing of pipes for water transmission. The water districts and municipalities are facing a future of building not only new infrastructure, but also massive repairs of old infrastructure. Estimates show that this could equal $1 trillion dollars over the next 20 years. The company is positioned nicely to supply this new pipe as needed. Furthermore, the stock currently trades at very attractive multiples and could be a likely takeover target for a much larger company.