Ethanol, to be sure, is here to stay.
But if you look at the falling stock prices of companies that produce it below, you might be tempted to view it as "demon ethanol." Unfortunately, some very common myths about ethanol may keep you from investing in these stocks now that the prices have been beaten down.
Why should investors take another look at the ethanol concept?
Here are some ideas for investors in high-growth stocks to consider:
The new law creates a big ethanol and biofuels market opportunity.
The Energy Independence and Security Act signed last December mandated fuel economy, development of biofuels and energy efficiency. This law set a goal of 36 billion gallons of alternative fuels (largely ethanol) by 2020. It is widely recognized that the maximum production of ethanol from corn starch is only 15 billion gallons a year, implying a mandated production shortfall of some 21 billion gallons a year.
Two large companies produce nearly half of the ethanol fuel in this country, and the whole industry capacity would have to go up sixfold to meet the mandate.
Think about this a minute. At the current average pump price of $2.77 a gallon of blended E85 ethanol, President Bush and Congress created a market with an annual revenue potential of more than $100 billion a year. This is big business.
Investors initially reacted very positively to this news last November, driving the ethanol stock prices up 40% to 60% in 30 days. Then the next reality set in.
But the new mandate also creates a supply gap.
Ethanol is a great opportunity, but it is not without its challenges.
The federal mandate cannot be reached solely using U.S. corn-based ethanol alone. According to some studies and projections, even if we planted all our farm land with corn, we could not meet the goal without major changes.
We will need new technologies for production.
Fortunately, ethanol can be produced from nonfood crops, such as switch grass and straw. However, these approaches can not yet compete in the marketplace, and they are unlikely to do so in the near future.
We will need more alternative-fuel cars.
All major American auto makers offer models called Flexible Fuel Vehicles, or FFVs, that can actually run on E85, E-10 Unleaded, ordinary unleaded gasoline -- or any combination thereof. The computerized fuel system automatically adjusts for the level of ethanol in the fuel. In other words, FFV owners do not have to fill up with E85 all the time.
We will need more distribution.
Today there are 1423 public gas stations that dispense E85 fuel, and the number increases every day. But vendors of E85 still make up less than 1% of the total gas stations in the country. Go to the
National Ethanol Vehicle Coalition Web site to find a station near you.
We will need more imports.
The U.S. currently fills the supply gap by importing lower-price sugarcane ethanol from Brazil, which is subject to a much-debated 54-cent per-gallon import tariff. There is a growing global market for ethanol fuel, and Brazilian producers are aggressively working to increase their ethanol production capacity from 5 billion to 7 billion gallons of fuel alcohol a year by 2010.
We will need luck.
If ethanol fuel production depends on farm crop harvests, then weather will become an even more important and uncontrollable factor in our economy.
Speculation has driven up production costs. The ethanol supply issue has had a very negative effect on corn prices and, indirectly, food inflation. At current September futures prices of $6.24 per bushel, some ethanol producers cannot turn a marginal profit. They will need to dip into their capital to fund needed growth.
Investors are less enthusiastic about ethanol now and are staying away from startups. Just last month,
filed for bankruptcy as it was unable to get a new capital infusion. The weaker capital market for ethanol stocks has been signaling a consolidation was needed after a dot-com style craze period.
This new cost and capital scenario will nonetheless benefit the larger companies in the sector that have the market position and capital to grow either organically or through mergers and acquisitions. It will also benefit the companies in the agricultural, transportation and other areas that service this growing activity.
How to invest in the ethanol business.
Stick with the larger ethanol producers.
Here are the top three international-scale producers, ranked by ethanol production capacity expected for 2008.
( VSE) is the largest publicly traded ethanol stock. Now that its merger with US BioEnergy is completed, the combined entity will have capacity to produce 1.64 billion gallons of ethanol annually.
Archer Daniels Midland
ranks as the second largest producer of ethanol with 1.4 billion gallons of installed capacity coming online in 2008. Ethanol is not a large business at ADM yet, but the company's $1 billion in cash on hand and multibillion-dollar balance sheet can certainly make a difference. According to ADM management, "We're devoting a lot of time and energy to this area (ethanol). We're not talking about something 10 years down the road. It's on the front burner."
, through its subsidiaries, manufactures and sells of sugar and sugar cane-based ethanol, primarily in Brazil. It is Brazil's largest ethanol producer with a low cost profile, and the world's largest exporter of sugar cane.
For a free LatinCapitalMarket.com stock report on Cosan, the leading international ethanol company, click here.
Find stocks that will benefit from ethanol production, transportation and other services.
Companies that provide fertilizer, seeds and equipment to the agricultural sector will be huge winners, and we are likely to see the big-name stocks continue to benefit from the forces we discussed.
One way to do this is through a mutual fund that holds the largest agricultural stocks.
Last year, a new ETF came out that does just that. It's the
Market Vectors Agribusiness
. The top five stocks in this portfolio represent 40% of the holdings, and the fund's holdings list reads like a Who's Who in global agriculture. IT holds
and other leading names, with 40% of its portfolio in non-U.S. stocks.
MOO is a good fund for general agriculture, but you may want to focus more on ethanol or agriculture in the Americas.
My preferred way to invest in ethanol providers may be to find the stocks in this portfolio that service both U.S. and Brazilian producers of ethanol. Four stocks immediately stand out as plays here. They were up an average of 11% last week and merit special mention.
makes Massey Ferguson equipment, and 16% of its business comes from South America, primarily Brazil. Revenues from that segment were 16% of total revenue last year and growing at a 65% annual rate. Overall earnings per share are expected to grow 22% next year.
engages in the agriculture and food business. It has operations in Latin America, North America, Europe, and Asia. Over 25% of revenue is earned in Argentina and Brazil, and another 24% comes from the U.S. Overall earnings per share are expected to grow 11% next year.
is a fertilizer company that does business in Latin America. As an alternative, you might consider
. These two high-flying stocks are up 335% and 235% respectively over the last 52 weeks and continue to climb. Large swings in prices prove that they are still cyclical stocks.
4. Monsanto sells seeds everywhere, with 19% of revenues from Latin America and growing at a 23% annual rate. Overall earnings per share are expected to grow 17% next year.
These four stocks posted on average gain of 102% during the past 52 weeks and show positive earnings growth prospects for the coming year and the next. This is an example of how focusing on these U.S.-based companies that provide required products and services to the Brazilian ethanol industry can pay off. These four stocks have exceptional balance sheets, positive earnings momentum and solid future market opportunities
Investing in ethanol stocks requires looking beyond the list of U.S. producers to see where the real money is being made.
MON, MOS BG and AG: Latin Agriculture Stocks Gone Wild!
Rudy Martin is the former director of research for TheStreet.com Ratings. Earlier he worked 25 years in investment research and management positions with Fidelity Investments, Lincoln National, Dean Witter Reynolds and Transamerica Investments. He began his career as a securities investment analyst at Duff and Phelps where he published equity and fixed income securities investment recommendations.