Kinsman Oak Capital Partners, an investment management firm, published its “Kinsman Oak Equity Fund” first quarter 2021 investor letter – a copy of which can be downloaded here. A return of 3.7% was delivered by the fund for the Q1 of 2021, trailing the S&P 500 Index that delivered a 6.2% return for the same period. You can view the fund’s top 5 holdings to have a peek at their top bets for 2021.
Kinsman Oak Equity Fund, in its Q1 2021 investor letter, mentioned BWX Technologies, Inc. (NYSE: BWXT), and shared their insights on the company. BWX Technologies, Inc. is a Lynchburg, Virginia-based nuclear components and fuel supplier that currently has a $6.1 billion market capitalization. Since the beginning of the year, BWXT delivered a 7.85% return, extending its 12-month gains to 18.20%. As of May 14, 2021, the stock closed at $65.01 per share.
Here is what Kinsman Oak Equity Fund has to say about BWX Technologies, Inc. in its Q1 2021 investor letter:
“The Fund has owned shares of BWX Technologies for quite some time despite the stock going nowhere until the last two weeks of the quarter. We initially prepared our write-up when the discount to intrinsic value was much larger but, after some internal deliberation, we still decided to include our notes on the company because we feel the business is incredibly unique and would be of interest to our partners.
At a high level, the investment thesis for owning the stock boils down to 1) the base business is undervalued and 2) shareholders have a free option on BWXT’s nuclear medicine business. We don’t want to get too into the weeds but will provide a general overview below.
The Base Business
BWXT operates three business segments but derives the majority of revenues/earnings from its Nuclear Operations Group (NOG). This segment is the monopoly manufacturer and supplier of naval nuclear propulsion systems for the U.S. Navy’s submarine and aircraft carrier fleets. The company faces no direct or indirect competition from other entities, no substitutes exist, and the U.S. Navy cannot perform these functions internally. BWXT is the only game in town.
The other two business segments – the Nuclear Power Group (NPG) and the Nuclear Services Group (NSG) – are less valuable by comparison. The former provides services to Canadian nuclear power plants (CANDU reactors) and commercial services for other power production facilities. The latter primarily provides nuclear materials processing and site remediation services to the U.S. government.
The NOG segment possesses growth tailwinds as the U.S. government appears committed to building out their nuclear submarine and carrier fleets. BWXT will be a beneficiary of what will likely become a multi-decade fleet build. The company has already undergone a large capex cycle over the past two years preparing for growth and that spending will roll off in 2022. The free cash flow and margin profile of the business will improve quickly going forward.
We believe the BWXT deserves at least a market multiple based on its low double digit earnings growth trajectory and its impenetrable competitive moat alone. On top of that, as re-investment needs diminish, the company will have more capital allocation options at its disposal to further drive shareholder value creation. We anticipate a combination of share buybacks and strategic M&A.
Nuclear Medicine Potential
The medical isotopes division has considerable potential upside, in our opinion. BWXT entered the market by acquiring Sotera Health’s Nordion Medical Isotope business in 2018. Radioisotopes, specifically molybdenum-99 (Mo-99) and technetium-99 (Tc-99), are primarily used for diagnostic purposes. Mo-99 decays into Tc-99 which is then injected into patients and used in 80% of nuclear medicine procedures.
Medical facilities purchase generators that contain Mo-99 which decays into Tc-99 on site shortly before use. A few companies supply these generators, and the end products are relatively commoditized. Instead, the economic moat comes from how the main input material (Mo-99) is obtained. We believe BWXT has developed a highly scalable and proprietary production method for sourcing Mo-99. This differentiated technological process virtually guarantees a structural cost advantage over competitors. Further, national security considerations could allow them to take monopolistic market share.
Mo-99 is a by-product from the nuclear fission process which is where most of the supply currently comes from. Uranium (U-235) is the main input. The traditional method of production poses two drawbacks. First, the process itself is incredibly wasteful. Of all the U-235 used, only 7% becomes Mo-99 and the remaining 93% is essentially nuclear waste with no alternative use. Second, the U.S. government is the only supplier of U-235. The first drawback ensures an expensive production/disposal process, and the second creates a potential tail risk event should the government decide to stop supplying U-235.
BWXT has developed a unique approach to Mo-99 production that does not rely on nuclear fission or uranium at all for that matter. Their alternative process involves the use of a commodity industrial metal called molybdenum. Molybdenum (most commonly Mo-98) undergoes a neutron capture process, and the output is a combination of various Mo particles (Mo-96, Mo-97, Mo-98, Mo-99, Mo-100). The next step is filtering out the Mo-99 and putting only those particles into the generators sold to medical facilities.
Neutron capture solves both traditional method drawbacks. Even if BWXT’s competitors received U-235 for free, the incremental production and disposal costs are so excessive that it results in a structural cost disadvantage. Waste from the neutron capture process becomes inert within weeks and is not even considered industrial grade waste at time of disposal, whereas traditional method produces nuclear waste.
U-235 is a highly controlled substance for obvious reasons. The U.S. government has previously indicated that if Mo-99 can be supplied to the market via alternative methods, they would seriously consider reducing or eliminating the supply of U-235 for national security and non-proliferation reasons. A blue-sky scenario like this could allow BWXT to effectively take enormous market share. Only one other company called NorthStar Medical Radioisotopes is attempting to use a similar neutron capture approach but is experiencing production challenges.
According to BWXT’s Q3 2019 investor briefing, the North American TAM is estimated to be approximately $1 billion (comprised of ~$160 million for Tc-99 generators plus ~$840 million for Tc-99 cold kits). Worldwide TAM is roughly $2.5 billion (~$400 million plus ~$2.1 billion). We believe BWXT stands a reasonable chance at being one of the few players to capture meaningful North American market share in the coming years. Expanding globally will take longer but can certainly happen as well.
BWXT expects commercialization to begin at some point in 2022. The company needs to obtain FDA approval before sales can ramp which is expected to take between six to nine months. No human trials are required because Mo-99 is an existing product which leads us to believe regulatory pushback at this point is unlikely. The company has indicated they can scale enough production capacity to supply the entire North American market almost immediately after commercialization commences.”
Our calculations show that BWX Technologies, Inc. (NYSE: BWXT) does not belong in our list of the 30 Most Popular Stocks Among Hedge Funds. As of the end of the fourth quarter of 2020, BWX Technologies, Inc. was in 19 hedge fund portfolios, compared to 21 funds in the third quarter. BWXT delivered a 9.91% return in the past 3 months.
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Disclosure: None. This article is originally published at Insider Monkey.