Top Five Ethanol Picks

With corn prices up and ethanol prices down, profit margins for ethanol producers are brutally slim.

Shares of many ethanol companies have been in a freefall for months, a number plunging 50% or more, even as interest in alternative energy continues to gather momentum.

What's the problem? The market has a glut of ethanol, and there are still more than 80 new refineries slated for construction in the next year. And this comes at a time when corn-based ethanol is facing mounting criticism for its role in driving up food prices and questions about whether other feedstocks are less reliant on fossil fuels in the first place.

Though it's difficult to look past the growing hurdles, a few ethanol companies should ultimately prove hardened enough to survive, especially if the politicians in Washington provide an assist.

Ronald Miller, CEO of Aventine Renewable Energy(AVR), said in a speech last fall that many of the proposed ethanol plants ultimately won't receive financing if the broader problems persist.

That's great news for the best-of-breed ethanol companies. A thorough cleansing of the space is exactly what they need to eliminate the oversupply and fatten their margins.

Most analysts agree that stocks in the ethanol space will likely remain flat through 2008. However, investors with a slightly longer time horizon could reap rewards. Of course, not all names are created equal, so your best chance to find a winner lies in five stocks. Don't confuse this with a ringing endorsement. Instead, think of these as the best houses in a struggling neighborhood.

Top Players

VeraSun(VSE) is the popular favorite in the pure-play ethanol space, boasting the strongest analyst ratings of any name in the sector. The fact that its average rating is neutral reflects the problematic economics of the ethanol space itself, rather than the way that VeraSun is being managed.

The company harbors the most ambitious expansion program of any of its peers. After it announced last month that it will acquire US BioEnergy(USBE), its production outlook surpassed agriculture giant Archer Daniels Midland (ADM), with an expected capacity of 1.75 billion gallons of ethanol by the end of 2008.