Growth Stock
Northern Technologies
( NTIC $12.00 )
Northern Technologies is the leading provider of systems that prevent rust and corrosion while products are in transit. The company's unique packaging releases a protective vapor that protects steel and other ferrous metals from the elements. Northern Tech also sells packaging that inhibits oxidation on aluminum, copper, and brass. The packaging is removed once the products reach their final destination. The protective vapor molecules disappear within two hours, leaving a pristine final product. Northern Tech invented the technology before the turn of the century. The basic patent has expired. The company continues to hold an estimated 50%-75% of the market, though, due to superior marketing, customer service, product development, and dependability. Customers include a large proportion of the S&P 500 universe. Competition consists mainly of local operators that supply routine service at discount prices.
New products are helping growth to accelerate. Three years ago the company uncorked a liquid version of the technology, designed to coat the bottoms of large oil and gas holding tanks. Many of those tanks are in harsh climates (Louisiana), and are subject to high temperature, humidity, and salt in the air. Energy companies have relied on various tricks to slow the rusting process. Northern Tech's process appears to offer a superior solution, one that lasts longer, performs better, and involves less ongoing maintenance. Several customers have tested the technology. Adoption has been slowed by generally low energy prices, crimping discretionary cash flow. A positive record of success has been established. Sales are believed to have jumped in the latest quarter. Further gains are possible in upcoming periods.
A different energy application promises additional leverage. A similar coating has been developed to protect pipelines that move oil and gas around the country. The potential market could be huge. To start with the new liquid coatings probably will be used to reinforce key elements, like stanchions; and in unusually harsh climates. Field testing is underway. Commercial roll outs could begin in the coming fiscal year (August). Even a modest level of adoption could yield a meaningful contribution to the company's financial performance.
Northern Tech stumbled across a completely different product line a decade ago - compostable plastic. It was a science project until a few years ago. The business now has reached an inflection point. Revenue is booming. Margins are expanding. New markets are opening up, fueled by declining costs and environmental regulation. And with the breakdown of the U.S. recycling industry, an almost limitless opportunity is emerging. The company manufactures a range of plastic products, from utensils and plates to packaging and garment covers. While 98% of all the plastic that's recycled in the U.S. today goes into landfills or is incinerated, composted plastic returns naturally to the earth . The critical raw materials are plastics derived from corn and cellulose. Costs remain higher than conventional plastic. But the gap is closing. Experience and economies of scale are bringing costs lower and creating new possibilities.
President Trump briefly disrupted the progression. Northern Tech imports most of its key bio-plastic materials from China. Tariffs were set at 10% last year, then 25% more recently. Northern Tech has been unable to pass through that large of an increase to its customers. So margins will be reduced in the third quarter (May), and probably again in the August period. Lucky for Northern Tech, two years ago the company joined forces with an Indian entrepreneur who discovered the operation's sweet spot. He now owns 10% of the bio-plastic business. Production is being relocated from China to India to avoid the tariffs. Automation is likely to reduce costs further. Most of Northern Tech's competitors still depend on Chinese sources for their raw materials. The market is expanding so rapidly that competition isn't a major concern right now. But the move to India will provide an enduring cost advantage. It also might facilitate acquisitions down the road, of competitors with good customer relationships who can't compete on cost any more.
Earnings widened at a 51% pace over the last three years to $.83 a share. Reported revenue climbed at a 19% annual rate to $51.4 million. Northern Tech conducts most of its international business through a network of 50% owned joint ventures. The company recognizes its share of earnings from those ventures, but revenue isn't consolidated. The ventures produced $120 million in combined revenue in fiscal 2018 (August). Northern Tech's share of that was $60 million. Only the $51 million generated by the company's U.S. and other 100% owned subsidiaries appear in the official financial statements. All of the income generated by the joint ventures is shown, however. Those ventures represent more than half of Northern Tech's entire business income. About half of the venture income is retained by the partnerships. The other half is paid out as inter-company dividends. Reported taxes appear low at 15%. Again, income taxes paid by the ventures aren't consolidated. They don't appear on the financial statements. Altogether, Northern Tech pays taxes at an appropriate rate.
Growth has moderated in the current fiscal year. U.S. auto sales have slipped, impacting domestic results. International trade also has slowed, due in part to the tariff related trade battles. Two years ago Northern Tech ended its joint venture in China, moreover, starting up a 100% owned subsidiary instead. That move promises to earn far more in the long run. But start up costs and cheap competition have impacted performance so far. We estimate earnings will rise 14% in the current year to $.95 a share, fueled mainly by the bio-plastics business.
Bio-plastics and oil and gas coatings promise to re-charge growth in fiscal 2020 (August). Faster and more profitable growth in China could amplify performance. Less turbulent trade disputes could support a resumed expansion in world trade, as well. Foreign results are denominated in foreign currencies. The U.S. Dollar's ascent over the past three years has lowered the translation value of those operations. A pick-up in Europe and Asia might reverse the currency trend, enabling Northern Tech to convert foreign earnings at a higher rate. Assuming no benefit from those external variables, we estimate earnings will improve 16% to $1.10 a share.
In 2-3 year earnings could attain $1.30-$1.70 a share. Applying a P/E multiple of 20x to the midpoint of the range suggests a target price of $30 a share, potential appreciation of 150% from the current quote. Accretive acquisitions in the bio-plastic business might underpin a stronger showing. A breakthrough in the oil and gas segment would engage further momentum. Northern Tech already pays cash dividends to its shareholders that are approximately 25% of reported earnings. That payout ratio seems likely to be maintained. Limits are advised when placing orders.
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A different energy application promises additional leverage. A similar coating has been developed to protect pipelines that move oil and gas around the country. The potential market could be huge. To start with the new liquid coatings probably will be used to reinforce key elements, like stanchions; and in unusually harsh climates. Field testing is underway. Commercial roll outs could begin in the coming fiscal year (August). Even a modest level of adoption could yield a meaningful contribution to the company's financial performance.
Northern Tech stumbled across a completely different product line a decade ago - compostable plastic. It was a science project until a few years ago. The business now has reached an inflection point. Revenue is booming. Margins are expanding. New markets are opening up, fueled by declining costs and environmental regulation. And with the breakdown of the U.S. recycling industry, an almost limitless opportunity is emerging. The company manufactures a range of plastic products, from utensils and plates to packaging and garment covers. While 98% of all the plastic that's recycled in the U.S. today goes into landfills or is incinerated, composted plastic returns naturally to the earth . The critical raw materials are plastics derived from corn and cellulose. Costs remain higher than conventional plastic. But the gap is closing. Experience and economies of scale are bringing costs lower and creating new possibilities.
President Trump briefly disrupted the progression. Northern Tech imports most of its key bio-plastic materials from China. Tariffs were set at 10% last year, then 25% more recently. Northern Tech has been unable to pass through that large of an increase to its customers. So margins will be reduced in the third quarter (May), and probably again in the August period. Lucky for Northern Tech, two years ago the company joined forces with an Indian entrepreneur who discovered the operation's sweet spot. He now owns 10% of the bio-plastic business. Production is being relocated from China to India to avoid the tariffs. Automation is likely to reduce costs further. Most of Northern Tech's competitors still depend on Chinese sources for their raw materials. The market is expanding so rapidly that competition isn't a major concern right now. But the move to India will provide an enduring cost advantage. It also might facilitate acquisitions down the road, of competitors with good customer relationships who can't compete on cost any more.
Earnings widened at a 51% pace over the last three years to $.83 a share. Reported revenue climbed at a 19% annual rate to $51.4 million. Northern Tech conducts most of its international business through a network of 50% owned joint ventures. The company recognizes its share of earnings from those ventures, but revenue isn't consolidated. The ventures produced $120 million in combined revenue in fiscal 2018 (August). Northern Tech's share of that was $60 million. Only the $51 million generated by the company's U.S. and other 100% owned subsidiaries appear in the official financial statements. All of the income generated by the joint ventures is shown, however. Those ventures represent more than half of Northern Tech's entire business income. About half of the venture income is retained by the partnerships. The other half is paid out as inter-company dividends. Reported taxes appear low at 15%. Again, income taxes paid by the ventures aren't consolidated. They don't appear on the financial statements. Altogether, Northern Tech pays taxes at an appropriate rate.
Growth has moderated in the current fiscal year. U.S. auto sales have slipped, impacting domestic results. International trade also has slowed, due in part to the tariff related trade battles. Two years ago Northern Tech ended its joint venture in China, moreover, starting up a 100% owned subsidiary instead. That move promises to earn far more in the long run. But start up costs and cheap competition have impacted performance so far. We estimate earnings will rise 14% in the current year to $.95 a share, fueled mainly by the bio-plastics business.
Bio-plastics and oil and gas coatings promise to re-charge growth in fiscal 2020 (August). Faster and more profitable growth in China could amplify performance. Less turbulent trade disputes could support a resumed expansion in world trade, as well. Foreign results are denominated in foreign currencies. The U.S. Dollar's ascent over the past three years has lowered the translation value of those operations. A pick-up in Europe and Asia might reverse the currency trend, enabling Northern Tech to convert foreign earnings at a higher rate. Assuming no benefit from those external variables, we estimate earnings will improve 16% to $1.10 a share.
In 2-3 year earnings could attain $1.30-$1.70 a share. Applying a P/E multiple of 20x to the midpoint of the range suggests a target price of $30 a share, potential appreciation of 150% from the current quote. Accretive acquisitions in the bio-plastic business might underpin a stronger showing. A breakthrough in the oil and gas segment would engage further momentum. Northern Tech already pays cash dividends to its shareholders that are approximately 25% of reported earnings. That payout ratio seems likely to be maintained. Limits are advised when placing orders.
