Flexible Solutions International: Specialty Chemicals At An Especially Good Value

Whether it's revenues that have doubled since 2016 or shrewd acquisitions that are playing out as planned, the many near-term catalysts of Flexible Solutions International (NYSEMKT:FSI) appear to have gone largely unnoticed by Wall Street. I'll break down each of these under-appreciated positives and contrast those with the unique risks that may keep investors on the sideline. Like many stocks, FSI's share price has rebounded nicely from March lows, but it still represents a compelling value under $3/share.

Valuation

Using data from the company's third quarter 10-Q filing with data for the nine months ending September 30th from 2019 and 2020:

*Income value shown in table refers to the 10-Q's "Comprehensive income attributable to Flexible Solutions International Inc."

My first takeaway is that profits year over year are subject to substantial variation, but taking into account one-time negative impacts in 2019, FSI appears capable of earning $2.5-$3 million on a typical year, and will substantially exceed that in 2020.

Forward P/E - 11.6 - Taking a conservative approach using $2.5 million of annual income, and a current market cap of roughly $29 million.

Forward EV/Earnings - 8 - Again, conservatively using current assets and total liabilities, I compute an enterprise value near $20 million.

Below we'll take a look at revenue sources, unappreciated positives, and some very real risks to form an opinion as to whether these ratios are fair or not.

Revenue Sources

Flexible Solutions derives its revenue from its own products, products of subsidiaries, and investments in complementary companies. We'll start with FSI's array of products which interestingly balance economic value to customers with positive environmental impact.

NanoChem Solutions (NCS) is a wholly owned subsidiary contributing more than half of FSI's revenue with products used in agriculture, detergents, oil & gas, and water treatment.

Thermal Polyaspartate (TPA) is a biodegradable polymer with uses in agriculture, oil & gas, irrigation, and detergents. As an agricultural product, it improves the uptake of fertilizer by plants, including nitrogen, phosphorus, and potassium, meaning farmers can produce more food with the same amount of fertilizer. It is well established in the Oil & Gas industry used to treat oilfield water to prevent pipes from plugging with mineral scale.

SUN 27 is a nitrogen stabilizer that conserves nitrogen from attack by soil bacterial enzymes. While economical for farmers on its own, it has a great environmental side effect because nitrogen protected from bacteria can't be turned into nitrous oxide by them. According to the EPA, nitrous oxide has a climate warming effect roughly 300x greater than carbon dioxide, so governments motivated by climate change may consider incentivizing or mandating use of stabilizers. Overall adoption for nitrogen stabilizers is around 25% in North America and lower globally with solid growth in all markets.

N Savr 30 is another nitrogen conservation product directed towards reducing nitrogen loss through leaching and evaporation. This is another product that can lower fertilizer costs for growers with another positive environmental side effect. Studies have shown that harmful algal blooms can result from nutrient runoff like nitrogen and phosphorus, so it's important to keep fertilizer where it's placed to prevent leaching into water supplies.

NCS's 65% ownership in EnP Investments - This $5.1 million acquisition was a natural expansion beyond row crop agriculture into the turf and golf markets with auspicious timing given golf hasn't been as negatively impacted by COVID as popular indoor and contact sports. Because EnP's revenue is fully consolidated the exact sales impact is difficult to discern, but what we do know is that 35% of EnP's profit is backed out to its minority shareholder. We can use this information plus the third quarter 10-Q filing to estimate the 65% of EnP's profit FSI is entitled to keep, is roughly $667,000. If this seems like a disproportionately high amount, remember that Q3 is seasonally strong for EnP, and this quarter was exceptionally good.

Florida based LLC - This early 2019 investment is engaged in the international sales of fertilizer additives and represents part of FSI's broader growth strategy. FSI does not have control of the company, but acquired a 50% interest in the profit and loss of the company in exchange for a ~$1 million investment and future payments of $1 million, $1 million, and $500,000 depending on EBITDA target milestones. Comparing the first nine months of 2020 vs. 2019 of the Florida LLC:

It's also worth noting that NCS manufactures a large amount of the product sold by the LLC, so there is a synergistic benefit beyond the share of profits.

Water Application Products - HeatSavr, EcoSavr & WaterSavr were and still are revolutionary products, but you should absolutely not base a bullish investment thesis off of them. These products combined represent less than 1% of FSI's sales and profit, and despite 15 years of proof that these products effectively conserve water in a safe, economical manner, governments around the world continue to balk at the opportunity. While it's possible to imagine a political shift that turns WaterSavr into the blockbuster, that in my opinion it deserves to be, my recommendation to my fellow investors is to treat profits around these products for what they are, not what you hope they could be. I'll emphasize the point with CEO Dan O'Brien's own words, "the intense difficulty of selling to governments who essentially have shown over 15 years that they are not interested in our product even though it works."

Underappreciated Positives

Tariff Recovery

Raw materials imported from China have been subject to tariffs since September of 2018, but the cost has not been passed on to international customers because FSI applied for export rebates. Unfortunately, while FSI moves at the speed of industry, the US Government moves at the speed of, well, government, and continues to report that it is working on processing the paperwork. I expect the issue will eventually be resolved, but by my estimates, this continues to negatively impact FSI's reported profits by $50,000 to $150,000 per quarter. A successful resolution could also add a $500,000 to $1 million one-time payment for past tariffs paid. Because the tariffs have already been paid, there is no potential negative to FSI's balance sheet, only upside from this issue. The only risk is that the market is already pricing in expectations that this issue will be resolved to FSI's benefit, potentially resulting in a share price drop if contrary news emerged.

Returning Dividend

Despite its small market cap for a public company, FSI has historically shown consistency in revenue, and prior to COVID, did offer shareholders a dividend payment. The company acted prudently and suspended its dividend in March 2020 in addition to reducing inventory to supplement its already strong balance sheet. FSI clearly survived the downturn with enough cash to resume the dividend, but CEO O'Brien made it clear that "the FSI Board is feeling very strongly that no resumption of a dividend should happen until that vaccine or let's be honest, maybe vaccine is never achieved, but a reliable cure for people who get sick is in place." Because FSI has the capacity combined with recent positive vaccine news, I believe it's only a matter of time before a dividend payment resumes opening up stock ownership to an entire class of shareholders that screen out non-dividend paying companies. If the dividend never returns, the company has a proven track record of putting assets to good use creating value for shareholders and customers alike.

Paycheck Protection Program Forgiveness

NanoChem Solutions and EnP Investments each received two year loans through the Paycheck Protection Program for $322,000 and $215,960 respectively. It's likely that these loans will be forgiven, but they are currently listed as long-term debts. Should the loans be forgiven as expected it would have the effect of boosting shareholders' equity by ~2% providing small, but not insignificant cash and optionality for FSI's management.

Risks

Competition - FSI's TPA products compete directly with Lanxess AG, which also uses a patented process different from FSI's. Because the two companies have cross-licensed each other's processes, either company can use either process, which I would think should mitigate risks of patent infringement. There are also competitors in Asia, and while competition could be a future problem, FSI's growth and margin don't suggest present issues. Given FSI's strong balance sheet, a larger competitor or fertilizer manufacturer may find it more lucrative to simply acquire FSI and its interests.

Cyclicality - My primary concern around cyclicality is in regard to the fertilizer additives business because additional fertilizer, subject to significant price swings, can be an economical substitute for stabilizers when prices drop. Fortunately, TPA products are cost-effective for crop enhancement, and the nitrogen stabilizers offer numerous environmental benefits. TPAs are also subject to the cyclicality of oilfield production, but given the drop in oil prices and production, a great deal of the risk in that market is already realized.

Customers - Three major customers accounted for more than 45% of FSI's sales in 2019, and while acquisitions have brought additional sales diversity, this remains a risk going forward. The loss of any one of these three customers may not be catastrophic to the company, but the impact will be material.

Key-Person Risk - President and CEO Dan O'Brien serves in many roles beyond those handled by the CEOs of larger companies and has been with the FSI since its inception. I doubt there is anyone that knows the company better, and while recent acquisitions have brought on-board some talented people, it also made FSI a more complex company. After listening to several conference calls, it's clear that Mr. O'Brien cares about the company, its mission, and its people, which could make him all the more difficult to replace should he leave for any reason.

Liquidity - This should be obvious in a micro-cap stock, but given the limited number of shareholders and volume, investors in need of liquidity, risk having to offer significantly below market prices to redeem large amounts of shares quickly.

Investment Conclusion

Flexible Solutions International Inc. is a company with a desirable array of products, undervalued positives, but some uncertainties that are likely to keep risk averse investors away. For those that can afford some risk, I'd recommend a long-term base position coupled with a tradable position to take advantage of the company's above average beta. Given the risks I'd suggest adding below $3, reducing above $4, and holding between. These values correspond to EV/Earnings ratios of roughly 11 at $3/share and 15 at $4/share. The long-term base position allows investors to participate in additional upside if growth initiatives play out or FSI sees regulatory benefit like incentivized nitrogen stabilizers or widespread adoption of its water saving products. To summarize, I recommend that risk averse investors stay away, and that better options exist for purely "buy-and-hold forever" investors. However, for active investors willing to monitor their positions, FSI share prices below $3 represent an attractive entry point.

Disclosure: I am/we are long FSI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.