My Number 1 Alternative-Energy Share

Published in Company Comment on 21 September 2011

This firm converts diesel engines to run on natural gas.

In recent years I've become quite interested in alternative energy, mostly because oil companies make up more than one-third of my portfolio and it's usually a good idea to keep an eye on the competition.

I now believe the combination of environmental concerns, worries about future oil supplies (so-called 'Peak Oil') and various technological developments have made alternative energy an extremely interesting sector in which to invest for the long term.

My one and only alternative-energy investment to date is in a company with natural-gas interests. It has been listed on the Toronto Stock Exchange for twelve years, yet it still doesn't make a profit and it's the only share I've ever bought solely on the basis of gut feeling. I therefore consider it to be my most speculative shareholding.

By the way, George Soros and his funds own almost 12% of this company. So what is it?

Diesels to gas

The company is Vancouver-based Westport Innovations (NASDAQ: WPRT.US), which designs diesel engines to run on natural gas (and other alternative fuels) and the kits that convert existing diesels into gas-powered engines.

Westport subcontracts the manufacture of its engines and kits to its partners Weichai Westport, a Chinese company in which it owns a 35% stake, and Cummins Westport, which is a 50/50 joint venture with American diesel producer Cummins (NYSE: CMI).

Natural gas is a much cleaner fuel than diesel and improvements in gas-to-liquid technology mean that it's now possible to deliver it to most parts of the world without the need for pipelines. Since huge reserves of natural gas have recently been discovered in America and there is a lot of political support for cleaner fuels, the demand for natural-gas engines should increase substantially during the next few years.

In my view, Westport is ideally placed to benefit from all of this.

A leap of faith

In the television show Quantum Leap, whenever Sam Beckett leapt across time into someone else's body the first thing that he said was "Oh Boy!" That's how I feel whenever I try to value Westport.

Now I'm used to valuing loss-making oil companies because their reserves and potential reserves can be quantified and much of the sector is valued by referring to reserves rather than profits. Furthermore, most other companies that have previously been profitable can always be valued by assuming some sort of return to profitability.

But I really struggle when looking at a company such as Westport, which has never made a profit. So my investment in Westport is based upon its technology, its prospects, political trends and the likely state of the global energy market in five years rather than now.

This is something that I've never done before!

Valuing Westport

When looking at a loss-making company such as Westport, conventional metrics such as P/Es go out of the window. Instead you're forced to rely on ratios such as price-to-sales and enterprise value-to-sales, earnings before interest and taxes, as well as discounted cashflow calculations, which require some educated guesswork concerning future sales and profit margins.

Westport is currently valued at approximately US$1.6 billion. Last year its sales were $148 million and it made a net loss of about $42 million, so its shares are trading on a price-to-sales ratio of 10.5, which is pretty high to put it mildly.

Westport's most recent balance sheet showed roughly US$160 million of cash and short-term investments, which can cover four years of losses at the current rate. Total assets were $265 million while liabilities were just $82 million, which leaves a net asset value of $183 million. I suspect the goodwill in the balance sheet substantially undervalues Westport's proprietary technology, as is so often the case for this type of company.

One of Westport's closest competitors is Fuel Systems Solutions (NASDAQ: FSYS.US), although it is a fairly different business because it makes gas-conversion kits for cars. Unlike Westport, Fuel Systems is profitable and trades on a PE ratio of 47 with a price-to-sales ratio of 1.

However, the market clearly favours Westport as its shares are up by almost 75% on the year while Fuel Systems is down by almost 30% because of worries about its earnings.

The Nat Gas Act

Politics, rather than economics, is going to be the greatest influence on Westport's share price during the next few months. You see, Westport's prospects are highly dependent upon House Resolution 1380 -- more commonly known as the "Nat Gas Act" -- which is currently working its way through the US Congress. This legislation proposes substantial tax breaks for anyone who buys a new vehicle that runs on natural gas. If the legislation is passed, I feel demand for Westport's engines should increase dramatically.

Westport received a significant boost during May when President Obama issued the Federal Fleet Memorandum, which required all new light-duty vehicles leased or purchased by federal government agencies to be alternative-fuel vehicles by December 31st 2015.

Deals, deals

The proverbial rocket has been put under Westport's share price in the last few months thanks to a marketing deal with Royal Dutch Shell (LSE: RDSB) and an agreement to develop engines for General Motors (NYSE: GM.US).

With deals like these, it's a fairly safe bet that Westport is going to be selling many more natural-gas engines in a few years' time. The big question is whether it can turn it all into a decent profit.

If, like me, you're interested in this investment story, the ticker for Westport Innovations is WPT on the Toronto Stock Exchange. As I type the shares are priced at C$32.67 in Toronto and US$32.91 in New York.

More from Tony Luckett:

> Tony owns shares in Westport Innovations.

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jaizan 21 Sep 2011 , 8:40pm

To command that kind of fancy valuation, I expect to see a business with clear technical advantages, patent protection and a strong market position.

In fact I've ridden on a few natural gas buses, usually made by German or Japanese companies who don't get a mention on the Westport factsheet.

TonyTwoTimes 22 Sep 2011 , 6:44am

Hi jaizan,

Westport is the world's patent leader. They've got a summary here and there are several German and Japanese companies on the list

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