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Cleaning Up With Westport Innovations

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Westport is the technology and intellectual-property leader in its field, with more than 15,000 natural gas engines already in service through its 50/50 joint-venture with diesel engine giant Cummins (CMI).

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Cities and companies have talked a lot about reducing air pollution and dependence on foreign oil lately without doing a lot about it. But lately a single solution to both problems has emerged as feasible, and fleet managers are beginning to take notice.

That solution is compressed natural gas, which is both plentiful in North America and a clean-burning fuel. Natural gas vehicles are widely used overseas, but in the United States they have met with a lot of resistance, mostly at the sly behest of the gasoline industry. Although you may have seen a few natural-gas powered vehicles here and there, the problem so far has been the lack of a distribution infrastructure and the high expense of the vehicles.

Now that is set to change thanks to a company called Clean Energy Fuels (CLNE), which is building the filling-station infrastructure in California, and Westport Innovations (WPT.TO), which has exclusive technology that turns a smelly, dirty, heavy-duty diesel engine into a sweet-running CNG machine. Both companies are in line to get a big boost from the Clean Air Action Plan (CAAP), a $2 bln initiative at the ports of Los Angeles and Long Beach to freshen the air around their vast facilities.

I've been recommending Clean Energy since it IPO'd back in the early summer under the veteran guidance of chairman T. Boone Pickens, but only in the past ten days did I catch onto Westport. Here's why I like the Canadian small-cap, which you can buy in any U.S. trading account by paying a little extra in commission.


Click here to enlarge.

It's not well known, you see, that once the CAAP is fully funded and starts rolling, Westport is in line for a whopping $400-mln, five-year deal to convert more than 5,000 diesel trucks at the docks to natural gas. Compare this with the $22 mln in revenues that the company generated last year, and you are talking about a very material ramp in revenue and earnings in a hurry.

In spite of its diminutive size at $150 mln in market capitalization, Westport is the technology and intellectual-property leader in its field, with more than 15,000 natural gas engines already in service through its 50/50 joint-venture with diesel engine giant Cummins (CMI). The joint company, called Cummins Westport, is profitable and has limited competition, thanks to the tiny size of the market for heavy-duty engines powered by natural gas. Plus, other large diesel engine manufacturers like Caterpillar (CAT) and Volvo are busy preparing for more stringent diesel regulations in 2010, which paves the way for the more environmentally friendly services provided by Cummins Westport to step into the spotlight.

But even before their joint venture with Cummins, Westport was working hard to solidify its position in this niche market, with initial research on its technology beginning in the early 1980s. Back then the company was unhindered by competitors, so Westport was free to develop an impressive list of engine and fuel technologies through ties with the University of British Columbia. After years of development, its natural gas solutions include all the necessary pieces including fuel injectors, cryogenic storage tanks for liquefied natural gas, compressors and exhaust treatment systems.

Westport's flagship is its high-pressure direct injection technology, or HPDI, which is a clever way to make natural gas a viable fuel for heavy-duty engines at a reasonable cost. You see, natural gas, like gasoline, requires an ignition source to burn. Big, bad diesel engines, on the other hand, rely only on the intense heat and pressure from the upstroke of the piston -- no spark plugs required. And since building high-power natural gas engines from scratch would be ultra-expensive given the small size of the industry, Westport decided to combine these two technologies and came up with HPDI.

The solution created by Westport is to modify existing Cummins diesel engines to operate on natural gas. The method of action is elegant and simple: A small amount of diesel fuel is compressed per normal procedure, but at the point of ignition, a quantity of natural gas is injected at high pressure directly into the cylinder. The result is a big boom and lots of power -- without all the nasty particulates and pollutants of a normal diesel engine.

Other programs that Westport operates include spark-ignited engines for buses, and a direct-injection engine that uses a superheated ceramic surface to ignite the natural gas instead of diesel fuel. The company is teaming with Japanese truck maker Isuzu on the latter project. And Westport is also working on a number of hydrogen technologies,currently demonstrating how their hydrogen direct injection technology works to the suits over at Ford (F) and BMW.

Even with a solid portfolio of offerings, Westport's immediate success depends on California's CAAP initiative. The influx of orders from this plan will help Westport achieve critical mass, expand production and bring its product costs down to levels that will make the switch from diesel to natural gas reasonable for the operators of large trucking fleets across the country. The incentive for trucking companies to switch is the 35% lower price of natural gas over diesel. Plus, given the environmental benefits of using natural gas, there are a number of government subsidies that will sweeten the deal. Because of these incentives, I wouldn't be surprised to see big diesel fleet operators like Wal-Mart (WMT) and Pepsico (PEP) make the change to CNG down the road.

Westport is in a great position to win the CAAP contract, and the best case scenario has the company's sales ramping to $160 mln in 2009 and over $200 mln in 2010. But keep in mind that there are a lot of hurdles to be cleared between now and then. For one, the boards of the Port of Los Angeles and the Port of Long Beach must ratify a recent economic report that was supportive of the conversion of trucks to natural gas under the CAAP. Once this is done, the first 150 natural gas trucks will be ordered. Also, Westport is still tweaking its HPDI technology so that it can be certified under 2007 diesel emission regulations.

This is a pretty speculative small-cap, so don't bet too much on it. But it's a little known green-tech operator that's not too well known, so a higher profile along with that contract could really make the stock move. I'm looking for at least $3 in the next year, which would be 40% higher from here.

On the Horizon

Sticking to the energy theme, tomorrow we'll check in with one of the top performers on the Buy List -- Flotek (FTK). As you know, we already have a fat 287% gain, and I still think there's much more to come from this great company. Be sure to tune in.


(Special thanks to researcher Anthony Mirhaydari)
No positions in stocks mentioned.

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