Headwaters Stays the Course

Think of Headwaters (NYSE: HW  ) as a river. Its three main divisions -- construction materials; coal combustion products; and alternative energy -- are three separate and distinct tributaries that merge together to create one mighty stream.

This past quarter, the construction materials fork of Headwaters' river dried up slightly; its quarterly revenues evaporated by 12% to $115 million, largely because of a major slowdown in home construction across the country. Luckily, this weakness was more than offset by a 21% increase in its synthetic fuel business, as well as a 6% swell in the coal combustion segment. All in all, net profits rose 48% to $27 million or $0.59 per share -- a 48% increase year over year.

But investors must ask whether the overall strength of the company's revenue and profit will slow down or gain strength in the months ahead. On this front, management merely shrugged its shoulders, reiterating its 2007 earnings outlook of $1.60 to $1.80 per share.

After listening to the conference call, I'd argue that Headwaters is only being conservative, and that it remains a solid investment. First off, while home construction will still be weaker than in past years, it should increase over the next two quarters as the spring and summer construction cycle kicks into high gear.

More importantly, I remain cautiously optimistic about the company's proprietary nanoparticle catalyst technology, dubbed HC3, which can help oil companies increase the value of lower-grade oil. According to CEO Kirk Benson, a number of refineries continue to assess the technology. He indicated that there's a 50-50 chance a deal will be signed by the end of the year. If this occurs, the stock could experience a nice run. Put another way, it would be like a healthy rain refilling a dwindling river.

All the same, Headwaters hardly lacks risk. It's quite possible that the overall market for construction materials will remain weak, that the company's synfuel operations will be hurt by higher oil prices (an important tax credit begins to be phased out whenever oil surpasses $62 a barrel), and that higher corn prices will squeeze margins on its new ethanol plant. But for me, the possibility of life-giving rains on the horizon -- in the form of its HC3 and CTL technology -- keep me optimistic that the company's river of profits will begin gathering strength in the not-too-distant future.

Dive into further Foolishness:

Headwaters is a Motley Fool Rule Breakers recommendation. Discover all of David Gardner's top growth stock picks free for 30 days.

Fool contributor Jack Uldrich owns stock in Headwaters. The Fool has a strict disclosure policy.


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