I owe this idea to @teamonfuego. He brought it up to me a couple weeks ago. Unfortunately, I was on vacation and I was slow to the punch. As it was I ended up picking up the stock at $1.10 on average.
Liqtech has been your typical little energy technology company. They have an interesting technology but have struggled to sell it into established markets that aren’t all that interested in new ideas.
The consequence is that the stock has spent years bouncing around with no real upward momentum, every year losing money and raising capital.
What they sell
Liqtech sells a suite of silicon carbide filter products. They’ve tried to break into oil and gas, into mining, even into pools and spas. But they’ve only had moderate luck. They have a small but fairly steady business selling diesel particulate filters (around $8 million a year of revenue). Beyond that they sell a few filter systems a year but never enough to break-even on a consistent basis.
From what I can gather, their lack of success is not because of the product. The silicon carbide filter is a better product for many industrial waste/purification applications than what is used right now. But that doesn’t always guarantee a win.
The problem has been getting a foot in the door. This article, from way back in 2014 with CEO Sune Mathiesen, describes the problem that the company has had in the past:
My initial, and most important focus point was to turn the Company around from being a supplier of membranes into a supplier of complete water treatment systems. Since LiqTech started commercializing its membranes in 2009, it has proven very difficult to convince system integrators to invest time and money in developing systems around our membrane technology. The reason is simple, most engineers know how to build a system around sand filters, polymer membranes or other well-known technologies, but they don’t know how to handle our silicon carbide products.
Beginning in 2015 Mathiesen made the transition from selling membranes to selling filter systems. They began to research and invest in building a full filter assembly so they could by-pass the system integrators.
Three years has passed and the stock hasn’t exactly lit the world on fire. But they’ve been slowly built out a product line of filter systems for various applications. And now one of those applications appears about to take off.
IMO 2020 refers to new regulations from the International Marine Organization that come into effect in 2020. These regulations change the pollutant requirements of bunker fuel, reducing the maximum SO2 concentration in marine fuel exhaust from 3.5% to 0.5%.
About 60-70% of the shipping fleet uses a bunker fuel that has >0.5% SO2. The most common bunker fuel has SO2 of about 2.7%. The ships that use this fuel will have to do something about that by 2020.
The ship owners don’t have many choices. They can either switch to a more expensive low sulphur fuel or install scrubbers that clean out the SO2 from the high-sulphur bunker fuel.
The economics around fuel switching versus scrubbers is in favor of the scrubbers. Here’s a quote from Rudy Kassinger, consultant at Veritas Petroleum Services, from this article:
The cost of installing scrubbers is somewhere between $3 million and $6 million depending on the ship (though I have seen estimates that use a high-end number as much as $10 million). The payback on scrubbers can be 1-3 years. Most of the articles I’ve read peg the number at 2 years, which is not too bad.
So how does this impact Liqtech?
Liqtech filters are installed as part of the scrubber assembly.
Scrubbers can operate in open loop, closed loop or hybrid configurations. When a scrubber operates in an open-loop, sea water is used to remove pollutant from the exhaust stream. The sea water is then discharged back into the ocean.
But in harbors and in some regulated waters seawater discharge is not possible. In these areas a closed loop or hybrid system needs to be used where no polluted water is discharged.
The closed loop requires that the effluent water be filtered for re-use. This is where Liqtech filter systems come in. The silicon carbide filter is ideal for the application (in terms of durability, temperature resistance, corrosion and operating performance).
The opportunity for Liqtech is large. Each scrubber installation needs a filter. Ships require on average 1.6 scrubbers (so some need 1, some need 2). The shipping fleet is about 70,000 vessels. Some percentage of those ships will be retrofitted for filters. As well more new builds will include scrubbers going forward.
According to Goldman Sachs less than 500 ships have scrubbers installed today. Goldman estimates that by 2025 we should expect to see over 5,000 ships equipped with scrubbers. Other estimates are even higher. The IMO put out its own estimate (quoted in this WSJ article) forecasting 4,000 ships with scrubbers by the end of 2020. Liqtech said on their second quarter call that:
Analysts believe that by 2025 roughly 14,000 vessels are roughly 20% of the global fleet with have a scrubber.
Whatever the number, its meaningful to Liqtech. Liqtech sells the marine scrubber filters for about $450,000 a unit. At 1 scrubber per ship, the total addressable market is somewhere between $1.8 billion and $6.3 billion.
Liqtech has 72.7 million shares outstanding and no debt. So even after the latest run, its only a $87 million market capitalization company. The addressable market is truly multiples of the capitalization.
The obvious question is what sort of market share can they capture? Things look pretty good so far.
- In March they announced a framework agreement with “one of the world‘s largest manufacturers of marine scrubbers” for “an initial term for 2018 and 2019 and provides that more than 95 systems are estimated to be delivered”
- In April they announced a second framework agreement for “a minimum of 35 systems are estimated to be delivered during the initial term” of 2018 and 2019.
- Also in April they announced a letter of intent with “one of the world’s largest marine scrubber manufacturers”. This was extended in July. On the second quarter call they said the LOI was for 95+ systems.
On the first quarter call Liqtech said they were working with five or six of the largest scrubber manufacturers. They said on the second quarter call that they are expecting to see orders coming from other sources as well:
we believe that we see a lot of the orders in the future come directly from the shipyard operators. It doesn’t necessarily mean that — or it doesn’t mean that we’ll not see orders coming from scrubber manufacturers, it just means that I have told to several sources for orders in the future.
I’d make a guess that the 95 system framework agreement is with Yara, which is a large scrubber manufacturer. Liqtech has previously disclosed they have been working with Yara. A look at this Yara video shows a filter that looks pretty much the same as what Liqtech shows in their own presentation.
I’m not sure who the other 35 systems or the LOI are with. The list of scrubber manufacturers includes: Alfa Laval, Wartsila, Saacke, Yara, Puyier, DuPont, and Feen Marine. Liqtech has said there are 10 major manufacturers in total.
So what kind of impact is this going to have on the bottom line?
I think its going to be significant. Here are a few points to consider.
- The company says their break-even is $16-$18 million of revenue, on the sale of about ~20 filters systems for marine scrubbers
- On the second quarter call they said incremental systems sold should expect 70-75% gross margins and they have also said they expect 65% contribution margin from incremental sales
- The current expense run rate is $1.25 million per quarter
- There are $14 million of NOLs in the US and another $6 million in Denmark
I’m assuming they need to sell about 20 systems in 2019 to hit a break-even point at current run-rates. If the two framework agreements come to fruition they will sell 130 systems, heavily weighted to 2019. Let’s say they sell a total of 80, so 60 that are incremental to the break-even number.
I’m throwing in the 21% tax rate even though they shouldn’t be taxed through most if not all of 2019. Un-taxed EPS is over 23c with these assumptions.
One downside is that sales of filters to the existing marine scrubber fleet is not going to last forever. There are limits on ship-yard capacity which will extend the retrofits out to 2025. But probably some time around then (maybe sooner, maybe later depending on how things play out) the installs will taper off.
There will be continued sales from new-builds after 2025. There are 70,000 ships globally. It seems like for most markets (containerships, dry bulkers, tankers) at least 3% of the fleet is added every year. So that’s ~2,000 ships a year. On the first quarter call Liqtech said they expect to see a further uptick on the 30-40% of new-builds that are currently being built equipped with scrubbers. So the opportunity is not insignificant.
Also, by the time the retrofit opportunity is exhausted, and assuming everything plays out positively, Liqtech will have an install base numbering into the 100’s of ships.
I would expect it will be a lot easier to hock their product to big oil producers, power producers, miners, and municipal water suppliers with a resume that includes a major vertical that has accepted their filters in an extreme environment.
But that’s a long way off. For now, its enough to say that the stock is cheap if they can secure the expected number of deals from the existing framework agreements and have those agreements project forward, and it is very cheap if they can capture even more market share from other scrubber manufacturers and shipyards.
A second risk is that they start to see price pressure. They are the only provider of a silicon carbide filter but there is competition by way of centrifugal filters. Liqtech has said before they are the cheaper and better option. But as the higher volumes are borne out you have to expect competition. The margins I’m showing in the table above are admittedly very high, and unlikely to be sustainable in the long run.
A third risk is that IMO 2020 gets delayed. From everything I’ve read I don’t see this happening. But you never know.
The bigger upside is that they capture a larger share of the market. I’m assuming about 80 filters a year. The opportunity size is significantly larger (as much as 14,000 installs according to Liqtech) next 5 years.
The other upside is that I have to think it will be easier to sell into other verticals once they can come to these customers with a portfolio of installs throughout the marine scrubber industry.
Anyways, it seems like a pretty tiny capitalization for such a big opportunity. Worth a portfolio spot in my opinion.