Just as new drilling technologies have created a boom in natural gas supply, so, too, has that boom borne renewed investor interest in the industry.
Prices have dropped to decade lows, and it seems that new market opportunities are springing up with every new well built. Some analysts have advocated investing in the actual commodity because of rock-bottom prices, or in large producers that are creating that growing supply. Still, others believe a "picks-and-shovels" approach is best, thereby taking advantage of the increasing demand for drilling equipment.
One company that has caught the eye of many industry observers is Westport Innovations
Not only have Westport shares more than tripled their worth in the past two years, but investors have also remained bullish on the stock, giving it a four-star rating in our CAPS community. Despite its bright prospects, however, the company's lack of profitability and price-to-sales ratio of 10.7 have led others to believe the stock is overvalued, leading to a significant number of shares sold short.
With convincing arguments on both sides of the debate, let's take a closer look at what's powering this engine-maker of tomorrow.
Under the hood
Westport has three major divisions: heavy-duty (HD), light-duty (LD), and a 50/50 joint venture with Cummins
While Westport's top-line growth of 80% may be reassuring to shareholders, its lack of profitability in its independent sectors is not. The company's net loss for the quarter expanded from $6.2 million to $13.2 million. Investors may want to question when this 17-year-old company will finally reach consistent profitability.
The big picture
For Westport bulls, the argument is clear. Natural gas has become cheap and abundant and offers a cleaner alternative to gasoline.
A mass conversion to natural gas-fueled vehicles cannot happen overnight, however, no matter how much T. Boone Pickens-led Clean Energy Fuels
The enthusiasm for natural gas vehicles seems to have gotten ahead of the capacity. Honda recently announced that it will distribute its 2012 natural-gas Civic in 36 states, up from just four the year before. But despite casting a wider net for its NG vehicle, Honda is producing only 2,000 of them, and it's still the only major carmaker selling a natural gas car in the United States.
Westport has gained attention domestically because of low natural gas prices, but it's also making waves abroad. International revenue has been growing faster than in its home base, as the Americas' share of sales dropped from 65% to 59% in Q2 2011.
Westport owns a 35% stake in its joint venture with Weichai Power, WWI, which recorded $29.9 million in revenue in its most recent quarter on growth of 126%. In China, however, natural gas prices are rising as the government is testing a program to let prices float instead of keeping them artificially low to promote manufacturing. Prices in China are already more than $2 per MMBTU higher than in the United States, where they've fallen to less than $3 per MMBTU. In Europe, the January 2012 price was $11.45 per MMBTU and in Japan $16.25 per MMBTU, several times more expensive than in the United States. The higher prices internationally mean a dramatic shift to natural gas fuel is unlikely.
Foolish final thoughts
The momentum fueling Westport's rise has come from a cheap supply of natural gas, but many producers believe current prices are unsustainable. Progress Energy Resources just last week joined a list of companies including Chesapeake Energy and ConocoPhillips in cutting its gas production. From a long-term perspective, the natural gas glut should lead to U.S. exports, and Cheniere Energy
Given these assumptions, the time horizon for Westport to take advantage of seems relatively slim. Domestic natural gas prices should either go up in the near future as producers curtail output or around 2015, when exports begin. For a company that is not currently making a profit and seems at least a year away from developing the scale to do so, the expectations on the stock seem to weigh pretty heavily. Risk-seeking investors may like a company like Westport with high upside potential and strong momentum behind it, but for those afraid of the fallout from an increase in natural gas prices, Cummins looks like a better bet. Buying shares in that company will give investors exposure to natural gas engines through its independent projects and joint ventures with companies in India and China in addition to Westport, and it also offers the security and stability of a company that's been around since 1919.
Whether you're a believer in Westport or Cummins, I recommend learning more about another energy stock that's poised to benefit from the natural gas production boom. It's a drilling-equipment manufacturer with a 60% market share, and you can read all out about in this new special free report: "The Only Energy Stock You'll Ever Need." Get your free copy.