VeraSun Battles Back

In recent months, global warming resulting from CO2 emissions from fossil fuels has been gaining more and more attention in the public sphere. Paul A. Mayewski, an Earth sciences professor at the University of Maine, stated in a recent CBS 60 Minutes interview that "we haven't seen CO2 levels like this in hundreds of thousands of years, if not millions of years." This awareness has elicited an amplified demand for alternative fuels with lower levels of CO2 emissions. This is where ethanol comes into play.

VeraSun Energy (NYSE: VSE  ) is the second-largest ethanol producer in the U.S., based on production capacity. Ethanol is widely used as a blending ingredient in gasoline, because less total CO2 is released into the atmosphere than with conventional gasoline.

Monday, VeraSun announced that its second-quarter earnings of $152.3 million had surpassed last year's second-quarter earnings of $34.5 million by $117.8 million, or 341.7%. These sales soundly beat analysts' expectations of $142.9 million. The increase swung the company from being $3.9 million in the red for 2005's Q2, to $19.6 million in the black for the 2006 Q2. It also set the stock ablaze; Vera Sun opened at $25.01 on Tuesday, 8.64% above Monday's close.

"We had a strong second quarter, as ethanol prices rose and many of our refiner customers converted to blending ethanol for its high octane and clean-burning characteristics," noted VeraSun Chairman and CEO Don Endres.

While this pure-play ethanol producer probably isn't for investors who don't have ice water in their veins, it does have a lot of promise for growth. VeraSun will definitely add some zing and volatility to your portfolio -- which could be good or bad, depending on your tolerance for volatility.

For its recent IPO in June, the stock opened at $28. Since then, it has steadily decreased to Friday's low of $21.53. This drop was likely due to investors who bought in on the hype but quickly realized that the stock wouldn't have a Googlesque run. Monday's earnings release, however, lends credence to the notion that there is money to be made in ethanol production. This company appears to have turned the corner.

VeraSun only has a market capitalization of $1.75 billion, compared to the $27.29 billion market cap of rival Archer Daniels Midland (NYSE: ADM  ) , the nation's largest ethanol producer. It carries a P/E of 969, compared to ADM's P/E of 21. While this might sound a bit absurd from a valuation standpoint, the P/E is skewed, largely because of VeraSun's substantially lower earnings per share in the previous three quarters. It had an EPS of $0.01 for the fiscal year ended 2005, while its EPS for this past quarter alone was $0.29. Should the company experience similar earnings in its upcoming quarters, the P/E should plunge back down into the 20 range. Given that it is a smaller company than ADM and is on pace to attain a P/E of similar value, I believe that the upside potential makes it an attractive opportunity for Fools who can handle the risk and want to add alternative fuel to their portfolio.

There is certainly a place for VeraSun in the ethanol market. Environmental concerns have driven enormous demand for an increased shift to ethanol, led by the Federal Government, Ford (NYSE: F  ) , General Motors (NYSE: GM  ) , and DaimlerChrysler (NYSE: DCX  ) . VeraSun intends to help meet this demand by increasing its ethanol production from its current level of 230 million gallons per year to 560 million gallons by early 2008. These factors will make the company a cold lock to experience similar continued growth and epic revenues in its upcoming quarters.

Fools should take into account additional risks associated with this investment. No one knows for certain when the government will mandate higher ethanol blend levels of gasoline for vehicles, or how well the automobile industry can adopt higher standards in terms of ethanol blend. Additionally, new competitors will be entering the public arena, with Aventine Renewable and Hawkeye Renewable preparing for IPOs. While the prospects for ethanol are exciting, Fools should do their own additional research and carefully consider their risk tolerance before diving in.

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Fool contributor Billy Fisher does not own shares of the companies mentioned. The Fool has a disclosure policy .