Wednesday, July 2, 2014

Northern Technologies International - Rust Never Sleeps

Northern Technologies International (Nasdaq: NTIC $20.45) is a leading provider of anti-corrosion technology and solutions. The company mixes its formula with plastic pellets to create plastic sheets, which can then be formed into bags of various sizes. Parts are placed into the bags to inhibit vapor corrosion. The chemicals inside the bags release gases that will settle on the parts, keeping them protected. Once the bag is opened, the chemicals will evaporate. The company also sells to oil and gas companies, both to preserve flanges on ocean rigs and to safeguard oil storage tanks.

Northern Technology initially sold its products to automobile manufacturers. The company's offering is an alternative to "dipping lines," a method where car parts were coated in grease to protect them from rusting during transit and storage. Dipping tanks take up space and also present fumigation and fire hazards. Also, dipped pieces have to be cleaned off before being put to use.

Corrosion costs companies around the world roughly $300 billion per year. Of that amount, losses in the oil and gas industry total about $126 billion. Northern Technologies currently generates 9-10% of its revenue in the oil and gas sector. The company expects this business to grow faster than its core business, based on increasing demand and not much in the way of direct competition.

Nothern Technologies has two primary opportunities when it comes to the oil and gas industry. The first is protecting flanges on off-shore oil rigs. These rigs have miles of pipes that are connected by these flanges. Left unprotected, flanges generally need to be replaced in a matter of months. Rust and corrosion can  prevent the flanges from opening or closing, and a malfunctioning flange can lead to disaster in the event of an emergency. Revenue from an oil rig depends on the size of the rig and the number of flanges that can be treated. Some flanges operate at a high temperature that would compromise the corrosion inhibitor. Northern Technologies  generates about $50 in revenue for each flange it treats. Larger oil rigs can have around 8,000 flanges.

The company also treats oil storage tanks. The crude oil that's stored in these tanks usually isn't in there alone -- significant amounts of sulfur, water, and other contaminants like to crash the party. The sulfur and water can combine into hydro-sulfuric acid, that is very damaging to the tanks. It can cost a company millions of dollars per day to take a tank out of commission for repair or replacement. The company charges $25,000 on average for a tank job, but it ranges from $10,000-$100,000 depending on the size of the container.

Nothern Technologies operates with a number of joint ventures. The business model is derived from the Coca-Cola system, so the company ships the "secret ingredient" -- in this case, the chemical additive -- to its partners, and lets them deploy it in projects worldwide. There is a basic understanding that Northern Technologies will provide ongoing technical support to its joint ventures, including R&D. The joint ventures are responsible for sales and marketing in their respective territories. Northern Technologies pays taxes in the countries its joint ventures operate in, and receives foreign tax credits in the US. It is responsible for any difference between the foreign rate and the US rate.

Price negotiation can be impacted by the customer's circumstances.
In 2004, one U.S. automaker learned the value of Nothern Technologies the hard way. The automaker decided to shift to a Chinese part supplier to cut costs. The problem was that this new supplier had very little experience in shipping these parts overseas and didn't take proper precautions. The parts passed through essentially every type of climate imaginable on the route from Northern China to Detroit. The parts were useless upon arrival, and the carmaker had to have new parts delivered via air freight to prevent production lines from shutting down. The automaker wound up losing billions of dollars that year. The company then hired Northern Technologies to work with the manufacturers in China and ensure the parts could be safely shipped by sea. In this case, Northern Technologies was able to negotiate a very favorable deal, because the automaker didn't have much of a choice.

Earnings per share have increased 58.8% since 2010, from $0.51 to $0.81 in 2013. We project earnings will finish 2014 at $1.05, and we have set a 2-3 target of $2.20-$2.80 per share. Applying a P/E ratio of 20 to the midpoint of that range suggests a target price of $50 per share, an appreciation of 145% over the current price. Revenues figure to be in the neighborhood of $28 million for 2014, per the company's guidance, a 24.4% increase over $22.5 million in 2013.

Eric Ramsley

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