I'm not sure whether John Maynard Keynes, the father of Keynesian economics and an ardent proponent of government interventionism during hard economic times, and Rachel Carson, the mother of modern environmentalism and the author whose work is credited for the eventual creation of the EPA, ever met during their lifetimes. But if current voter sentiment holds until November 4, their ideas could soon converge and form the basis of government policy for at least the next four years. Let me explain.

First, John Maynard Keynes. There is no doubt that the deliberate and coordinated nationalization of financial services institutions across the West marks a new low for neoconservative economic thinking. This line of thinking holds that government should play as small a role as possible in the economy, and leave spending decisions to individuals and firms. Proponents of this philosophy argue that the best fiscal move a government can ever make is to return money to its citizens and corporations through tax cuts, who will then spend that money most efficiently. The Keynesian approach, on the other hand, is premised on the idea that it is not only OK but even desirable for governments to step in and directly incur large expenditures in difficult times to jump-start the economy.

Until the credit crisis hit, the Keynesian view had all but disappeared from Washington, and small and unobtrusive government was all the rage. However, in the wake of the economic and financial havoc wrecked by what many view as too much withdrawal of government from the economy, it appears as though its has become politically-acceptable for American lawmakers to overtly push for a more activist state. What form will this take, according to proponents? In old Keynesian fashion, large-scale infrastructure investments to create jobs and kick-start aggregate demand. While it is not especially surprising to hear academics argue for this form of government intervention, it's quite something to see Democratic politicians so emboldened by recent polls that they feel they can safely write about it in op-eds. The current crisis, it appears, has cast serious doubts in the minds of a growing number of voters on the ability of the free market to deliver wealth and well being for everyone, thus setting the political stage for a return to a more interventionist state in America.

Second, Rachel Carson. Obama's environmental credentials are strong to be sure. He has remained steadfast in his support of clean energy as a cornerstone of his broader energy policy, even in the face of overwhelming public support for domestic drilling and falling fossil fuel prices. It is therefore no wonder that in cleantech-addicted Silicon Valley, generally a place where big government is seen as a break on innovation and entrepreneurship, a number of high-profile VCs and their employees are supporting Obama. AltEnergyStocks.com officially endorsed Obama last week specifically for his credentials on alternative energy and energy efficiency. While some of Obama's motivations for being in favor of clean energy have to do with energy independence and economic development, it is fair to say that he is also strongly motivated by his own environmental values and his belief that climate change must be addressed.

What does this all mean for investors? As the macro-economic consequences of the credit crisis continue to spread, I expect an Obama victory to result in some form of an activist government strategy to boost employment and the economy. This activist program will revolve around massive expenditures in large-scale infrastructure projects, and if Obama can help it there will likely be an environmental angle to the program. If what politicians are currently saying is a true indication of what they intend to do, rail transportation is likely to be a major beneficiary. In the first of this two-part series on how investors can play the build-out in clean infrastructure, I present four stocks I came across while doing research on this.

Besides rail transport, the other major area of infrastructure alt energy investors care about is electricity transmission. Given Obama's promises on clean energy and the environment, the amount of press the Pickens Plan is receiving, and the state of America's transmission system, it is not unreasonable to expect that Washington could seize this opportunity to direct massive investments into this area as well. In the second part of this series, I will discuss potential plays on transmission.

Stocks For The Clean Infrastructure Build-out, Part 1 - Rail Transport

When doing research on this topic, I looked for companies that would benefit from investments in the rail infrastructure network, rather than companies linked to running or manufacturing/maintaining trains and cars. A severe economic downturn coupled with lower gasoline prices would reduce demand for rail transport, so this is not an area I'm particularly bullish on for the next year or so. In the long run, however, I believe that the renaissance of North American rail driven by high energy prices, tighter environmental regulation and an increasingly clogged highway network that's running out of space to expand, will be a strong theme to watch for alt energy investors.

I did not run any numbers or do an extensive amount of due diligence on the firms below, so if you have any information to share please go ahead.

Koppers Holdings (KOP). Financial statements here. At upwards of 45%, Koppers holds the largest market share in the North American railway tie business. Railway ties are the wooden beams that support the rails. Koppers also makes utility poles, and could thus benefit from investments in electricity transmission. One interesting thing about Koppers is that it runs a biomass power plant that burns recycled railway ties and utility poles (I found that out while checking the website. They have a video about it). At a PE of around 6.3x last year's earnings, this stock is trading in cheap territory.

LB Foster (FSTR). Financial statements here. LB Foster's rail division sells rail and other related products to a range of industries including passenger and freight railroads, rail transit, ports and others. One interesting feature of this company is that it also recycles and re-sells used rail. This stock is currently trading at a trailing 12-month PE of around 2.2x, which is very cheap by most measures. I haven't looked closely into this firm so I'm not sure why it would be trading at such a discount to its peers, even in difficult market conditions.

Stella Jones (STLJF.PK or SJ.TO). Financial statements here. At about 20%, this company has the second largest market share in the North American railway tie market after Koppers, and it has been an aggressive consolidator of the fragmented treated wood market. The company also has a 70% market share of the Canadian railway tie market, another jurisdiction where the government is weighing the merits of infrastructure spending as a counter-cyclical measure. Stella Jones is also active in wooden utility poles and could benefit from spending programs in electricity transmission. One of the major negatives with this stock is illiquidity: the largest shareholder owns about 62% of shares outstanding, and volumes tend to be extremely light. At a trailing 12-month PE of around 9.8x, Stella Jones is reasonably priced, although increased debt levels recently on the back of five acquisitions in five years could be a concern.

Global Railway Industries Limited (GRWIF.PK or GBI.TO). Financial statements here. Most of the company's business is in the sale of locomotive and other train components. However, it also sells a range of railway track and signal products. This stock is currently trading at around 10x last year's earnings, so it is the most expensive of the four.

DISCLOSURE: Charles Morand does not have a position in any of the stocks listed above.

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Charles Morand at 12:48 PM | Permalink | Comments (0)

This is a continuation of a series looking into the financial stability of companies in Energy Tech Stocks' "Wise Energy Use" index, described in part 1.  The first article in the series looks at three efficient lighting companies, while this one looks at four electric vehicle stocks and a private company, as described here.

Electric Vehicles... Good, but not Disruptive

I personally don't consider investing in any car companies, even relatively fuel efficient ones.  Either or both lean economic times and high oil prices are likely to lead to lower use of cars over the next few years, and this will likely weigh on car companies.  I'm more enthusiastic about relatively economical forms of transport, such as bikes, scooters, light rail, and busses.  Electrification is likely the future of ground transport, but which will come first, the electric car, or the electric bus?

New car sales typically rely on financing and consumer demand, something which could weigh heavily on all automobile manufactures, even for efficient vehicles.   But I didn't create the index, I'm just screening it for companies I think will stay strong in a prolonged downturn.  

I agree with Neal's post yesterday where he says, "In energy, there is no disruptive technology, only disruptive policy that makes some technologies look disruptive after the fact."  Neal makes an excellent case that Silicon Valley ingenuity will not overcome the energy industry.  The disruption, when it comes, will not be a better car, like a plug-in hybrid... it will come in the form of people abandoning the personal car for something better.

Today, I was at the Colorado New Energy Economy Conference, and I saw Neal's "disruptive policy" coming in the form of Denver's new Strategic Transportation Plan.  According to Bill Vidal, of Denver Public Works, Denver transportation planning has taken a new focus.  No longer will Denver transportation be car-centric.  It will instead focus on moving people, goods, and info, becoming more multi-modal.  A move to multi-modal transport will not be good for car companies.  While Denver may be on the forefront of progressive transportation, they are not the only ones, and a slowing economy is as much a driver of multi-modal transportation options as is a rising oil price.

So while I don't like any of the car companies in the Wise Energy Use Index, there is a bus company I like. 

Nissan (NASD:NSANY).   Financial data from 1Q 2008.  First quarter operating income was a positive 80 Billion yen, and they have a current ratio is about 1.3.  This is not bad, but I'd spend a lot more time scrutinizing their financing needs over the next few years before I would invest, if I were so inclined.  Nissan may be looking into electric vehicles, but if few people are buying any vehicles, how much will that help the company?

Mitsubishi Motors (MMTOF.PK).   Financial data from 1Q 2008.  Although Mitsubishi had positive operating income of about 10 billion yen in the first quarter, current liabilities exceeded current assets, with a current ratio of 0.87.  This might not be a reason to worry in ordinary times, but we are not living in ordinary times.

Toyota Motor (NYSE:TM).  Toyota's current ratio is almost exactly 1, but they did have operating cash flow of $30 Billion in the first quarter.  Like Nissan, Toyota may be able to survive without tapping the financial markets for a while, but I'm still uncomfortable owning any auto firm, even a progressive one such as Toyota.  Also like Nissan, I'd take a hard look at the next few years' financing needs before I decided to invest, if I were so inclined.

Ener1 (AMEX:HEV).  Battery, Fuel Cell, and Nanotech company Ener1 is not one I've considered before, partly because the ticker and company description make me think that they're slick marketers, while I'm more interested in boring companies that don't know how to get investors interested in their story.  Nevertheless, their technology is not totally tied to cars, and they have a fairly solid balance sheet with a current ratio of 7.7.  Their current assets less current liabilities are slightly larger than their twelve month operating cash loss, and they have no debt.  Ener1 should be able to survive for about a year without going to the capital markets again for new financing, so if you're betting on a quick resolution of the financial crisis, this is a company you might consider for your wise energy use portfolio.  I will not be making that bet.

A123 - This widely acclaimed lithium-ion battery company is private, and so not available to stock market investors, nor dues it publish financial statements.  They are planning an IPO, but until the prospectus is available, I won't be able to say anything about the financials.  Unless markets improve, I don't expect the IPO to take place.

DISCLOSURE: Tom Konrad has no position in any of these companies.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.  

Posted by Tom Konrad at 08:46 PM | Permalink | Comments (4) | TrackBacks (0)

The Casualty

Last Monday, I discussed how I had recently reviewed Railpower Tech with a view to potentially adding to my position on grounds that: (a) the company had a fair amount of cash in the bank, which reduced the need to go to capital markets for financing for a while; and (b) that it was getting badly battered by general market conditions, potentially offering an attractive entry point. Although my portfolio has taken a beating in recent weeks, I remain ready to take small positions in stocks if I feel they are being unfairly bashed, including in penny stocks. The current situation is bad to be sure, but I don't think we are at the point yet where every small and medium business faces certain bankruptcy.

I noted in the article that the reason why I decided not to commit any more money to Railpower for the moment was the lack of contracts being signed given the operating leverage the firm was taking on by building a new factory. Unfortunately, this exact problem forced Railpower to materially alter its plans, and on Monday evening it announced it was canceling construction of the plant on grounds that new orders were not coming in (PDF). I fully exited my position on Tuesday morning at a pretty handsome loss on a percentage basis, although luckily my position was very small and the cash loss wasn't needle-moving.

With my portfolio, I keep a log and always record the reasons why I enter and exit positions and what I've learned from different investments. What are main lessons I took away from this one? First, as money rarity spreads into non-financial industries, capital expenditures, especially for big-ticket items, will be some of the first things to be delayed or canceled. Prudence is therefore in order with firms that derive a large portion of their revenue from the capital expenditures of other firms. However, as pointed out by Tom yesterday, it is not impossible that the government may try to invest in infrastructure as a counter-cyclical measure.

The second thing I noted down was that in uncertain times, it is cautious to start out a position small and see how things develop. If the market turns in your favor, you can build up your position and the only real cost is an opportunity cost. If you missed something in your analysis or if the market ceases to pay attention to fundamental value as it is currently doing, you can exit the position at a smaller cash loss or you can try to weather the storm without loosing sleep over it.

Lastly, the balance sheet weighs a lot more heavily in my analysis in tough times in three main ways: (1) the cash position - it's gotta very strong; (2) debt levels - there has to be little or no debt and ideally refinancing isn't needed in the near-term; and (3) the value of tangible assets per share must compare favorably to share price (notably with the Price-to-Book-Value ratio). For penny stocks, I would look for firms with no debt, a completely depressed Price-to-Book ratio and assets that can be readily sold off to unlock some shareholder value should the going get too rough.

The Addition

Last Thursday, I purchased ABB Ltd. (NYSE:ABB) for the first time. I am down quite substantially since but it doesn't bother me very much. This is a long-term buy (3 to 5 years) that I had had my eyes on for quite some time but that I had always found too rich on a PE and Price-to-Book basis. ABB, a stock Tom has discussed on several occasions, is a prime play on the transmission infrastructure build-out and energy efficiency. I also applied my rule and took a very small position, which I stand ready to increase.

The Positive News

A stock that I've held for quite some time now, AAER Inc. (AAE.V or AAERF.PK), an emerging Canadian maker of utility-scale wind turbines, finally signed its first major contract on Monday. It is to deliver 100MW of turbines to a large Canadian wind project.

The next step in closing this transaction is for both parties to show they have secured financing within three months. This could prove tough in the current environment, so this is not a done deal just yet. However, if AAER can pull this through successfully, it could be the beginning of what patient investors such as myself have been waiting for for a long time - a buildup of the order book. The supply/demand situation for large turbines continues to be heavily skewed in favor of turbine companies and AAER should in principle be able to find customers.

Ironically, after the stock experienced a 40% pop last Friday probably because the news was leaked, I put in a sell order to exist most of my position Monday morning in case this was just an aberration. The company asked for a trading halt and I was never able to sell before the news came out. I wrote down in my log that I had been quite lucky on this one.

DISCLOSURE: The author is long ABB and AAE.V and does not have a position in RPWRF.PK

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Charles Morand at 06:42 PM | Permalink | Comments (0)

Over the past few days (and continuing this week), Tom has been writing about about what he sold recently. Lately, I have been thinking about what I could buy with the cash I have sitting around, seeing as many alt energy stocks look like bargains compared to where they were trading at just a few short months ago.

Over the weekend, I looked again into a stock I wrote about in May, Railpower Tech (RLPPF.PK or P.TO). I got a couple of requests for updates on this one so I decided to write about it. Railpower makes hybrid locomotives for short hauls in train yards, and its technology can also be applied to port cranes. The big selling point is that these locomotives can reduce fuel usage by 60% and various harmful emissions by 80%.

The Decision

What prompted me to look at Railpower again is the fact that the stock is down about 25% since I wrote about it in May, although nothing material has happened to the company. This is likely a case of a penny stock getting caught in the storm that is battering the markets. Risk is currently being repriced on a massive scale, and in my view we are at times overshooting to the downside, giving rise to good buying opportunities.

After reading through the Q2 2008 financial statements and recent news releases, I decided not to commit any more money to this company for the time being, although I am not going to sell any of my small position. My main concern is the lack of contracts being signed, with only six units (5 locomotives and 1 crane) being sold in Q2 and Q3 2008. Given the high degree of operating leverage the company is taking on by building its own plant and moving away from contracting out assembly, volume will be of essence.

The Good

I'm keeping my current position intact because Railpower is blessed with something few of its small-cap peers have: ample cash reserves because of a recent C$55 million financing through convertible debentures in two tranches, C$35 million in late 2007 and C$20 million in May 2008.

Railpower estimates its non-working capital cash needs at about C$25.6 million for 2009, mostly related to the construction of its new plant. With C$40.1 million in the bank, and the option to pay for the interest expenses associated with the debentures in shares rather than cash, the company is relatively well positioned to weather the current crisis in capital markets. Though management acknowledges it will need more cash for working capital purposes once production ramps up, this money should be relatively easy to access as contracts are signed.

The Bad

The new factory currently being built will have a capacity of 125 units per year. Dividing that number by four quarters yields 31.25, so selling about 27 new units per quarter would equate to operating at about 85% of capacity, which is pretty decent.

As mentioned above, Railpower is currently nowhere near that number with six units in the last two quarters. The firm has cash in the bank, a great technology, no real competitors and one of North America's most sophisticated institutional investors as its main financial backer, so at this stage in the game investors need to see the order book getting filled. Press releases about how cool the technology is just won't cut it anymore, especially in an environment where investors need to see real operating cash flow to feel reassured.

The Ugly

Now the C$55 million in financing is great news to be sure, but there is a rub. As mentioned above, Railpower has the option of paying all interest expenses on both debentures (coupon rates of 5%) until maturity (2013) in shares rather than cash. In Q2 2008, Railpower elected to pay its interest expenses in shares, resulting in the issuance of 1,980,166 new common shares, or a 2.2% increase over the common shares outstanding prior to that period (89,495,458).

The holder, for its part, has the option of being paid the whole of the principal in common or another class of shares. For the C$35 million debenture, the conversion price is set at C$0.30 per share, which would result in 116,666,667 new shares being issued. For the C$20 million debenture, the conversion price is set at C$0.40 per share, which would result in 50,000,000 new shares being issued. As at June 30, 2008, there were 91,475,624 shares issued and outstanding. The debentures are secured by a claim on anything that's "movable" on the balance sheet (i.e. not land or a plant), which encompasses all of the assets that actually matter right now.

Paying interest expenses via share issues is a double-edged sword for the company's shareholders: on the one hand, bankruptcy risk is nearly eliminated in the near-term; on the other, if the company can't figure out a way to boost sales and generate operating cash flow, shareholders get progressively more diluted. In effect, this turns cheap capital (debt at 5% plus a tax shield) into very expensive capital (equity). While the cost of equity capital is not reflected through an immediate cash outflow, the opportunity cost in terms of not being able to raise money through an equity offering later on because of concerns over shareholder dilution is very real.

In a context where the company is filling the order book, this situation isn't an especially big deal as interest expenses can be paid in cash and existing shareholders can benefit from plenty of upside before the debentures mature and the massive dilution risk they represent materializes. However, in a context where the company isn't selling units and no operating cash is coming through, management has the option of diluting shareholders instead of facing bankruptcy, which it could be argued reduces pressure to perform. The holder of these debentures, the OTPP, is in a position to have its cake and eat it to: if the company fails, it can get a good chunk of its money back, and if Railpower succeeds it'll get a controlling position for what is likely to be a fraction of the company's intrinsic value.

Conclusion

I don't mean to sound like a bear on this stock and I am not. For one thing, I think the management team has exactly the right profile for the job. I like the proximity, both from a key personnel and from a geographic standpoint, to Bombardier, which is a global leader in rail transport. Any signs of the two cooperating on projects would be great news. I also expect that sales will pick up as the plant nears completion and as customers feel reassured that Railpower can deliver.

But as a small minority shareholder, I can't help but feel a little uneasy at potentially being diluted if management fails to sign sales contracts. I therefore want to see signs of commercial success before dipping my toes any further, which would materialize as sales edging closer to an average of 27 units sold per quarter.

DISCLOSURE: The author is long Railpower Tech

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Charles Morand at 03:08 PM | Permalink | Comments (0)

As part of a general portfolio cleanup, I recently considered selling my stake in UQM Technologies, Inc. (AMEX:UQM), a manufacturer of electric motors for hybrid and electric vehicles.  I chose to keep the stock because they seem to have sufficient cash on hand to fund several years' operations.  I'm glad I did, because the stock is up 76% since Monday, with no recent news.

But there's a rumor that Chrysler will be using a UQM product in one of its planned electric cars.  If that rumor is true, the stock's rise is probably justified.  I like the company either way, but don't expect all the gains to hold if the rumor turns out to be false.

DISCLOSURE: Tom Konrad owns UQM.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 08:19 PM | Permalink | Comments (2) | TrackBacks (0)

Linamar (LNR.TO or LIMAF.PK) is a Canadian auto parts designer and manufacturer whose primary customers include GM, Chrysler and Ford. Before you rush to the exits because of their exposure to the North American auto industry, consider the following. Often, cyclical downturns beat a stock down far more than is deserved. We've seen it over the years with home builders, as discussed here, and we've discussed here how cyclical downturns offer opportunities for value investors to buy companies while they're cheap.

Many will argue that this is in fact a secular downturn for a company like Linamar. However, Linamar is showing some signs of being able to emerge from this storm as strong as ever. The company's focus on technologies that improve fuel efficiency has led to market share gains, with Linamar's North American content per vehicle rising from $94 last year to $105 this year. Although Scotia Capital analyst David Tyerman is bearish on the industry, he sees a bright spot with Linamar: "Linamar remains our favorite, given its exposure to new technologies."

The company also recently acquired a plant in Mexico to help keep costs down. They have also been increasing sales into Asia, and continue to make market share gains in Europe. As a result, sales, margins and earnings were actually up this quarter, both year-over-year as well as incrementally, despite a weak North American economy.

Nevertheless, its stock price has been brought down along with its sector peers, leaving it with a P/E of 7.5 and a price to book value of less than 1. This has prompted its chairman, Frank Hasenfratz, to acquire shares on the open market, stating in a press release that he believes they are undervalued.

No one knows how long this downturn in the US auto sector will last, but Linamar is showing signs that it can do just fine navigating through it.

Saj Karsan is a guest contributor on AltEnergyStocks.com. Saj is a value investor at Barel-Karsan, and can be regularly found writing for Barel-Karsan's blog.

Interested in writing for AltEnergyStocks.com? Please contact us

DISCLOSURE: The author does not have a position in Linamar

DISCLAIMER: The author is not a registered investment advisor. The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Guest Contributor at 11:01 PM | Permalink | Comments (0)

Two related pieces of news yesterday, one that was the day's headline and the other that drew a little less attention.

First, the big news: auto makers, especially US-based ones, got hammered by their product mixes. As expected, Americans are responding to a rise in gasoline prices by turning away from trucks and demanding cars, especially small ones. Of course, this spells nothing but hard times for the likes of Ford, GM and Chrysler, who are still hungover from a decade-long party fueled by high-margin pick-up trucks and SUVs. Economic incentives, whether state-imposed or market-driven, work after all.

Second, the International Energy Agency, the OECD's energy body, put out yet another gloomy forecast on the medium-term oil supply situation. By 2013, when a good bit of energy demand in the West will have been destroyed by high prices, the emerging world will have more than picked up the torch from us. Throughout this period, the physical reality that consuming ever-growing amounts of a finite resource leads to..well...its eventual exhaustion should become clear through price signals.

There are two forces at play here pointing toward sustained increases in the price of gasoline. First, the oil supply-demand balance will continue to be skewed as (a) incremental demand from the emerging world will outstrip demand destruction in the West and (b) there are no viable alternatives to oil in the near and medium terms. Second, investors will continue to want the same returns no matter what happens to the marginal cost of oil , which will grow as more marginal reserves are brought into production. Given growing operating and resource costs and the lack of alternatives, prices will naturally trend up so that earnings stay unaffected and shareholder returns maintained, allowing firms to keep capital costs under control.

What does this mean for the so-called "Big Three" - GM, Ford and Chrysler? This means that the gasoline price picture will not drastically change on them, at least in the long run. They can thus safely turn their attention and capital away from gas-guzzlers and get real about small and next-gen cars like hybrids and plug-in hybrids. GM is already doing it.

This also means that they have a chance to start afresh in emerging markets, where their production and value chains aren`t burdened by a long legacy of manufacturing primarily large vehicles. And I'm also talking about image here. When the average American car buyer thinks efficiency, the first corporate logos to pop in his/her mind are T- or H-shaped, and as long as Ford keeps pushing the F Series through primetime TV adds its place in consumers' mental landscapes will stay right where it is (along with its sales).

I therefore think that, gloomy as they may look, the next few years will offer some interesting opportunities, at least for GM and Ford. In the car sector, companies take a few years to respond to demand shifts, so there may yet be more pain on the way. However, the pain and all the media noise around it could mask smart strategic moves. What would I look for as signs that things are headed in the right direction? Here's three items for starters:

a) Announcements of North American factories being retooled to accommodate car (vs. truck) production. I`m not even talking new models here - just churn out sufficient quantities of existing car models to meet consumer demand

b) Announcements of next-gen car models to be rolled-out within reasonable time frames, and, even better, proof of execution on these announcements

c) Growing sales of small cars in key emerging markets like Russia, China, India and Brazil

Let us hope that 2008 is the year the Big Three wake up to the world Toyota has been living in for the better part of this decade, and that their capital and other resources are mobilized to meet the challenges $200 oil will bring their way.

As for investors, look for the indicators above, and for other signs the market may be ignoring (e.g. a growing ratio of small car ads to pick-up ads on TV). Many market participants still refuse to see something secular at play here, and this may provide an opportunity to pick up on promising developments early on.

Update (July 3): Interesting GM should announce today, on a backdrop of analysts claiming the company could go bankrupt, that it is thinking of launching its Chevy Beat here in North America. The Beat is a much smaller model that is popular in other parts of the world, namely Asia and Latin America. This car does 40 mpg, compared with the Hummer at 16.

DISCLOSURE: The author does not have a position in any of stocks discussed in this article

Posted by Charles Morand at 05:46 PM | Permalink | Comments (0)

Value Investing

A few months ago, I discussed my encounter with Warren Buffett, and promised that I would eventually analyze a stock using the value investing (VI) approach.

While I can`t say that I qualify as a hardcore value investor, there are many things about the VI approach that have influenced my thinking. For instance, I tend to stay away from very high PE stocks and momentum plays. While I take positions in firms with no earnings, they are generally relatively "unknown" or are past star stocks that investors have moved on from. I like the idea of investing in companies that have fallen below the radar, but that I believe have the potential to get back on it, either because they are fundamentally undervalued or because I believe they can execute on their business strategies and have a unique value proposition. However, I can't say that I have the discipline of a hardcore value investor, and will sometimes be swayed by a good story even though quantitative analysis dictates I perhaps shouldn't.

The value analysis I will conduct today is based on the methodology outlined in the book Value Investing: From Graham to Buffett and Beyond. If you are interested in finding out more about value investing, this is the perfect guide. It explains the philosophical approach to value investing, and provides enough information for you to build your own value analysis model in a spreadsheet. I will not go into a huge deal of methodological detail here, as this article is long enough as it is. I instead encourage you to buy the book (or any similar book) and read it.

Value Investing: The Three Sources Of Value

There are three key components to value to the VI approach: Net Asset Value (NAV), Earnings Power Value (EPV), and Growth.

Net Asset Value

NAV is the replacement value of the firm's assets minus its liabilities - this is therefore a balance sheet analysis. The way the value investor looks at the balance sheet and a firm's assets is in terms of what it would cost a competitor to come in and reproduce the firm's business. The firm is looked at as a going concern, and the balance sheet is therefore not a measure what one could fetch if they liquidated the assets, but rather the cost of matching the firm's position in a market. Certain adjustments must therefore be made to the balance sheet:

1) The gross value of capital assets (e.g. PP&E) is employed instead of their net value, and in certain cases such as land, those values are actually grossed up to reflect the fact that acquiring land today would be more expensive than at some time in the past. What assets are grossed up and by how much requires knowledge of the industry. For instance, machinery may be less expensive to acquire today for similar levels of economic output than it was 10 years ago because of technological improvements. In this case, the gross value would actually be brought down by an appropriate factor (eg. gross value x 0.8 or 0.7).

2) New assets are created for the product portfolio and customer relations. This is a way to account for the competitive edge represented by technological leadership and well-established relationships with key customers. The quick and dirty way to create those items is to take a realistic percentage of SG&A, and multiply it by the number of years it would take to reproduce the asset. For instance, assuming a company with a large market share spends half of its SG&A on sales and marketing, one could take 50% of SG&A and multiply that figure by 3, reflecting the fact that it would take about 3 years at this level of marketing and sales expenditure to match the level of customer loyalty.

3) Creating a liability for stock options outstanding in cases where this is material for companies

Now remember, this is just a rough guide to approaching replacement value analysis, and requires a good deal of judgment and knowledge. There are more things one could do, but those are the major items. Again, this approach comes from the book, and an analyst with plenty of experience in one industry could tinker more or differently.

Earnings Power Value

EPV essentially measures the cash generation potential of a firm's assets via an income statement analysis. Earnings are adjusted to come up with something akin to a free cash flow, which is then discounted and compared to the adjusted value of assets, or NAV.

In a situation of market equilibrium with ample competition, EPV should equal NAV for all market participants - the adjusted earnings of companies are just sufficient to replace assets, and revenue growth doesn't create any incremental value as the asset base grows by a proportional amount. In such a situation, the return on invested capital (ROIC) equals the weighted average cost of capital (WACC). I will expand on this later.

Just like for NAV, adjustments are made to the income statement. Changes are:

1) Take at a 5-year avg EBIT margin

2) Apply that margin to current year revenue to smooth out any unusual events

4) Take out taxes

5) There a couple more adjustments needed that are discussed in the Growth section below, but that I will leave out for now

You then take this number as a numerator and, using the firm's WACC, do a straight perpetuity assuming no growth. From the resulting figure you subtract debt and excess cash (i.e. greater than 1% of sales), and this gives you the firm's earnings power.

If this figure is equal to NAV, the cashflows from the firm`s assets after investors are paid at the rate they require are just sufficient to replace those assets, and no incremental value is created. If EPV is smaller than NAV, then managers are actually destroying value, and the asset base needs to shrink to meet EPV.

If EPV is greater then NAV, then the firm is able to replace its assets and create an additional return for investors over and above what is already captured in the discount rate - ROIC is greater than WACC and return on equity (ROE) is greater than the cost of equity. In end, equity holders are really the prime beneficiaries from this situation, as debt holders`returns are capped.

Growth

Value investors typically don't like to include growth assumptions in their models, because they believe that in most cases firms whose EPVs are larger than NAVs won`t be able to sustain that position because of competition, and therefore that the long-term equilibrium lays with EPV = NAV. Remember, in this case, ROIC = WACC, and sales growth does not create any incremental value as it just goes to pay for more assets.

The only time value investors actually compute growth is when a firm's EPV is greater than its NAV and they believe that the firm has a so-called moat, or a competitive advantage that can't be undone (think of Microsoft and its position in the operating systems market). Only in such a case would value investors actually pay for growth, and include it in their valuation (more on this later). Barring the existence of a moat, competitors will eventually notice the value creation potential of a given industry, will enter, and will force equilibrium through competition - all EPVs will equal NAVs.

In #5 above, the other two adjustments needed when computing EPV are to account for maintenance SG&A and maintenance capex. In other words, some of the SG&A expenditures and some of the capital expenditures are made to maintain and replace the existing assets, while some are made to grow sales. Since we are only interested in what it costs a going concern to maintain its existing asset base, we add back a percentage of depreciation and SG&A (between 25% and 50% - again, this is a matter of judgment and industry knowledge) to make up for the fact that some of this expenditure went to fund growth and shouldn't be accounted for.

Closing Remarks On The Value Approach

There are thus two main types of value plays (excluding growth, to be discussed later):

1) Asset-based --> If NAV/shr is larger than share price, is there a high probability that investors will eventually wake up to that fact and that the two will converge, creating a capital gain? If so, you have a value play on your hands and are paying for undervalued assets.

2) Earnings Power-based --> If EPV > NAV, does the company have the means to prevent competition from eating away at its margins – in other words, is there a moat around its market position? If so, is EPV/shr lower than share price? If you can answer yes to both questions, you also have a value play on your hands but you are paying for sustainable earnings power.

There are more adjustments to the financial statements and more nuances to those adjustments than I’ve presented here. However, in the interest of length, there is only so much I can get into. I just wanted to provide a high-level picture of how value investors approaches valuation and security analysis. As I mentioned earlier, I would strongly encourage those interested to read more about it on their own. In the end, what your VI valuation yields is a result of your particular assumptions, which by the way holds true for any type of valuation.

The Search Process

In theory, VI is a bottom-up approach, meaning that one typically starts the search for stocks by looking at fundamental ratios, and only worries about the industry and qualitative factors if the investment makes sense quantitatively. The two preferred ratios are the price-to-earnings (PE) ratio and the price-to-book-value-per-share (P/BVPS) ratio, and the preferred valuation levels are typically around 15x for PE and 1 to 1.3x for P/BVPS.

However, I’m not entirely sure how it is actually done in practice. For my part, I start at the industry level and then work my way down to valuation, and I don’t let a PE above 15x or a P/BVPS of over 1.3x discourage me from pushing on.

Stella Jones

The company I chose to analyze for this article is Stella Jones (STLJF.PK or SJ.TO), which is a treated wood product manufacturer. The company’s main business segments are railway ties (35% of 2007 sales) and utility poles (48%). The remainder is made up of other treated wood products, but those are the two key segments. SJ thus has significant exposure to two sectors I believe are very well-positioned to benefit from the transition to a green economy: rail transport and the electricity grid.

Both the railway ties and the utility poles industries are fragmented in North America…or at least in the US. In Canada, SJ has been an aggressive buyer, consolidating the market. It now has a roughly 70% market share in both industries in Canada, and following a recent acquisition in the US now holds upwards of a 20% market share in railway ties, which places it second there in terms of market share. As you will see below, SJ has done a great job of integrating acquisitions so far, and is considered by analysts to be in a strong position to consolidate the US market, starting in the east and southeast. As can be noted from the share price performance over the past five years, this expansion hasn’t gone unnoticed, and this has been a great ride for shareholders who were there early.

The company currently trades in the FY2007 17x PE ($2.04/shr) and 3.4x P/BVPS ($10.35) ranges, so on the latter metric it certainly seems rich for a value investor. The reason why this company drew my attention is that the stock has seemingly halted a largely uninterrupted 4-year run over the past 12 months. The reason is simple: the company is based in Canada but has operations in the US, and it has been hit hard by a rapid increase in the value of the Canadian dollar. While SJ has some natural hedges in the form of facilities in the US, and uses derivatives to control its forex exposure, this hasn’t proven enough and SJ missed it targets in Q4 ’07.

Value Investors will typically like a stock whose underlying business is intact but in which, for one reason or another, the market has lost interest. This qualifies as one of those. Already liking the sector and the company’s positioning in it, the pullback in share price led me to want take my analysis further.

Despite completing five acquisitions in five years, SJ has managed to steadily improve margins as well as a key profitability ratios.

The capacity of Stella-Jones to acquire and successfully integrate businesses at this rate while continuing to improve returns for capital providers is a signal that the management team is likely very strong. While margins and other ratios will certainly not continue to improve at this rate indefinitely, SJ’s track record speaks volume as to its ability to be a successful consolidator in the US treated wood market.

Value Investing Valuation

NAV

Through my NAV adjustments, I ended up adding about $29 million in net assets, mostly as a result of adjustments to capital assets and the addition of a $15 million customer relations asset. As explained above, I took two years of 50% of 2007 SG&A (or full 2007 SG&A) as what it would cost a competitor in terms of marketing and sales expenditures to come and establish the market position SJ has achieved, especially in the Canadian market.

I did not push too much on this analysis because I knew that, at a non-adjusted BVPS of $10.35, no realistic adjustments would bring NAV anywhere close to the $35 figure the stock is trading at. Looking at the company’s margin and profitability ratio improvements over the past five years, I knew this was an earnings-power story and not an undervalued asset story.

EPV

My income statement analysis yielded more interesting results. Following the earnings adjustment approach above, I got an EPV of about $24 per share.

I discounted the company’s adjusted earnings at 11.15%, using a before-tax cost of debt of 8% and a cost of equity of 16%. The target capital structure for this firm likely lays at around 45% debt-to-total cap. About 60% of the stock is held by one shareholder, so I added a percentage point of liquidity premium to the 15% cost of equity I had originally come up with. The choice of a discount rate, however, varies widely from person to person, so this is by no means the only "right" discount rate.

Still, at $24/shr, we are still far from the ~$35 the stock is currently trading at, indicating that much of Stella Jones' potential is already priced in.

Growth

I believe Stella Jones has a moat, in the form of a high market share in Canada and the ability to consolidate at least a part of the US market on a back of a successful integration strategy to date. Moreover, my understanding is that wood is not about to be displaced as the primary material for railway ties and utility poles, because the cost of alternatives is plain too high.

As you can see if you compare SJ's profitability ratios to the cost of capital I came up with, the company is creating additional value for its stockholders, and there is a good bit of room to absorb any error on my part in computing that cost of capital. It would therefore seem reasonable to want to price in some growth, as discussed above.

In order to value growth, value investors (at least the ones who wrote the book :) use a matrix called the Growth Value Multiplier matrix. The GVM matrix outputs a number by which EPV is multiplied to get the value of growth for the firm.

The two axes on the matrix are the expected long-term sustainable growth rate over the cost of capital (g/K), and the ROIC over your cost of capital (ROIC/K). How does this all make sense? Believe me, the algebra works, and if you are familiar with the Gordon Growth Model the vertical axis should make sense. I'm not going to lay out the algebra here however, both because that would take too long and because this isn't my model, and I doubt the authors would be happy with me giving away too much.

So how does one use this matrix? First, a reasonable long-term growth rate must be determined, which can't be too much greater than the economy as a whole given that the underlying algebra assumes a perpetuity formula. In this case, I picked 4%, which places SJ between 0.25 and 0.5 on the vertical axis. I used a 16% ROIC as the long-term figure to reflect further marginal improvements on 2007 but not much more, which divided by the WACC at 11.17% lends SJ on 1.43, close enough to 1.5. Given the position on both axes, it would be reasonable to assume a multiplier of 1.2.

Multiplying the EPV/shr by 1.2 yields an intrinsic value of about $28.60/shr, still short of $35. And I haven't even worked in a margin of safety, which is a way to hedge risk in case the valuation is off or if one misses a major qualitative factor. Typically, the intrinsic value arrived at is multiplied by something like 66%, and if the share price is still below the resulting figure, it's a buy. Needless to say, we're not even close here.

Where Do We Go From Here

Any way you slice it using the VI approach, SJ's past achievements and future potential are fully priced in...and then some. The story remains pretty attractive, and although I didn't delve too much into the qualitative side, it's hard not to see a gem of a company here. The sell-side analyst notes I read on SJ are all positive with 12-month targets implying pretty respectable returns, all based on forward multiples (I didn't see a DCF, and I suspect it's partly because with reasonable assumptions you couldn't justify very elevated share price levels).

For the time being, however, I'm going to be disciplined and hold off on this one. SJ has essentially flat-lined over the past year, and it could be that some of the hype is gone - as I pointed out earlier, it wouldn't be realistic to assume a doubling of margins every five years in perpetuity.

Value Investing as a philosophy provides a good way of thinking about a business and its potential. However, I'm told by practitioners that you sometimes have to sit on the sidelines for long periods of time in hot markets, as you just can't find securities that meet the stringent value criteria. For my part, as stated initially, I can't claim to have the discipline of a true value investor, and maybe I'll end up owning SJ sooner than I think...

DISCLOSURE: The author does not a position in any of stocks discussed in this article

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Charles Morand at 09:12 AM | Permalink | Comments (0)

I took a small position today in Railpower Tech (RPWRF.PK or P.TO) at C$0.46. Tom briefly discussed Railpower last November in an article on rail stocks. I don't want to dwell too much on how I view the macro picture for rail, but suffices to say that a combination of increasing fuel prices and concerns about climate change is re-kindling interest in this sector in a significant way across North America (in other regions of the world, mainly Europe, the interest never really vanished in the first place). Tack on top of that the potential for material savings in fuel (25-45%) and reductions in harmful emissions (70-90%), and you have a nice value proposition. The company is also expanding its technology into other applications, namely port cranes.

I bought this stock on news that the company was moving ahead with construction of a new manufacturing facility, and had secured financing to pay for the facility (PDF document). Railpower has experienced its share of difficulties in the recent past, as evidenced by the stock's spectacular fall from grace. While the company has been successful in attracting a fair deal of attention to its admittedly innovative technology, execution and liquidity problems have dogged this stock for the better part of the past two years.

Last fall, the Ontario Teachers' Pension Plan (OTPP), one of Canada's largest institutional investors, threw the firm a lifeline in the form of a C$35 million (US$35.4 million) capital injection. Given OTPP's reputation as one of the most sophisticated institutional investors in Canada, I began paying closer attention to the firm. Today, on news that they were building a factory and getting another large cash infusion from OTPP (C$20 million), I decided to dip my toes and take a small position.

Before buying anything, I did a quick and dirty analysis of the firm (see table below). I liked the 274% pop in top line in 2007 over 2006, and gross and operating margins seem to be improving. I liked what I saw with regards to inventory management, which is a good measure of efficiency. Inventory appeared to me to be the major area of working capital weakness for Railpower. Finally, largely due to improved working capital management, Railpower showed a notable improvement in operating cash.

A rough calculation, using the Q1 balance sheet (PDF document) and adding the C$20 million of new financing to assets, yields a price-to-book ratio of around 2.35 at today's closing price of C$0.75. This is therefore not a 'cheap' stock, but also not an outrageously expensive one based on this metric. The real value in this firm, however, may lay with its potential earnings power, which won't be measurable until its starts to actually generate earnings. C$55 million in financing in the space of a few months from the public equity division of OTPP speaks volume, and I doubt OTPP would've provided this cash if it did not believe in Railpower's ability grow earnings substantially. Moreover, operating out of a brand new, state-of-the-art facility should help the firm improve its operating performance.

I can't claim to know this company inside and out, which is why I only took a small position. I intend to do more research over the next few days to decide whether to increase my stake. If momentum takes hold of the stock and it gets pushed beyond levels where I'm comfortable, I'll just have to table this one for the time being.

UPDATE (May 27): P.TO gave back much of yesterday's gain to close at C$0.55. Volume was higher today than it was yesterday at 18.2 million trades (Vs. ~16 million). I'm not surprised this happened as there was almost certainly going to be some profit-taking on a one-day pop of 87%. The major milestone to look for in this company for the remainder of '08 is the ability to fill the order book.

DISCLOSURE: The author is long R.TO

DISCLAIMER: I am not a registered investment advisor. The information and trades that I provide here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Charles Morand at 05:42 PM | Permalink | Comments (2)

Taking a study break, I happened to see an article in the Denver Post bringing together two of my favorite clean energy themes: Efficient transport, and wind power. Rail transport has become essential to delivering windpower across the country.

The full article is here: Rolling With the Wind.

Posted by Tom Konrad at 04:53 PM | Permalink | Comments (0)

Tom Konrad

I'm more than a little obsessed with finding investments which will increase with the price of oil, but not contribute to global warming.  This is quite tricky, because most forms of renewable energy produce electricity, which we cannot use in our current fleet of cars.  Biofuels ( even cellulosic) can be used in cars, but are limited by supply of feedstock, and by the environmental degradation that growing and collecting biofuel feedstocks can cause.  Not to mention the impact on food prices (despite the fact that this may help poor farmers even as it hurts poor city-dwellers.)

A Drastic Peak Oil Scenario

When the supply of oil cannot grow to meet increasing demand, the price must increase to keep demand in check.  However, the fastest growing consumers of oil are countries where the government subsidizes oil as an attempt to avoid civil unrest or political discontent.  That means that demand destruction in developed markets must make up the difference for markets where demand destruction will not occur due to the lack of price signals.

How elastic is gasoline demand in North America?  While there is some evidence that we are already responding to the long term rise of gas prices, demand is almost always much more elastic in the long term.  Most people are more willing to skip going out to eat once a month than they are to start riding the bus.  That means that a slow, gradual rise in the price of oil might be accommodated through a shift to more efficient vehicles, the construction of light rail systems, and people choosing to live more densely.  On the other hand, it will take a much more drastic oil price spike (say $10 per gallon within 3 years) to pry Americans' white knucklrideres from the steering wheels of their SUVs.

That is precisely what I expect to happen.

$10 Gas Would Mean...

People who have been cutting back on other things in order to keep up with the increasing cost of driving will not be able to afford a new Volt or Prius Plug-in Hybrid Electric Vehicle, or even my favorite, the Aptera.  For people forced out of their cars by pure economics, the only options will be those that cost no more than a few thousand dollars, or even no down-payment at all.

Of all the options, mass transit has the lowest up-front cost for the user, and the only option which can be expanded quickly is bus rapid transit.  Busses can typically be ordered and delivered within a year, the upfront cost is fairly low (the largest component cost of bus operation is the driver, not the cost of capital), and new routes can quickly be added by converting lanes of existing roads to dedicated bus lanes.

Long haul bus operations are already taking off in the United States.   Mass transit ridership reached a new 50 year high in 2006 (I have not been able to find 2007 numbers yet.)  Bus mass transit is additionally likely to be a response of municipalities to peak oil because 80% Federal funding for bus purchases to meet increased ridership or replace old busses has been available since 2005.

New Flyer

New Flyer Industries (NFI-UN.TO, NFYIF.PK) is the largest supplier of heavy duty busses in North America (42% delivered market share in 2007, and a 50%+ market share in terms of new orders in the last year.)  They have a broad product offering, and including a wide variety of alternative fuel options, including LNG, CNG, Hybrid, and Electric options.  They even have an exclusive agreement with Ballard (NASD:BLDP) to develop Hydrogen Fuel Cell busses.

The Company has a strong position in the North American market, a market which has high barriers to entry due to the need for many US buyers to "Buy American" (New Flyer qualifies), and the fact that US fleet operators are interested in an established brand with good local service.  Since many American buyers only pay 20% of the capital cost (but all the service costs), service and maintenance is likely to be more important in the buying decision than the initial purchase price.  This should also help push purchasers towards cleaner running busses such as New Flyer's natural gas and hybrid versions, despite the increased capital costs.

Securities Details

New Flyer's available securities are Income Deposit Securities (IDS), an approximate 50-50 hybrid between high yielding (but not well secured) debt and equity.  Because of Canadian withholding (I have not been able to determine if this applies, but I suspect it does,) these may not be the best choice for US based tax-advantaged investors, but for Canadian and US-based taxable investors, these income deposit securities should be an excellent hedge against the rising price of gasoline.  Unlike most gas price hedges available, the income from the security can directly be used to buy gas without selling even part of your original position.  (Although it does have the slight disadvantage as a hedge because the mechanism is not direct, and higher gas prices may take 1-3 years to flow through to higher earnings at New Flyer.

On the subject of hedging, the company runs a very sophisticated financial operation. The unusual nature of the securities arises from their sophisticated use of the US tax code to allow deductibility of the interest part of the monthly distributions.  They have fully hedged their exposure to exchange rate changes between the Canadian and US dollar (something I wish another favorite, Carmanah Technologies (CMH.TO, CMHXF) had done in recent years.)  They are also taking advantage of the strong loonie (C$) to buy back some previously issued securities using excess cash and the proceeds of a new offering of additional IDS in Canada.  Because of the exchange rate terms of the class B and C shares they are redeeming, this will have an immediate positive impact on cash flow. 

Conclusion

From listening to the most recent conference call, I get the impression that management is very conservative, and has not built a rising oil price into their projections for market growth.  None of the analysts on the call asked about the effects of rising oil prices either.  In fact, management had expected the current strong market for bus orders to slack off towards the end of the year, and they were surprised that they see no signs of slackening growth.  

Since management and most analysts have not incorporated peak oil into their projections, we can expect unpleasant surprises at the pump to lead to pleasant surprises during earnings announcements.

Note

Since I wrote the above, one of my New Years Speculations, Capstone Microturbine (CPST), received an order for 150 turbines for use in a fleet of hybrid busses.   Although this is not a new application for their microturbines, it was one I had forgotten when looking for bus stocks.

DISCLOSURE: Tom Konrad and/or his clients have long positions in NFYIF, CMHXF, CPST.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 01:59 PM | Permalink | Comments (10) | TrackBacks (0)

Over the weekend, EnergyTechStocks published two articles based on an interview with me.

The first was about my conviction that Peak Oil induced rising gas prices is going to lead to a rush into mass transit building by cities, or investing in mode-shifting last September.  I've since written about opportunities in rail transit stocks, (P.TO, TRN, PRPX, and WAB), and more recently Hedging your peak oil risk with your lifestyle.  However, I have been frustrated until now that the only pure play bus stock I've been able to find is Firstgroup PLC (FGP.L, FGROF.PK), the British based owner of Greyhound and owner or operator of many other UK and North American transit services (both bus and rail.)  Back in September, Firstgroup seemed very expensive after a prolonged run-up, but it is now looking more reasonably valued.

Two weeks ago, however, I found a pure-play North American Bus stock, which I will be writing about this weekend.  I'm not ready to reveal the name, because I still have an account which has not yet bought the stock.  This is the company I was not ready to reveal in the EnergyTechStocks interview.

The second part of the interview referred to my conviction that lean economic times will benefit Energy Efficiency over other forms of clean energy.  I highlighted two of the stocks from the 10 Solid Clean Energy Companies to Buy in a Downturn series.

DISCLOSURE: Tom Konrad and/or his clients have long positions in TRN, PRPX, WAB.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 01:59 PM | Permalink | Comments (0) | TrackBacks (0)

Investors act in irrational, but predictably irrational, ways.    That is the basic tenet of Behavioral Economics.  (Looking for references, I came across an interesting book by that title, by the Alfred P. Sloan Professor of Behavioral Economics at MIT’s Sloan School of Management.)  

For me, these predictable irrationalities provide ways to profit from the mistakes of others in the market, so long as I do not fall into the same (or other) cognitive traps which cause the market opportunities in the first place.  I describe one such technique in this article.

Applications to Policy Design

In addition to those of us who use it to make a slow buck (it's the people trying to make a quick buck who are often most responsible for many of the opportunities) in the stock market, Behavioural Economics also has useful application to policy.  Richard Thaler and Shlomo Benartzi, two of the foremost researchers of Behavioural Finance (Behavioural Economics as applied to investment decisions) used insights into why people procrastinate to design the Save More Tomorrow (SMarT) design for 401(k) defined contribution schemes to help employees who want to save more but lack the willpower to do so.  This design is now incorporated into commercial products, such as Vanguard's Autopilot 401(k) program.

In the researchers' words (links mine):

[Save More Tomorrow] has the following ingredients: First, employees are approached about increasing their contribution rates a considerable time before their scheduled pay increase.  Because of hyperbolic discounting, the lag between the sign-up and the start-up date should be as long as feasible. Second, if employees join, their contribution to the plan is increased beginning with the first paycheck after a raise.  This feature mitigates the perceived loss aversion of a cut in take-home pay.  Third, the contribution rate continues to increase on each scheduled raise until the contribution rate reaches a preset maximum. In this way, inertia and status quo bias work toward keeping people in the plan. Fourth, the employee can opt out of the plan at any time.  Although we expect few employees to be unhappy with the plan, it is important that they can always opt out.  Knowledge of this feature will also make employees more comfortable about joining.

Behavioral Gas Tax

Fellow energy blogger Jeff Vail at rhizome inadvertently reminded me of Save More Tomorrow by his assertion that "assuming rational consumer behavior is pretty silly, but any other basis of assumption is even more silly."  

This begs the question, "How can a policy to reduce gas use be based on the fact that consumers are irrational?"  Classical economics teaches us that we need to raise the marginal cost of behaviors which we don't like, but behavioral economics tells us that we'll get a lot more bang for our buck if we work with people's irrational tendencies rather than against them. 

Jeff has a clever idea for making a gas tax work better.  If it were implemented, I expect it would be effective.  However, the most important feature of any policy to reduce gas use is implementation.  Voters must be willing to accept the policy, and while voters generally think that it's a great idea to punish others for harming the environment, they're still unwilling to actually make changes themselves... especially if it will effect their pocketbook.

Since it's more effective to reduce driving than to attempt to increase the efficiency of the cars on the road, I used SMarT as a model to help people make the decision to use their cars less:

The Department of Motor Vehicles could offer drivers a discount on their annual auto registration if they agreed to buy an annual transit pass within the next 6 months.  The instant incentive of savings would lure people to buy the more expensive pass, and because it's the Department of Motor Vehicles, the car owner could be charged and the pass mailed to them on the date they specified at vehicle registration.

Some of the money from the transit pass would go to make up for the discount to the Vehicle Registration Fee, but since all these pass holders would by definition own cars, they would likely be relatively light transit users, meaning that the transit authority would still be getting enough money to cover their costs.

This scheme might not do much to reduce driving.  Nothing is forcing anyone to opt in, and those who do might not end up using their passes... just like all the people who buy annual gym memberships and only show up once.  But just like those "wasted" gym memberships, the extra funds could be used to improve the city's transit system, over time making it more attractive and usable, and thus improving ridership.

On the other hand, because the scheme is voluntary, there would likely be little political opposition to enacting it, and the best way to reduce gas consumption is the method that actually gets passed.

Room for Improvement

I note that I'm not the only one thinking about behavioral economics and energy use.  My idea is far from perfect... mainly because it would likely not do too much to reduce driving.  If you have a suggestion, the comments are open.

Posted by Tom Konrad at 12:10 PM | Permalink | Comments (0) | TrackBacks (0)

by Tom Konrad

Lifestyle Risks from Peak Oil

In the US, we all have a large exposure to the risk of rising energy prices.  In addition to the cost of gasoline, the whole US economy runs on oil, so a rise in the oil price is likely to affect our jobs, and the prices of all our assets, including our homes.  If other people have less money to spend and invest because of high oil prices, there will be a fall in demand for anything they were buying or investing in.

House prices in exurbs and suburbs where the car is the only available transport option are likely to be most affected because living there entails relatively high car use.  If you live far from where you work, your expenses will not only go up with the price of oil, but the value of your home is likely to fall, leaving you doubly exposed.  In contrast, real estate which is centrally located or which is well-served by mass transit may show positive correlation with the price of gas, and hence serve as a against the gas price.  

This oil price exposure can be (imperfectly) hedged with investments in clean energy or oil price futures, but a more effective way to reduce your risk is to live close to your work.  If you already live far away from most jobs and own your home, you can reduce your personal expenses by finding ways to telecommute or use mass transit, but the value of your home is still linked to the oil price.  Since this is a long term trend, you may be able to protect the value of your home by advocating for better public transit in your area, but given the time and effort this entails, a large allocation of your portfolio to clean energy stocks or oil futures is probably the best you can do.  In addition to my own blog, Jim Kingsdale's Energy Investment Strategies is an excellent place to learn about investments available to the retail investor.

However, you should not underestimate the magnitude of oil's direct impact on your expenses.  If you drive 30 miles round trip, five days a week, that's about 300 gallons a year, even in a 30 MPG vehicle.  Each $1 increase in the price of gas requires $300 of extra income a year to hedge your exposure.  

Driving an alternative fuel vehicle is not a hedge for oil price risk, since the prices of alternative fuels are highly correlated with the prices of petroleum based fuels, although a more efficient vehicle is a partial hedge.

Investments as a Peak Oil Hedge

For investments to hedge that expense, you will need investments that increase $6,000 to $8,000 for each $1 increase in the price of gasoline to produce $300 of extra income annually.  Assuming you have found a portfolio which increases 10% for every $1 increase in the price of gas, you will need approximately $70,000 invested to hedge your commuting costs, and possibly as much again to hedge the price of your home.

Even with $70,000 to invest, most stocks or portfolios of stocks are an imperfect hedge against the price of gas.  The best hedge in terms of correlation with gas prices are oil or gasoline futures, but trading futures is considerably less accessible than trading stocks, and does not produce income.  Trading oil futures is a zero-sum game: for everyone who makes money, a counterparty loses money.  In stockmarket investing, the internal profits of companies can provide a basis for a positive net return for all investors.  That extra benefit and the opportunity to invest with my beliefs, make me willing to accept the much weaker correlation clean energy stocks have with energy prices.

Better Than a Hedge, Reduce Your Risk

If you don't have $70,000 in your portfolio to neutralize your gas-price risk, or are uncertain of your portfolio's correlation to the gas price (most stocks will actually fall as the price of gas goes up,) it makes sense to find less gas-intensive options to your normal commute.  Then, if fuel rises to a painful level, it will be easier for you to switch quickly to less fuel-intensive options. 

Even though I live near my work, I've been doing just that, ever since I became convinced that better cars are not an effective solution (or investment response) to peak oil.

An EV You Can Carry in One Hand

A couple weeks ago I mentioned that I was cutting my driving with a Motorboard.  The motorboard is an electric scooter which is so compact that you can fold it up in a few seconds and carry it in one hand (it weighs about 16 lbs.)  I think of it as a much cheaper and cooler Segway which I can carry.  Since it has a low range, it is best seen as a supplement to mass transit, not a stand-alone transit option.  The combination of motorboard plus transit allows distance travel without the limitation of start and end points within walking distance of transit stops.

I wrote a review of the Motorboard for Carectomy.com, which you can read here.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 05:59 PM | Permalink | Comments (0) | TrackBacks (0)

Here is an interesting article on the Carbon Tax Blog about dropping gas usage in the US due to sustained high prices.  As I've said before, now that peaking oil supply has made gasoline supply inelastic, price will have to be set by marginal demand... we're beginning to get a look at what the demand elasticity for gasoline is.

But gas prices are not dropping.  US demand may actually be elastic, but world demand is not yet showing elasticity.  In large part, this is because most emerging economies and oil producing company consumers enjoy fixed price oil, courtesy of subsidies.  Those subsidies may turn out to be elastic, when it breaks the bank, but it will take a long time.

My new Wheels

I've personally been cutting my driving with a Motorboard, which I tried for the first time on Saturday (after which it snowed... weather may be a factor for a month or two.)  I'll write something about it after I've had a chance to use it more.

Posted by Tom Konrad at 03:41 PM | Permalink | Comments (0) | TrackBacks (0)

Johnson Controls (NYSE:JCI) has long been one of my favorite energy efficiency picks, with an added bonus coming from their joint venture with Saft to produce batteries for hybrid and electric vehicles.  They have also shown some energy saving innovation making parts for auto interiors.

Building Efficiency

Efficient buildings are much more complex than simply replacing inefficient HVAC and lighting with more efficient versions.  Quite often, the most cost effective measures come from using systems more efficiently.  As an analogy to the home, look at any list of quick tips for energy saving around the home.  This list of ten steps on Squidoo includes five tips for using existing equipment more wisely (programming your thermostat, cleaning air filters, loading your dishwasher fully, and only using the dryer when you can't air-dry.) Considering Squidoo is quite clearly trying to make money by referring people to Amazon to buy products, it's all the more significant that half of the steps need not involve buying anything.

In commercial and industrial buildings, the most economical gains also involve using existing equipment more wisely.  They offer a full suite of products focused on automation and integration to businesses and residential (with the recent York acquisition) customers alike. 

Building efficiency systems comprise about one third of 2007 revenues.

Batteries and Automotive Power Systems

Johnson Controls' joint venture with Saft has been making headlines recently, no doubt in large part due to Johnson Controls automotive industry network.  The partnership has won contracts to supply batteries to Chinese auto manufacturers Chery and SIAC for their Hybrid electric vehicles, and a battery development contract from GM to develop Li-ion batteries for GM's Saturn Vue Green Line Plug-in Hybrid.

I'm extremely enthusiastic about the growth prospects of the automotive battery industry, the reasons for which I detailed in this article about another battery company, and this one about the long term prospects for cellulosic biofuels.  The power systems division comprises about one third of 2007 revenues.

JCI also supplies automotive battery management systems and power systems, with a focus on energy savings, as part of their automotive division described below.

Auto interiors

Energy savings can come from unexpected places... like car seats.  Johnson Controls' EcoClimate seat provides much higher heat absorption and moisture absorption than conventional seating, which in turn provides for passenger comfort with less use of the vehicle's air conditioner.  New bio based materials may also appeal to automotive consumers concerned about environmental health effects and fossil fuel usage.  About half of JCI's 2007 sales were in this division, but most of the company's growth comes from the other two divisions.

Conclusions

With half of the companies 2007 revenues coming from two of my favorite alternative energy sectors (efficient buildings and automotive batteries), and these parts of the company growing much more rapidly than the auto parts division (which is likely to be a great competitive advantage in selling batteries and power systems to automakers,) JCI is a must for alternative energy investors attracted by the superior economics of energy efficiency.  

The stock has declined significantly since the start of the year, but it currently seems only fairly valued to me at the current price of around $34.  However, a decline in auto sales caused by a slowing economy, along with an increased debt burden due to recent acquisitions could easily hurt short-term profits.  With continued stock market weakness, patient investors could easily see some excellent buying opportunities in the next 6-12 months.  If we do, I will be buying more.

Click here for other articles in this series.

DISCLOSURE: Tom Konrad and/or his clients have long positions in JCI.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 04:18 PM | Permalink | Comments (0) | TrackBacks (0)

Peak oil is likely to have everyone re-examining their transportation options over the next few years.  Rail will likely be one of those options given special attention because rail transportation is inherently much more fuel efficient than road based transport.

I first mentioned Trinity Industries (NYSE:TRN) in November as a rail transit related stock.  I didn't give it an in-depth look because rail transit is only a tiny part of its business, but investors interested in the broader rail sector will be very interested.

Not only is Trinity focused on the most energy efficient form of land transport, its fundamentals should appeal to the value investor.  A forward and trailing P/E of around 8.5, and a price to book ratio of less than 1.5 are so low they make you wonder if something is seriously wrong with the company.  The company has been investing aggressively over the last few years (something I consider prudent given the prospects of the rail industry.)  The aggressive investment program has resulted in consistently negative free cash flow, and has been primarily financed by new debt.  However, their debt to equity ratio is still a comfortable 0.86.

Trinity's businesses include railcar manufacture, railcar leasing, inland barge manufacture, construction materials (mostly concrete and highway crash cushions), liquefied gas canister manufacture, and Wind tower manufacture.  Investors interested in efficient transport and clean energy will be keenly interested in all these businesses with the exception of construction materials and LPG canisters, which constitute[.pdf] less than 30% of revenues and less than 20% of operating profits.  Interestingly, the manufacture of LPG canisters and wind towers share facilities, which allows them to buffer the wild swings in wind tower demand driven by changes in the production tax credit by shifting manufacturing between these products.

Trinity is a group of related growth businesses, mostly focused on efficient modes of transport, priced like a value company.  To me, the company seems too good to be true, so I went looking for dirt in their SEC Filings.  Their corporate governance seems comprehensive and robust.

The firm shows a talent for financial engineering, but only to an extent that seems appropriate to a rapidly growing company in several capital-intensive industries.  This talent seems to have allowed them to secure a large quantity of low cost debt.  Company insiders have been net buyers of the stock since it dropped below $40 last July, a factor which enhances my confidence of a lack of skeletons in the closet.

Trinity will release 4th quarter earnings after the close on February 20.  I expect a positive earnings surprise, although given the current mood of the market, that's not a guarantee of a jump in the stock price.  The 13.7% positive earnings surprise in November lead to a price drop, since the surprise wasn't as big as in previous quarters.  I don't see any reason to chase this one.  $29 seems like a good price to me, but the economic slowdown and a slowdown in Trinity's earning growth may provide opportunities to pick up this solid company at even lower prices.

Click here for other articles in this series.

DISCLOSURE: Tom Konrad and/or his clients have long positions in TRN.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 02:42 PM | Permalink | Comments (5) | TrackBacks (0)

On January 13th, I posted some speculations about how many people really want an Electric Vehicle that can go 400 miles without having to recharge.  It was only a little over a week ago, but in the few days since then we've learned that what I used to call a "Plug-in (Series) Hybrid Electric Vehicle" (PHEV) is now called a "Range Exteneded Electric Vehicle" (REEV.)  How quickly times change.

I also posted a poll to test my speculations at the end of the article.  I asked about the Aptera, which will be offered in both EV and "REEV" versions: Would be willing to pay the extra $3,000 it is likely to cost for the REEV, and would they have another vehicle as well?  The results are in, and they contain a number of surprises, but also some confirmation.

Ignoring respondents who weren't sure, wouldn't buy either version, or didn't know what I was talking about), here is a summary of the results:

In the original article, I hypothesized that:

1. People in multiple car households would be more likely to buy the EV than people in single car households, since they would have the option of using the other car for long trips.  This guess was confirmed by the poll.
2. Over 60% of multiple car households would opt for the EV version.  Here, I have underestimated the the attraction of long range even in multiple car households.
3. Most single car households would opt for the REEV version, since they were less likely to have other options for long trips.  Nevertheless, I significantly underestimated the attraction of EVs to single car households.
4. Combining the above, I hypothesized that at least 30% of all Apteras sold would be the EV version.  In this case, my errors seem to have cancelled out, with 38% of respondents preferring the EV.

What can we conclude?

1. I enjoy theorizing on very little evidence.
2. While having another vehicle is a significant factor in the decision between an EV and an REEV, this is not the sole dominant factor in the decision.
3. There is a significant market for highway capable, pure electric vehicles with limited range.

All of which leaves me with more questions than answers:

• Why is Detroit obsessed with REEVs?
• Why is no US carmaker considering an EV, when they are all rushing to come out with REEVs and PHEVs? 
• Are the major carmakers leaving themselves open to outside competition?

Comments are open.

Posted by Tom Konrad at 12:03 AM | Permalink | Comments (4) | TrackBacks (0)

Romm v. Kholsa

In a persuasive series of articles, entitled "Pragmatists vs. Environmentalists" (Parts I, II, and III) on Gristmill, Vinod Khosla provides the reasoning behind his "dissing" of plug-in hybrids, which drew the ire of Joeseph Romm.  Neither seems to think the argument is settled, and Joeseph Romm returns fire here.

As someone who knows as much about investing as Joe Romm and has written as much about Climate Change and Energy Policy as Vinod Khosla, I feel the need to jump into the debate and settle the matter.  (Will either of them will notice?)

To summarize, Khosla argues that cellulosic ethanol shows more promise for reducing carbon emissions than plug-in hybrids because he sees the barriers to plug-ins (the need to improve batteries and clean up the grid) as harder to surmount than the barriers to cellulosic ethanol (the improvement of conversion technology.)  In his words, 

I consider replacing coal-based electricity plants (50-year typical life) a much longer, tougher slog than replacing oil with biofuels (15-year car life).

Romm blasts back reiterating the multiple problems of corn ethanol in response to the first of Khosla's series, but has not yet responded to his point about cellulosic.  I thought I'd tackle the point about cellulosic myself.

There Isn't Enough Biomass

According to the National Renewable Energy Laboratory's From Biomass to Biofuels [.pdf] study, given all the available biomass in the United States, we will only be able to displace a little less than 2 billion barrels of oil equivalent a year.  But we currently use about 7 billion barrels of oil a year, so to displace all our oil usage, we would need nearly a 4x increase in fuel efficiency (not the 1.5x increase in internal combustion engines Khosla talks about.) 

Image source: NREL (From Biomass to Biofuels)

If the problem we're trying to solve is the need to displace petroleum as the transport fuel of choice (because of both climate change and peak oil), Khosla's "solution" can at best only tackle about 40% of the problem.

A Third Way: Cellulosic Electricity

Now let's return to Khosla's belief that it is simpler to replace the fuel (petroleum) in vehicles than the fuel (coal) in the grid, because of the longer lifetimes of coal plants than cars.  If you take a moment to review my article Ten Insights into Carbon Policy, you will note (insight #2), co-firing biomass in existing coal plants is more effective for reducing carbon emissions than turning it into liquid fuels.  You will also note (insight #9) that electric drivetrains are inherently more (5x) efficient than gasoline drivetrains.

Khosla may be right that we are not going to shut down old coal plants quickly (although my own utility, Xcel Energy, is planning to do just that.)  But even given an existing fleet of coal plant some biomass can be cofired with coal in existing plants with relatively easy retrofits.  Cofiring biomass is part of the Arizona Renewable Energy Assessment, which Black and Veatch predict would cost about 6-7 cents per kWh, and the limited amount included in the assessment is mostly due to Arizona's limited biomass resource.

According to the NREL report referenced above, converting biomass into cellulosic ethanol can be done at about a 45% efficiency (i.e. 45% of the energy of the biomass makes it into the fuel.)  In contrast, biomass can be converted at 33-37% efficiency [pdf] when cofired.  Combining this with the 5x improvement of drivetrain efficiency that comes with electric propulsion, and the same amount of biomass converted to what I'll call "cellulosic electricity" will take a vehicle 3.8x as far as it would in the form of cellulosic ethanol.  In a more recent article on Biomass, Vinod Khosla states "we consider [Energy Return on Investment] a less important variable than carbon emissions per mile driven."  If carbon emissions per mile driven are the most important variable, a 3.8x increase in miles driven on the same energy source will lead to a less than 27% of the carbon emissions per mile driven.

While cellulosic electricity is still not sufficient to displace all of our current petroleum use, it comes much closer than cellulosic ethanol.   Biomass cofiring with coal also tends to reduce SO_x and NO_x emissions.

Direct Combustion of Biomass

Biomass is a distributed resource, seldom available in large quantities in any one place.  This will be a problem for the cellulosic ethanol and cellulosic electricity industries.  Only a fraction of the available biomass will be close enough to existing coal plants that it will be practical to transport for cofiring.  Cellulosic visionaries see a system of distributed ethanol plants, yet that still leaves the problem of getting the fuel to market, since the current pipeline system for petroleum products has difficulty accommodating ethanol.  

On the other hand, while distributed direct- fired biomass generation of electricity is probably twice as expensive as cofiring with coal, distributed generation leads to opportunities for Combined Heat and Power (CHP), or cogeneration.   CHP can displace heating fuels such as natural gas, propane, or electricity, and often have combined efficiency from 50% to 80%.  In addition to the potential of displacing additional fossil heating fuel, cellulosic electricity is identical to the fossil fuel derived kind.  Therefore, unlike cellulosic ethanol, cellulosic electricity is completely compatible with the existing electric grid, leading to far fewer difficulties in transport.

A Cellulosic Sideshow

While I'm sure that economic techniques to convert various forms of biomass into ethanol and other liquid fuels will be developed, including by some of the companies in Khosla's portfolio, I think it is unlikely that a large fraction of what is likely to become an increasingly valuable and scarce resource, biomass, will be used for ethanol.  As a scarce resource with relatively inelastic supply, the price will rise to the point where only the most efficient uses will be profitable.  In most cases, cellulosic ethanol is unlikely to be one of the most efficient uses of biomass.

Khosla's dichotomy of replacing cars versus replacing coal plants is a false dichotomy.  While it is easy to retrofit gas cars to burn ethanol, it is also easy to retrofit coal plants to burn some biomass.  Given the dispersed and varied nature of the feedstock, both solutions are likely to coexist for a long time, but biomass cofiring has a little-heralded head start (unlike cellulosic ethanol, it is already progressing beyond the experimental stage), and cofiring's superior efficiency should allow it to keep, and widen its lead.

But Vinod Khosla will have little reason to weep.  His Concentrating Solar Power investments will also be fueling our cars, and his "clean coal" technology has the potential to produce carbon-negative cellulosic electricity.

Posted by Tom Konrad at 02:25 AM | Permalink | Comments (9) | TrackBacks (0)

The logic behind Plug-in hybrid vehicles (PHEVs) is that they combine the best characteristics of a Electric Vehicles (EVs), most importantly efficiency, which brings with it much lower operating costs and lower net emissions and no tailpipe emissions, with the benefits of a liquid fuel vehicle, mainly the range available with energy-dense liquid fuels.

But how important is range to car buyers?  PHEV advocates say that 80% of all daily car use is less than 50 miles, which is easily achievable with today's electric vehicle (EV) technology.  The freeway-capable EVs being developed today have a range between 100 and 200 miles, as you can see from the following comparison, which is edited down from a helpful comparison by Robert Green at DIY Electric Car (follow the link for an expanded table and sources.)

Still, I wondered how much do people value range in a vehicle?  It finally occurred to me to ask.  

On January 1st, I posted a poll.  In the hope of getting less biased results, I didn't want people to know why I was asking.  My question was, "At what price would you stop filling up your gas tank all the way?"  When someone does not fill their tank all the way, they are implicitly saying that they have better uses for their money than extending the range of their car.  I asked about a car that had a 400 mile range, so I found out what the last miles were worth to people on a per-mile basis.

A Demand Curve for Range

Here is a graph of my results (blue line), which we can take to be an approximation of the demand curve for range.  I was surprised at how little gas prices had to rise before people stopped filling up all the way (ignore the green supply curves for now.)

A person who only fills up a 400 mile gas tank halfway is not saving much money, only delaying when the money is spent, as the tank must then be refilled sooner.  75% of my respondents said they would not fill up all the way if fuel cost $0.40 per mile.  If these people on average only fill up the tank 1/2 of the way at $.40/mile, they're essentially giving up the last 200 miles of range for $80 loans, which they must repay if they ever decide to fill it up all the way.  Only if they never fill it past half a tank would they get to keep that $80.

Even for someone who doesn't fill up his tank all the way, there is still the option of doing so, and options are valuable, so that same person who hardly ever filled up his tank past half way would be unwilling to give up the option of ever filling it up past half way.  But most people in a two-vehicle household do have the option of using the other car, so they would likely be willing to give up that option for much less than someone in a one car household.

The Bottom Line: What's Another 200 Miles Worth?

Admittedly, the above contains many untested assumptions.  That said, here's my stab at the extra value a person in a two (or more) car household would put on a vehicle with a 400 mile range over a 200 mile range.

Since buying a car with a 200 mile range means never being able to use that extra 200 miles, and having to use the other car in the household, I'll multiply the $80 calculated above by 10 to account for the value of the option of increased range.  This puts a value of only $800 on the last 200 miles of range.

Only Eight Hundred Bucks?

$800 seems awfully low to me, considering we are talking about the price of a car.  Yet a factor of 10 still seems generous for the option value, so I've also shown the calculation for 5x and 20x multipliers in the graph; this seems like a good range for two car households.  I would assume that single car households would pay more for the extra range of a PHEV, leading to higher PHEV adoption than in multiple car households.

The high expected adoption of EVs may be due to how I phrased my poll, since I now realize I should have asked "At what price would you start only filling up the tank halfway?" rather than "Would you stop filling it up all the way?"

In any case we'll soon be able to test the demand curve for range much more rigorously.  The vertical supply curves in the graph show the per-mile cost of the extra range of a PHEV Aptera over an EV Aptera ($6), divided by 5, 10, or 20 which I'm using as estimates for the multiplier on what the option of extra range is worth to a 2+ car household (for single car households, this line would probably be farther to the left than the 20x line.

As you can see from the graph, if the option of increased range for a single car household is 10x the cost of the extra fuel to fill up, only 22% of multiple car households would buy the PHEV over the EV.  Most likely at least half of Apteras will be bought by households with another car, and a few single-car households will also buy the EV version, so I estimate that no more than 70% of Apteras sold will be PHEVs (at least 30% EVs), if they stick to the announced pricing structure.

Time (and, I hope, Aptera) will tell.  You can say what you'd do below:

Posted by Tom Konrad at 06:28 PM | Permalink | Comments (5)

Investing in Renewable Energy Stocks seldom fails to be exciting, although it can lead to crushing losses as well as mouthwatering gains (Think Ethanol stocks and Thin Film Solar in 2007.)  With this in mind, I usually emphasize that the majority of most investors portfolios should be targeted towards larger, profitable companies, especially those focused on Energy Efficiency rather than the more sexy Renewable Energy technologies.  This is the philosophy behind Alternative Energy Stocks' Blue Chip Portfolio: companies which aren't sexy, but which still are well positioned to take advantage of rising oil prices and increasing efforts to reduce and regulation of Greenhouse Gas Emissions.

That said, a small exposure to even extremely volatile stocks can, if kept small, improve the risk-return profile of a portfolios, so long as those stocks are not overly correlated to the portfolio as a whole. 

Other people just like to gamble.   Given the vertiginous returns we have seen in the alternative energy sector recently (First Solar, NYSE:FSLR is up by a factor of ten in 2007,) it's a safe bet that this Alternative Energy has drawn more than our share of gamblers.

This article is for the gamblers (and a little bit for the cautious diversifiers.)  If you're a gambler, these are the gambles I would be taking.  If you're a cautious diversifier, you can consider using a few of these bets as a way to diversify your portfolio of bonds and energy efficiency companies, just keep it small (no more than a few percent your portfolio.)

In either case, be prepared to have any of these bets go wildly wrong, or succeed well beyond your expectations.  

Some Educated Hunches

Many people who see themselves as cautious diversifiers like to set aside a small part of their portfolio as "play money," which they can use without their normal portfolio discipline, to invest in something that makes them feel good.  I feel this is the wrong approach.  Emotional investing is a sure-fire way to stack the odds against yourself.  Even in risky assets, there are good bets and bad ones.

Especially when it comes to highly risky and emotive companies, I'm a great believer in Behavioral Finance, the theory that investors make the same mistakes over and over again because of the way our emotions are wired.  Roughly, this means that we all tend to invest in the same stocks at the same time because it feels good to do so (which means we buy precisely when the price is irrationally high) and sell the same stocks precisely when they're screaming bargains.

My favorite gambles therefore are stocks I think have the potential to be tomorrows feel-good fad, that is currently being ignored.  I call this gambling because it has very little or nothing to do with the underlying fundamentals, an a lot more to do with wild emotional swings of the retail investor.  While it is gambling, it has more in common with card-counting, than with slot machines.

Ten Gambles for 2008

I personally am more a cautious diversifier than a gambler, but I do have some gambler in me.  All the speculations below are ones I am taking with my own money, and some of them are also positions in client portfolios.  I don't see this as play money, but at the same time, I know that any of these gambles cold turn against us unexpectedly, and I keep the positions accordingly small.  In reverse order of my guess at their riskiness, here is the first installment detailing ten bets I'm currently making, and which I expect to pay off as a whole in 2008 (although individual stocks will undoubtedly be losers.)

#10 and #9: Cree, Inc. (NasdaqGS:CREE) $23.50, and Lighting Science Group (LSGP.OB) $0.32.

I've been invested in both of these for a long time, and last wrote about these LED stocks in June.  I sold half the holdings of many of my managed accounts  soon after that article when CREE was around $27-$30, about double the price at which I'd bought them.  Smaller positions in Lighting Science Group have followed a similar pattern, mostly due to buyout speculation in LED stocks, with only modest gains over the last year as speculation has died down.

Yet the fundamental reasons to be bullish about LEDs are stronger than ever.  This Christmas season was the Season of LEDs in more ways than one.  In my personal experience, I went to Target on December 15 to get another string to add to the ones I'd bought last spring, and found that they were totally sold out (although conventional lights were well in stock.)  I left empty handed, but I expect that Philips (NYSE:PHG - another holding), will report LED sales well above expectations this quarter.

Also, while solar stocks may suffer with tax incentives removed from the recently signed Energy Bill, the bill did contain a "Ban the Bulb" provision, phasing out incandescent lights by 2014.  Lighting Science saw a 20% jump the day it was signed, but it's still way down from its highs last summer, and Cree didn't budge.  It's true that most incandescent bulbs will probably be replaced with CFLs, but LEDs work better in several sorts of applications: they are dimmable, work better at low temperatures (such as in freezers), and are more tolerant of vibration.  Thus, the new law provides a practically guaranteed, large market.

I'll be surprised if both these stocks don't see significant run-ups sometime in 2008, and Lighting Science could easily see one soon after the New Year, due to the publicity they'll be getting in Time Square on New Year's Eve.  Most likely, we'll have to wait a little longer than that, but even without a run-up or buyout, I see these two as good long-term bets.

For hard-core speculators, one LED penny stock that you might look at is Cyberlux (CYBL.OB.)  Cyberlux was brought to my attention by a reader the last time I wrote about LEDs.  I looked into it again last week, but decided not to invest because of the large overhang of convertible debt.  In my analysis, it will be virtually impossible for long-term shareholders to profit because of the expected dilution due to the convertibles.  That does not mean that short term traders might not make a killing (or lose their shirts.)  For more on Cyberlux, go to this message board (run by the reader who brought the stock to my attention.)  There's a lot of information there, although I don't know if its accurate.

#8 Maxwell Technologies (NasdaqGM: MXWL) $8.10

Maxwell is a developer of ultracapacitors, which are currently used in wind turbines, utility power quality applications, and other industrial applications.  Wind should continue to see strong growth throughout the world, which should continue to help turbine component suppliers.

They also have the potential to be an important component for energy storage in Hybrid Electric and Electric vehicles.  Maxwell has recently announced a partnership with China's Tianjin Lishen Battery to manufacture hybrid powerpacks, which will combine the speed, long cycle life, and low temperature performance of ultracapacitors with the large energy storage capacity of lithium-ion batteries.  Readers and anyone who has seen one of my presentations already knows that I see energy storage as the best way to take advantage of the adoption of hybrid, plug-in-hybrid and electric vehicles.

The downside here is that Maxwell is currently in a large patent-infringement suit with private ultracapacitor company NessCap.  I find patent-infringement suits to be very unpredictable.  Maxwell filed the initial complaint in October 2006, and NessCap countersued in December.  A large negative earnings surprise last June and subsequent analyst downgrades further depressed the stock, possibly aggravated by tax-loss selling.  I see a good chance of a quick rebound in 2008, especially if the courts start ruling in favor of Maxwell, or the two companies reach a settlement. While negative ruling would hurt, they would be unlikely to destroy the company.

Maxwell's top-line revenue has been flat for over a year, so a large part of the recent price drop has likely been due to investor fatigue.  Nevertheless, insiders have been buying the stock on the open market, which I find reassuring with regard to internal confidence at the company.  Any significant uptick in sales volumes would likely bring with it a strong increase in the stock price.

Picks 4-7 are here, and Picks #1-3 are available here.

I decided to split this article into parts because the stocks I'm picking seem to be rising even as I write... I was clearly not the only person who has been thinking along these lines over Christmas...

Here's what has already happened to picks #8,9, and 10 on December 26, as I was writing:.

Cree jumps on American Technology Research Comments (up 10.7%); Lighting Science up 25%; Maxwell Technologies up 6%.

DISCLOSURE: Tom Konrad and/or his clients have long positions in CREE, LSGP, PHG, MXWL, and a short position in FSLR.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 12:56 AM | Permalink | Comments (3) | TrackBacks (0)

Last month, I wrote that investors concerned about peak oil should invest in suppliers of alternatives to driving.  One of the sectors I highlighted was public transit: busses and rail, although I did not provide any stock picks at the time.

Here, I will focus just on rail transit.  It's a bit tricky to invest in rail transit systems as they are operated by cities, not by private companies, so I took a step up the value chain and started looking for companies which supply transit operators.  I focused not on rail line operators, but suppliers, since these companies are most likely to participate in a boom in urban mass transit.

Here's what I found (in order of the strength of their exposure to mass transit.)

Rail Stock #4: A Speculative Hybrid Locomotive Stock

Charles first brought Railpower Technologies to your attention in January.  Railpower (RLPPF.pk, P.TO) is maker of hybrid diesel-electric yard-switching locomotives.  We like the technology, but the Railpower story is typical of a lot of cleantech stocks: they're having trouble turning cool technology into sales and profits.  

With a recent investment from one of Canada's largest pension funds, a two-bit stock price, and a recent order from Union Pacific (NYSE:UNP), Railpower's long stock price slide may be over, but despite the investment by Ontario's Teacher's Investment Plan, this is hardy a widows-and-orphans stock.

This company does not have direct exposure to rail transit, and its success or failure is more likely to be driven by company specific factors such as execution and the ability to enter into profitable contracts (their record has been poor in the past, but they have likely learned from painful mistakes.)  

Nevertheless, a growing concern about climate change and rising fuel prices create an environment which should make their products much easier to sell than in the past.  This is clear from the fact that both Union Pacific and the pension fund cited global warming in their decisions.

Rail Stock #3: Diversified Rail, with a Little Wind

Trinity Industries, Inc. (NYSE: TRN) is a conglomerate, with a strong presence in rail.  They also have an inland barge division, another form of highly efficient transport, and an arm which constructs (among other things) structural wind towers.  This closely held company has been seeing significant purchases by insiders, but has been recently downgraded by two of the seven analysts following the stock, despite higher 3rd quarter profits.  

The recent price drop following the downgrades has me watching for opportunities to buy this stock on the cheap.  I always hate it when this happens, but I find myself agreeing with Jim Cramer.

Rail Stock #2: Railway Maintenance

Portec Rail Products (NasdaqGM: PRPX) supplies rail joints, anchors and spikes; railway friction management products; railway wayside data collection and data management systems; and load securement systems.  Regular readers know that I love boring stocks, and railway maintenance fits the bill nicely.  Protec is solidly profitable, and the lone analyst following the stock has recently raised his estimate for future earnings.  Revenue is growing at 15% yoy, and they have no debt.  

Portec serves both railway and transit customers in North American, Canadian, and British markets, and are positioned to benefit not only from any industry growth, but also from a growing need for efficient operations, which should also increase the interest in good track maintenance. 

 Rail Stock #1: Global Diversification, Strong Mass Transit Exposure

Wabtec Corporation (NYSE:WAB) is a global rail services firm, with business on five continents.  The company has been growing both earnings and margins.  Of all these companies, Wabtec has the largest current exposure to mass transit, serving virtually every major intercity passenger transit system in North America.

However, insiders have been selling the stock, despite the fact that analysts have been raising their estimates of future earnings.  This one bears watching, but I trust insider actions more than analyst estimates, so I would not be surprised if we see some disappointing news in the next couple quarters.  If bad news does emerge, that may be a good time to get some excellent exposure to an industry poised to benefit from rising oil prices.

DISCLOSURE: Tom Konrad and/or his clients did not have positions in any of the stocks mentioned at the time of this writing.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 04:12 PM | Permalink | Comments (0) | TrackBacks (0)

Is General Motors (NYSE: GM), with their plans for as many as 100,000 Volts in 2009, or Toyota (NYSE:TM), with their long term lead (and behind-the-scenes research) in hybrid technology, or some other carmaker going to win the race to bring consumers the first commercial Plug-In Hybrid Vehicle (PHEV)?  More importantly, will it matter?

The All-Electric Dark Horse

Ballard's (NASD:BLDP) recent confirmation that they are in talks with big automakers left many wondering if the Fuel Cell Vehicle is finally dead.  The consensus is now that the next generation of propulsion system will be the PHEV, which combines the range of liquid fuels with the efficiency of an electric vehicle.  One reason I thought hydrogen was a non-starter as a fuel was that it could not supply much range due to its low density (except at high pressure, which increases the cost of an already expensive hydrogen still further) leaving it to compete with pure electric vehicles on efficiency, a battle it was doomed to lose because of the inherent inefficiencies of producing hydrogen, and the high cost of Fuel Cells.

So is the road ahead clear for the triumph of the PHEV?  I doubt it.  I do expect many PHEVs to be built sold, but I think they are likely to be a gateway drug to real efficiency: the pure Electric Vehicle (EV.)  

The internal combustion engine (ICE) is a complex machine, with over a century of research and development designed into it.  This complexity makes it extremely difficult and expensive for new carmakers to break in to the market without substantial state support.  I'm not an expert on the car industry, but I have read constant news stories about countries massively subsidizing their carmakers, always with the goal (not always matched with success) of nurturing a national car maker.  

On the other hand, there are at least 22 Electric car startups (not counting aspiring makers of electric bikes, electric motorcycles, and stranger contraptions) today, each competing to break in as a new manufacturer.  I expect that some of them will succeed, and that the traditional car manufacturer who are currently pursuing the PHEV will be relctant to forsake their highly refined ICE technology.  Existing carmakers could thus fail to head off outside competition, leaving a niche open for EV-only manufacturers.

I'm not trying to say that the internal combustion engine is dead, long live the electric motor (although I wish I were), but I do expect that a growing proportion of the vehicle fleet will be all electric, even as Plug-In Hybrids are gaining ground.

Advantages of the EV

Along with the much lower complexity, the primary advantage of EVs is cost.  PHEV advocates say that 80% of all daily car use is less than 50 miles, which means that, most of the time, a PHEV will be operating as an electric vehicle.  Now suppose that Matt Simmons is right, and oil will soon hit $300 a barrel, along with $10 gas.  While people will be clamoring for public transport, many suburban dwellers will not have that option for a long time.  A time-tested American solution to most problems is to buy something, but money is likely to be tight (because of those same high gas prices.) 

Will that something be a PHEV or an EV?  Most people will already own a conventional car, which they can use when they need the range that energy-dense gasoline can provide, for the vast majority of trips.  The rest of the time, a true electric vehicle will suffice.  So why pay an extra $10,000 or so for a new ICE in your electric vehicle, when you already have one in the old car? (Estimated from the fact that the Zap Xebra MSRP is $10,500, while the cheapest hybrid today has a sticker price of $20,950.  The Xebra has a top speed of only 40 MPH, but the Prius I'm comparing it to is not a full PHEV, either.)  EVs may get a greater price advantage if the batteries are leased instead of owned.

In addition to the extra cost, an ICE and its fuel add weight to the vehicle, reducing the vehicle's efficiency.  In other words, PHEV buyers will not only be paying extra to add an ICE to their electric vehicle, they will be paying again in terms of lower performance and higher operating costs in all-electric mode.  This leads to an interesting thought: if the big automakers are confronted with EV upstarts cannibalizing their PHEV sales, might they just start selling cars in both PHEV and EV versions, perhaps with the engine and fuel tank of the PHEV replaced by more batteries?

Investing in Electric Vehicles

I think it's still too early to start trying to pick winners in electric vehicles.  This is a disruptive technology, which puts everything up for grabs.  I can say, however, that investing in traditional car-makers is probably more risky than most people Th!nk.

That said, here are the two public EV companies I know about (most are private.)  Zap (ZAAP.OB) and Zenn (ZNNMF.PK).  A much safer bet however, is an industry that's likely to be supercharged by the adoption of either EV and PHEV technology: Batteries.

DISCLOSURE: Tom Konrad and/or his clients did not have positions in any of the stocks mentioned at the time of this writing.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 11:36 PM | Permalink | Comments (3) | TrackBacks (0)

Technology cannot save us

Technology will not save us from peak oil, but the invisible hand of economics will.  It's easy to get excited about all the amazing new vehicles the world's car-makers are promising us.  Even if we believe manufacturers' hype, the Cadillac SRX your neighbor bought last week will be on the road for at least a couple decades, and all the fuel saved by your next plug-in hybrid will not make up for the amount it guzzles.

I, and many others, believe that the Western World will soon have to cope with much less oil than we are accustomed to, without the ability to increase the efficiency of our vehicle fleet significantly in the near term.  Since the oil supply available will not be increased significantly at any price, the result will be demand destruction: people will drive less.  Even alternative fuels are limited by available feedstocks, and can only moderate the crisis.  Yes, Americans have shrugged off $3 gas and are still driving like it's 1999, but when supply is constrained, the question becomes not: "Will $5 gas make people drive less?" but: "What price will gas have to reach to force people to drive less?"

I frankly don't know what price it will take to reduce oil consumption significantly, but I do know that whatever that price is, that is how much it will cost when we are confronted with reduced supply.  There's little doubt in my mind that fuel prices will be high, and headed higher.

Mode Shifting will save us

When it comes to drastically reducing oil use, the only short-term option is mode shifting: Carpooling, Biking, Public Transport, and Walking.  Westerners, and especially North Americans are typically very resistant to mode shifting because our cities are designed for cars.  Public transit is slow and unpleasant, and walking or biking are seen as downright dangerous.  Ironically, even before oil prices rise, mode shifting has gigantic societal benefits in terms of cost, health, and safety [.pdf], and can be encouraged with market based fixes such as congestion pricing, parking cash outs, and Pay as You Drive auto insurance.

But it will be painful

In some places, these fixes are happening, but in far too many they are not or are too slow.  This is because of  a classic chicken-and-egg problem: public transit mostly slow and uncomfortable because most people who vote drive cars, while most people drive cars because public transit is slow and inconvenient.  There certainly are exceptions, and far sighted cities like my own Denver are engaged in rapid build-outs of public transportation.  When the majority of voters are forced out of their cars by higher fuel prices, the public will demand a massive increase in such investments everywhere, but not until the realization slowly dawns that gasoline prices are high and rising, and public transportation and biking and walking is not just for the poor.  It can also be a virtuous cycle: Where levels of biking and walking are higher, bicycle and pedestrian safety is greater.

The sooner we realize that we are not going to be able to cling to our cars forever, the sooner we can start readying our cities for the transition, and the less painful that transition will be.  It also means that investors with the foresight to invest in mode-shifting industries today will be able to benefit from the trend sooner.

Sectors to Consider

It is possible to invest directly in some of the market fixing strategies that encourage public transit, but the companies involved tend to be small and private (or both.)  I prefer established companies which already have profitable businesses that will simply become more profitable when people take up new modes of transport.  The three sectors which have drawn my attention are manufactures of bicycles, light rail, and busses, and component makers for each. 

I plan to write about specific companies which will benefit from mode-shifting in future articles here.  Until then, you can follow the links above for some sector company listings.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.

Posted by Tom Konrad at 07:51 PM | Permalink | Comments (2) | TrackBacks (0)