Wednesday, July 2, 2008

Bookkeeping: Buying Fuel Systems Solutions (FSYS) for the 3rd Piece of my Alternative Energy Basket

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Finally Fuel Systems Solutions (FSYS) has fallen to its 20 day moving average - sheesh. I've missed a huge move in this one, waiting for a pullback that never came. It's finally down to the $34 area where I'm adding it to the portfolio as the final piece of my 3 stock basket of (non solar) alternative energy plays. [Jun 27: New Position in A-Power Energy Generation Systems (APWR) to Create Alternative Energy Mini Basket]

Actual purchases were 3 lots in the $32s and $33s, and I've created a 1.8% stake. My hope is a fall to $28 range which is the 50 day moving average; but with the stock down mid teens % today it was time to begin the stake. This stock has had among the best relative strengths of anything in the market that is not coal or natural gas related - but aha, it is natural gas realted, sort of.

Here is a company description via the corporate website

Fuel Systems Solutions, Inc. is the holding entity for BRC S.r.L., based in Cherasco, Italy, and IMPCO Technologies, based in Santa Ana, California.

Both entities are engaged in designing, manufacturing, marketing and supplying advanced products and systems to enable internal combustion engines to run on clean burning gaseous fuels such as natural gas and propane. BRC is a recognized leader in the light duty and automobile alternative fuel sectors. Additional information is available at http://www.brc.it. IMPCO Technologies is a leader in the heavy duty, industrial, power generation and stationary engines sectors. Additional information is available at www.impcotechnologies.com.

So we have 2 business lines - what I'll label transportation and industrial; but I only care about one - the transporation. The last earnings report shows why:

  • Fuel Systems Solutions, Inc. (NasdaqGM:FSYS - News) today announced record results for its first quarter ended March 31, 2008, supported by strong demand for its systems and components that enable internal combustion engines to operate on gaseous fuels.
  • Revenue for the first quarter jumped to a record $94.6 million from $54.8 million a year earlier.
  • Operating income for the same period climbed to $13.4 million from $3.8 million in the 2007 first quarter.
  • Net income for the same period of 2008 climbed sharply to $6.2 million, or $0.40 per diluted share, from $1.0 million, or $0.07 per diluted share, a year ago.
  • ``Results for the 2008 first quarter reflect a $38.3 million, or 118 percent, increase in revenue contributions derived from the company's transportation business, and a 6.6 percent increase in revenues derived from our industrial business, representing additional contributions of $1.5 million, on a year-over-year basis,'' said Mariano Costamagna, chief executive officer.
Where's the growth coming from (in English?)
  • He noted that the company's transportation business for the first quarter of 2008 benefited from a more than 50 percent increase in unit volume output from the previous quarter derived from its delayed original equipment manufacturing conversion operation -- enabling vehicles to operate on compressed natural gas (CNG) or liquefied petroleum gas (LPG). Costamagna added that aftermarket conversions of internal combustion engines to gaseous fuel operation still represent the largest percentage of business in the industry today, with automotive original equipment factory conversions relatively low in output volume.
Expansion plans for 2008
  • He highlighted the company's recent announcement regarding the expansion of its Italian delayed automotive original equipment manufacturing operation in Livorno, Italy. This facility, combined with the company's current operation in Cherasco, Italy, will enable Fuel Systems Solutions to more than double its 2007 delayed original equipment output. The new facility in Livorno serves original equipment automobile manufacturers such as Hyundai-Kia and Great Wall, while the operation in Cherasco supports automobile companies such as Chevrolet, Subaru and Citroen.
Financial Outlook
  • Based on its current assessment of near-term market trends, the company is increasing its full year 2008 consolidated revenue guidance to $320 million and maintaining its gross profit margin of approximately 24 percent and operating margin of approximately nine percent.
Now before this earnings report I had never heard of the company... but this got my attention. The stock jumped from sub $20 to $23s, then within a week spiked to near $30. Surely I could wait and get a pullback... err, umm the "pullback" was $29 to $27 from which it has made a month long run to $40. All the while I've gritted my teeth. So finally today we were able to start a position in the $32s/$33s and I hope lower as weak hands get shook out. Today's horrific fall only took the stock price back 3 weeks...



At a price of near $40 where it traded way back.... this morning, the stock traded at 40x forward estimates. Pricey. Now it trades at 32x forward earnings; cheaper but not exactly something found in the bargain bin. That said, I do believe this is the type of company in the right place, at the right time with the right product, even if crude retreats to $100. I also like the expansion plans which should allow 2009 estimates of $1.25 to be surpassed as long as the customer demand is there - which it appears to be in droves based on the past 2 quarters. This is yet another (what I consider) small cap, or certainly smaller than our normal fare at $500M in market cap, so I am putting it into my 3 stock basket of "non solar alternative energy" names an considering it as 1 'position', if you will. How the 3 individual pieces will do, will be interesting.

Now I certainly wished I had found this name back when this gentlemen did in mid April (per Seeking Alpha) and in fact, said writer put out a "sell" on the name at what appears to be timed perfectly (today). I still would not of added this type of high risk, smallish name (in April before earnings) without more proof of improving results, but it would of been nice to have had it on the radar and a familiarity with it so when it first spiked post earnings I'd be willing to jump in with no consternation.

So again, instead of recreating the wheel let's see his original thesis (which I agree with) and his sell call at today's peak price (obviously I sort of agreed with that as well, as I was unwilling to pay up after such a huge move)

Original piece
  • Fuel Systems Solutions's (FSYS) business model is based on crude at $40 a barrell, and at oil almost triple that amount, the company is reaping the dividends. FSYS is a alternative fuel supplier that produces products that enable gasoline and diesel engines to be converted to cleaner burning liquified petroleul gas [LPG] or compressed natural gas [CNG].
  • The conversion provides advantages; cost savings versus gasoline could be as much as 40% and the cleaner burning effects comply better with increasing environmental clean air demands.
  • The shares have seen a massive selloff within the last two years, trading as high as $24 before settling down to the $10 range. The company appears to have solid fundamentals, but their poor accounting controls continue to plague them. Last year the company launched a stock option investigation that prevented them from filing any financial statements for almost nine months resulting in a negative restatement of past earnings and just last month, FSYS said its 4th quarter results would be postponed due to its need to restate foreign subsidiary inventory costs. The good news is that the restatement will have a positive impact on past earnings. The company also announced it was increasing revenue guidance for 2007 from $255 million to $266 million. (my note: since then that has been pushed up to $320 million)
  • Broadpoint Capital recently added FSYS to its research coverage with a buy rating and a $14.50 target price. The analyst, Ron Oster, is impressed with FSYS's growth prospects and its new mangement team and stressed to me that his earnings estimates are on the conservative side.
  • Fidelty Magellan has noticed FSYS on its radar screen and has taken a 10% stake becoming its second largest shareholder behind Mariano Costamagna, FSYS's new CEO with a 12% ownership position (my note: so both good insider ownership by a new CEO AND Fidelity's staff have enough confidence in the name to take a major position - obviously if Magellan chooses to exit the stock it will cause some pain in terms of price)
  • Management inherited the accounting problems from the previous regime and is determined to quickly put these problems behind them in their quest to improve profitabilty.
  • Future prospects appear bright as FSYS has recently received certification from GM (GM) on its new 6.0 liter engine as well as Ford's (F) F150 to provide aftermarket conversion kits. Australlia has seen its useage of conversion kits triple within the past three years as its government has been offering $1800 grants for each vehicle conversion in order to promote cleaner air standards. (my note: would the US government ever offer such a thing? Nah - we sue OPEC)
On to today's "downgrade" if you will
  • The shares have nearly quadrupled in less than three months and are due for a correction, They have simply gone up too far in too short of a time frame.
  • Trading at 38 times 2008 earnings estimates and nearly four times book value of $9.70, the stock is vulnerable to some hefty selling if FSYS fails to execute its business plan flawlessly, as this equity is priced to perfection and beyond.
  • Both Broadpoint Capital and Canaccord Adams each lowered their opinions from buy to hold, while Lazard Capital still maintains a hold rating. Broadpoint and Canaccord share one year $28 price targets. I think their $28 target could be on the high side and see a more realistic target of $24, as it's often typical for stocks to retrace 50% of their gains. (my note: say it ain't so Mark - $28 is my target; to buy)
  • The shares have been running up a lot on pure emotion as momentum traders try and ride FSYS as an instrument to mirror the rise in crude prices. The company was added to the Russell 2000 index Monday creating even further demand. (my note: true that)
  • Three Mutual funds, Invesco, FMR and Wilderhill Powershares each own about 9% , totaling 27% of FSYS's outstanding shares. They all have substantial gains that they may potentially want to book by actively selling shares. This added supply of shares hitting the market could put a big dent in the share price. Mariano Costamagna, the CEO and largest single shareholder with a 11% stake, may also be tempted to "cash in" on the company's windfall. (my note: good points that I hinted about above)
  • Management might decide to take advantage of the spike in the share price by issuing a secondary offering to raise capital. The additional shares printed will cause dilution as well as flood the market with a much larger supply of shares creating downward pressure.
All good potential points and investors should always weigh the pros and cons to each investment. Myself, I'm willing to see a very large potential market opportunity here and look past some of the valuation issues - after all we've pointed out just today a few names that the market is looking past valuation as the stocks continue an ever upward climb up [Do Valuations Matter?] and we've seen the same in certain solar names such as First Solar (FSLR) and Energy Conversion Devices (ENER). I also would like to quote one of the comments on one of the Seeking Alpha posts - as we do tend to be US centric thinkers.
Most American investors do not have a clue as to how LPG conversions are going gangbusters around the world. Thailand is increasing it's LPG imports 5 fold to fill demand. They also have a shortage of gas cylinders for vehicles and are starting 4 new cylinder manufacturing plants. Indonesia has started converting 436 Taxis a month. Manila is now converting all public transportation and 20% of government vehicles to natural gas. There is a scramble on in Malaysia as the government has ended petrol subsidies. Petronas is going to construct an additional 200 natural gas stations there. Venezuela plans to have 500,000 NGV's by the end of 2009. Iran is manufacturing 250,000 cng cars this year. Peru is converting 50 to 60 cars a day. Enquiries for conversion are up 10 fold in England. There is a waiting list in Australia for LPG conversion. India, Pakistan and Bangladesh are into it big. Russia is planning to build natural gas filling stations across Europe.
Take it for what it's worth but we do have to realize the rest of the world is moving on, with or without us.

The last thing I do like is the small amount of shares outstanding (15.6M) which all things being equal mean as net income flows through the Profit and Loss Statement, they are divided over a smaller denominator (shares outstanding) leading to a larger Earnings PER share.

Long Fuel Systems Solutions in fund and personal account

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