Nordion (NDZ) is a health science company that provides medical isotopes and sterilization technologies. Due to fears about the future of the company's medical isotope division, the company is priced as low as just the value of its sterilization unit, providing investors with an excellent opportunity to buy the company's shares at a 25% discount and without any significant downside risk.
Business Overview & Operating Segments
Nordion used to be comprised of three distinct business divisions but sold the Targeted Therapy segment, and as of July 13, 2013, the company has only the two following segments:
Sterilization Technologies andThe Sterilization Technologies segment is focused on producing, installing and servicing Cobalt-60 (Co-60) radiation sources that are used for the sterilization of medical products as well as food and consumer products. The company not only provides its customers with the radiation devices but also supplies them with the radioactive material Cobalt-60. This segment, according to Nordion's 2012 annual results, will account for 49% of its revenue and approximately 57% of its earnings.
The Medical Isotopes segment is focused on products that are used in the diagnosis and treatment of diseases. The primary product of this division is Molybdenum-99 (Mo-99), which decays into Technetium-99 (Tc-99m), and is, according to the World Nuclear Association, utilized in approximately 80% of nuclear medical procedures worldwide. According to the same source, over 10,000 hospitals globally use radioisotopes with 90% of the procedures being for diagnosis. This segment, according to Nordion's 2012 annual results, will account for 51% of its revenue and approximately 43% of its earnings.
Competitive Advantages - Moat (examples?)
Nordion's segments, the Medical Isotopes segment and the Sterilization Technologies segment, are the dominant leaders in their respective markets and benefit from various barriers of entry that prevent new competitors from gaining access to their niche markets.
The Sterilization segment is operating under a razor-and-blade business model. Nordion sells expensive irradiation machines to its customers and then makes the majority of its profits from selling them the isotope Cobalt-60 which is necessary for operating the machines. Nordion has approximately 75% market share in the global $130 million market for Cobalt-60.
Because of the market's small size and the hurdles a competitor must overcome to enter, Nordion's revenue and market share is as safe as it gets. If a competitor decided to enter this market, they would have to convince first an operating reactor to undergo some modifications (not the easiest thing to do to a nuclear reactor) for a very small amount of profit. Supposing that they manage to do this, they should also wait for four years for the Cobalt to irradiate sufficiently before it is ready for sale.
Taking into consideration the capital expenditures needed to equip the producing reactor and the amount of time needed (which creates a huge opportunity cost) to enter this tiny market, it becomes pretty obvious that trying to enter is a highly unprofitable endeavor for any prospective new entrant.
Medical Isotopes segment has also some competitive advantages that make it very tough to compete with. The first one is geographical in nature and unfortunately will cease to exist by 2016. Nordion currently has exclusive access to North America's single source for Molybdenum-99 (Mo-99), which is the Atomic Energy of Canada Limited's National Research Universal Reactor. Competitors have to import Mo-99 from Europe, Australia or Africa and thus have a big cost disadvantage in North America, which represents 50% of the global market for Mo-99.
Unfortunately, this geographical advantage will cease to exist as by the end of October 2016 Nordion's Canadian supplier will stop producing Mo-99 due to instabilities in its more than 50-year old nuclear reactor.
The second advantage the Medical Isotopes segment has is its nuclear logistics experience and relations network. Transferring radioactive materials is no easy thing to do since it requires perfect coordination and constant communication with multiple third parties like reactors, customs, border patrol agencies, transportation vehicles, air cargo operators and many others. This logistical expertise and the vast network of established procedures and relationships is extremely difficult to replicate and customers are aware that a new entrant would have great difficulties in setting up a similar operation and matching Nordion's reliability.
The Market's Concerns
The Medical Isotopes business is also the reason Nordion has been treated so badly by the market. The uncertainty over Nordion's supply source for Mo-99 had the stock tumbling last year from $11 to a low close to $5.5. Since then, although the stock has recovered somewhat (now it's around $8.3), the company has remained well below its intrinsic value.
Don't get me wrong, the market is correct in worrying about Nordion's Mo-99 supply sources. If the company doesn't manage to find a sufficient and reliable source by 2016, then it will lose half its revenue and almost half of its earnings. While the market's fear is well-founded, there are two main reasons that I believe Nordion is an excellent investment opportunity with a highly asymmetric risk-reward profile.
The first one is that Nordion isn't sitting idle waiting for its fate to unravel. The company is already exploring alternative sources and is in talks with multiple parties that could supply in with Mo-99. Furthermore since many governments including the US strongly discourage the use of High-Enriched-Uranium or HEU, Nordion tries to move ahead of its industry by finding a source for its Mo-99 that uses low-Enriched-Uranium or LEU.
From Nordion's Q2, 2013 earnings call transcript:
Steve M. West - Chief Executive Officer, President, Director, Member of Technology Committee and Interim Chief Operating Officer of Targeted Therapies
[...] we are planning currently as far as NRU is concerned that when we get to the end of the license period in 2016 that we will no longer be sourcing HEU-moly from there. As to other options, and I have said this previously, Nordion does continue to explore other options for a sustainable, long-term supply of LEU-based moly. It's hard for me to talk about that because as you can imagine, these, again, are proprietary discussions taking place with potential partners. [...] And it's not clear as of yet how the whole supply chain will pan out when NRU comes offline. So we are, as I said, exploring a variety of options, and we'll continue to do that, noting that, obviously, as we get closer to the date of 2016, we need to get some clarity around potential partnerships. So we're actively engaged in that, and we'll continue to do so.
From Nordion's Q3, 2013 earnings call transcript:
Steve M. West - Chief Executive Officer, Director and Member of Technology Committee
[...] so first of all, I probably should have made it clear that our view is that for a credible source of supply, it has to be non-ATU based, LEU. So that is definitely a factor. We're no different to anybody else who's going -- who's looking at long-term LEU. [...] And currently to date, we should remind ourselves that still, by far, the majority of molybdenum that is on the world market is heavily enriched uranium based. And everybody is working towards a low-enriched technology base.
As you can see, Nordion is well into negotiations about founding a suitable supplier for its Mo-99. Given that it has more than two years time to accomplish this task, I believe that it is almost a certainty that the company will succeed one way or another.
Valuation
The second reason I believe that Nordion is an excellent investment opportunity is the highly asymmetrical risk-reward profile. Nordion has a rock-bottom value of at least $8 per share without its medical isotope business, and if we add it into the mix, Nordion is worth at least $10.5 per share. That is a 25% potential upside without any serious downside risk.
Nordion's $8 bottom value is justified by its huge cash hoard and the cash flow of its Sterilization segment. Nordion has $280 million of net cash or $4.5 per share, and excluding one-time items, its Sterilization segment is generating about $21.7 million of cash flows. Given this segment's powerful moat that we discussed above and the very low capital expenditures it requires, I believe that we could say conservatively that it is worth at least 10 times the cash it produces. That would add another $3.5 per share ($217 million) to Nordion's cash, raising the company's rock-bottom value to $8 per share.
Nordion's Medical Isotopes segment is contributing around to $16.2 million in cash flows, and given its similar competitive characteristics with Nordion's Sterilization segment, it should be worth at least 10 times that or about $2.6 per share. If Nordion surpasses its supplier problem, then this segment would increase the company's value to $10.5 per share. And this is without factoring any revenue growth into our assumptions.
Catalysts
There are two things that I believe can unlock Nordion's value. The first one is for obvious reasons an agreement that would ensure a Mo-99 supply for the company. And the second one is the company's annual earnings for 2013 along with the guidance for 2014. This is because at this time it will become clear to the market how much the company will benefit now that it has ended its legal battle with the AECL and finished its internal investigation. Those two items burdened the company with more that $14 million expenses in 2012 and $26 million in 2013.
Conclusion
Nordion is clear cut case where the market has overreacted and drove the company into absurdly low valuations. Although the stock has recovered some of the lost ground, there is still some room for another 25% upside before the stock reaches its fair value. While this may not seem much of a gain, we have also to take into account that due to Nordion's cash and the stable profitability of its Sterilization business, its valuation will stay at least around $8 per share. Given Nordion's current stock price of $8.5, that's a 25% potential gain for just 6% of potential downside. A pretty good deal don't you think?
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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. (More...)
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