Tired of surefire investing opportunities in Central Asia? No interest in dominant ketchup manufacturers that may have cut costs too far? Just looking for a decent ROE business at a low valuation in a sensible locale with a solid balance sheet? Look no further: I bring you Natural Alternatives International (NAII)!
NAII is located in sunny Southern California. It has two somewhat-related business lines in the healthcare space: contract vitamin manufacturing and an intellectual property portfolio around the naturally occurring amino acid beta-alanine.
Contract manufacturing takes place in two facilities, in Carlsbad CA and Manno Switzerland. We have visited the facility in Carlsbad and found it to be tidy and well-managed. They can track forwards and backwards throughout their supply chain. For example, if a supplier says that one of their ingredients has a problem, they can determine in exactly which bottles it ended up in; conversely, if one of NAII’s products has a problem, they can determine exactly which batches of ingredients went into the bottle. They are approved to manufacture for the American, Canadian, European, Australian, New Zealand, and Asian markets. The Swiss facility manufactures the bulk of the products for non-US markets.
To get the negative on the table straight away, they have a major customer concentration issue: 54% of sales in the last six months were to a single customer (Juice+). They have a complex relationship with this customer, which has a multi-year agreement for manufacturing and in exchange has been given a meaningful block of stock (vesting over the agreement). Juice+ has also been buying shares in the open market. Management has had some success in growing other customers (most notably Kaged Muscle) and clearly is making efforts in this direction. On the other hand, Juice+ has had a long history of growth, which is obviously attractive as well.
NAII’s second line of business, centered on the amino acid beta-alanine, is called CarnoSyn, and accounts for approximately 1/8th of sales; of note, margins are higher. This is a substance that helps muscle growth and has proven popular in the body-building community. NAII has developed two varieties of beta-alanine: CarnoSyn (the original) and CarnoSyn SR (sustained release). The original has less protection (e.g. the key patents are older); the SR version was introduced recently. Patent law in this area can be difficult because the substances occur naturally, instead of being purely artificial. This has the unfortunate effect of disincentivizing research into the area, but NAII does what it can. For example, NAII has recently gotten CarnoSyn to be considered a “New Dietary Ingredient” from the FDA:
The original product has some side effects that seem to me to be unpleasant: a tingling sensation; one of the advantages of the SR product is that you can get the same dose without the side effect. However, body builders seem to like the original because “they can feel it working”. Go figure. However, NAII hopes that the SR product will be able to find a market in the “healthy aging” segment, since retirees don’t care for tingles. Here are some press releases NAII has put out in the past few months on this effort (it should be noted that NAII does not typically issue many press releases; accordingly, we conclude that management is very excited by the potential):
In our opinion, if NAII is successful here, the rewards could be quite substantial – more than the current value of the company. There are a lot of seniors, and past the age of 50 muscle loss tends to accelerate. Happily, as the material on valuation below makes clear, one isn’t really paying for this option, so it is a bit of a “heads I win big, tails I stay the same” situation. The balance sheet is pristine – too pristine, in some sense. The company has $30mm in cash (about $4.32 / share) and no long term debt. We think that some of the cash may be used to make an acquisition and/or to help with the popularizing Carnosyn SR for the healthy aging community. We wish they would also buy back stock and/or pay dividends, but to date buybacks have been modest and dividends nonexistent. We’ll see what NAII eventually does with the cash. It doesn’t take a genius to realize NAII is cheap. Earnings per share in the last 6 months (the company uses a June 30 fiscal year) were $0.68. Accordingly, at around $11.25 per share, one is paying 5-8x earnings, depending on how much credit one gives to the cash. Returns on capital are decent – low teens – despite the cash drag. Sales are growing nicely on the contract manufacturing side (up 21.7% in the 1H, although the customer concentration issue is a factor to consider) and there is the potential for a major winner if Carnosyn SR breaks into the healthy aging market.
You can learn more about NAII from EDGAR and their website: http://www.nai-online.com/
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.