FSI - Flexible Solutions International Is An Opportunity At These Prices (Rating Upgrade)

Summary

• Flexible Solutions International manufactures polyaspartic acid and has enjoyed protection in the U.S. after a tariff was levied against Chinese imports.
• The company has shown 18% compounded bottom line growth since.
• Despite the growth, the company's management has shown conservativeness and has not invested in extra capacity.
• The company recently announced the cancelation of a merger deal that would have been very negative for current shareholders.
• Trading 20% below my previous hold recommendation price, I consider FSI to be a value now.

Flexible Solutions International ( FSI ) is a manufacturer of polyaspartic acids, a biodegradable chemical used in water and agriculture systems.

Since the U.S. imposed tariffs on aspartic acid imported from China, FSI has been growing in revenues and net income. The company has also proven relatively conservative debt and capital allocation policies.

In a previous article from April 2022, I did not recommend FSI because I did not know if recent net income growth was sustainable. Further, the company was trading at a $50 million market cap, against today's $40 million. In a subsequent article from August 2022, I also avoided the stock, this time because the company was proposing a diluting arrangement with a startup company called Lygos. The week the deal was terminated, the stock climbed 100%.

In this review, I find the company continues growing profitability and revenues. Despite this, its stock price has not returned to April levels. The company trades at a P/E ratio of 10x based on FY22E earnings. Additionally, the company's more branded water protection product generated an operating profit for the first time in years. At these multiples, and considering the growth of the past five years, I consider the stock a buy.

Note: Unless otherwise stated, all information has been obtained from FSI's filings with the SEC .

Business description

TPA manufacturer : FSI manufactures and sells thermal polyaspartic acids. The material is polyaspartic acid, and thermal is the method used to obtain it from aspartic acid, a raw material imported from China. Although the product is a commodity, FSI enjoys certain protection because of its proprietary manufacturing process. Its biggest competitor in the U.S. is Lanxess ( OTCPK:LNXSF ), a much larger spin-off of Bayer.

The trade war with China created an opportunity : Competition from China was thwarted when the U.S. imposed tariffs in 2018 and 2019. Since then, the company has been gaining market share steadily.

The company is not very competitive outside of the U.S. One indication of this is that its associate in Florida, dedicated to exporting the product, generated an operating loss because it has not been able to co-locate the product at adequate margins. FSI sells to this associate at arm's length.

Conservative capital allocation : With the failed merger with Lygos put aside (more on this later), FSI's management has not shown aggressive acquisition strategies.

Relative low debt : The company currently owes $7.5 million in debts. $2 million come from a credit line paying the prime rate plus 1% (about 6.25% as of September 2022 ). Another $2.8 million come from a 10 year loan paying 4.5% (maturing 2030) and $1.8 million paying 2.25% (maturing 2025). Against these, it holds $4.5 million in cash as of 3Q22.

Higher taxes than the U.S. : Although the U.S. corporate income tax rate is 21%, and most of the company's sales and all of its operations happen in the U.S., FSI is located in Canada. For this reason, it pays higher income taxes, averaging 30%. The company is not clear in this respect and shows a 'U.S. statutory income tax rate' of 30% on its financial statements, which makes no sense, given that the rate is 21% in the U.S.

Recent developments

Merged with Lygos canceled : FSI announced its intention to merge with Lygos in April 2022 . Lygos is a tech startup trying to develop a synthetical process for aspartic acid, the main raw material behind TPA, today coming mostly from China.

Lygos is a very early stage company, spending $10 million in R&D per year and with no revenues. This would completely change the profile of FSI, from mature and profitable to early stage and very unprofitable. It would also be a very bad deal, because 66% of the shares of the combined entity would belong to Lygos' shareholders, and only 33% to FSI's shareholders. FSI was also planning to take on $160 million of debt, convertible into $250 million in shares. It was an absolutely bad decision. Since the announcement, the stock slip down significantly.

Then in September, FSI announced that it was canceling the merger . The week the deal was canceled the stock climbed 100%. FSI still holds a $500 thousand interest in Lygos, much smaller yet much more conservative.

Revenues and profits continue growing : I was wary last year that the record earnings shown in 2021 were another example of a pandemic induced boom that would bust. However, the company's revenues and profits have continued their slow ascension into 2022. Their trend is slower than the booms generated after 2018 when tariffs were imposed on Chinese imports.

The water protection segment generates a small profit : FSI has a small segment called 'Energy and water conservation products' that has generally run a deficit. The exception was the 2017-2019 period, during which the segment showed a profit because its manufacturing facility in Canada was destroyed by fire and the company received payments from the insurer.

The segment manufactures chemical products that can be added to water bodies (a lake, a water reservoir, or a swimming pool) to reduce evaporation, and therefore save water. The segment generated a legitimate operating profit for the first time in 3Q22 , of $70 thousand on $180 thousand in sales. Small, but at least it is not running a deficit.

Valuation

FSI has generated net income below $4 million on operating profits marginally above $6 million. This year, the company has already generated $5.8 million for the 9M22. However, FSI usually runs an operating deficit in the fourth quarter, caused by higher operating expenses, probably related to more sales abroad.

This means that trading at a current valuation of $40 million, the stock trades at a multiple to expected earnings of 10x. Not specifically cheap. However, adding the growth in net income seen in the past four years, the story changes completely. FSI has been growing net income at a compounded rate of 17% for the past five years.

Conclusions

FSI is a growing business, backed by the ongoing trade war with China. The company has low debt, and cash holdings for half of that debt. Conservative capital allocation has meant not expanding production in ways that could oversupply the market. Some additional value enhancers would be a more profitable water protection segment, and moving the company to the U.S., where it already makes most of its profits, paying lower taxes.

While the company trades at a P/E ratio of 10x, it has shown growth of 17% per year compounded for the past five years. In my opinion, at these prices, it is a buy.

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