Ethanol Investments
The Smart Profits Report: Issue #312
Friday, May 26, 2006
Ethanol Investments: Two Ways To Profit from the Shift Towards Ethanol
By Karim Rahemtulla
Chairman, Mt. Vernon Research
With Memorial Day upon us, there’s a good chance you’ll be packing up the car and heading off for a few days’ vacation this weekend.
But as Americans whiz down the highway, they’ll be doing so knowing that the national average price for a gallon of gasoline is $2.88 - 75 cents higher than this time a year ago.
But is help on the way? By now, you might have heard about how ethanol could change the future of our energy situation. It’s something the government is promoting heavily, for several reasons:
- It makes the U.S. a little less dependent on Middle East oil and inches us closer to energy self-reliance.
- It’s less polluting than gasoline - not by much, but every little but helps.
- The technology to run cars on ethanol already exists.
Look at Brazil, for example. General Motors and other manufacturers are already making cars for Brazilians that can use any combination of ethanol and gasoline.
So, why aren’t we doing it in America?
The problem is that there are not enough ethanol stations here to pump out pure ethanol. But as gas stations add new ethanol pumps, this will change.
So, I’m going to give you two ethanol investments to think about…
A Pair of Ethanol Investments
The first is Archer-Daniels Midland (NYSE: ADM). My Covered Call members recently took a position in this company when it pulled back - and watched it then set new 52-week highs.
Using a covered call strategy basically allows you to own a company well below current levels. If you want to play ADM, then consider doing the same in order to reduce your cost. At current levels, shares are pretty fairly valued (not expensive, but not cheap either).
Another company for you to look out for is Pacific Ethanol, Inc. (NASDAQ: PEIX).
However, this one is currently trading at mind-boggling levels, thanks largely to Microsoft owner Bill Gates buying a huge chunk of it a couple of months ago (when the price wasn’t so mind-boggling).
Take a look at the recent closing prices for PEIX:
May 11: $42.39 (having hit new 52-week high of $44.50 that day)
May 12: $42.00
May 15: $37.88
May 16: $36.65
May 17: $32.86
May 18: $29.90
May 19: $29.57
May 22: $25.57
May 23: $29.89
May 24: $30.23
That’s some heavy fluctuation! And all in just 10 trading days.
What you’ve got here is the “Gates Factor” at work. He paid about $84 million for just under 25% of Pacific Ethanol. That valued the company at about $10 to $12 per share. But shares now trade around $30.20, down sharply from a 52-week high of $44.50 as recently as May 11.
My advice: Wait for a pullback of around 40% to 50%. This is what it will take for the “Gates Factor” to wear off and for shares to be more reasonably priced in the high teens to low $20s.
Ethanol vs. Oil Investments: Don’t Do It
There are other ethanol-based plays, too. For example, you could buy some of the major oil companies who are thinking of branching out and setting up ethanol service stations.
But that would mean you own oil, too. And if you read the Smart Profits Report Oil Forum last Friday, you’ll know that I’m not fond of oil at its current price. In fact, I have been short on oil using LEAP options for a couple of months now. And while oil hasn’t moved down enough to make me too much yet, with a year and a half to go on my options, I feel pretty comfortable.
But what if ethanol doesn’t take off and you’re stuck with a stock you don’t really want? Well, that’s where ADM in particular is a good bet. It’s a diversified company that could make big bucks from ethanol on the coming months and years - but it relies on more than the ethanol business for its profits.
Bone up on ADM and PEIX. These are two “free” plays that are worth getting excited about at the right price. ADM also has LEAPS available for an options play.
In Additon to Ethanol… Let’s Talk Turkey on Memorial Day
As I write, I’m in Turkey - one of the world’s most vibrant emerging markets. I’m keen to catch up with some old friends and witness the development since my last visit. Nothing excites me more than going back to an emerging market after a few years. It puts it all in perspective.
For instance, when I was in China last year, the growth was noticeable and impressive compared to my visit during the handover of Hong Kong. But my visit to India showed me that China was at least a decade ahead, and India, for all of its growth, has a long way to go - and may prove the better opportunity right now.
When I first started out in this business, I traveled a lot. I wrote about emerging markets before they took off, when there were only about 100 ADRs (American Depository Receipts) trading in the U.S. Back then, the only way to buy foreign stocks then was from an overseas broker; and with no Internet, high corruption, low liquidity, a lack of adequate research, and political tension, emerging market investing was a risky proposition.
For example, I met with the Malaysian Finance Minister a few months before he was jailed on trumped-up charges. And in meetings with a former director of the Bombay Stock Exchange, he mentioned casually that it was prone to manipulation because of its small size and lack of transparency. A few months later, the BSE crashed.
The one place that I returned to over and over again, however, was Turkey. Turkey was the emerging markets investor’s dream. No research, small market, undeniably a capitalist bastion, and beautiful to boot. I made three Turkish picks, and each one was up between 50% and 100% in a matter of months. It was awesome - until we went to sell. Turns out that we were the market! Those gains fizzled to less-impressive double-digit gains.
Emerging market investing has always been dangerous. It is still fraught with a lack of transparency, currency issues, political shenanigans, and outright fraud. The only difference is that there are many more choices for investors than there were before. And thanks to the Internet, you can actually get current information about what’s really going on.
Hopefully, my Turkish trip will yield a couple of investment ideas that are still “emerging.” More later…
Good investing,
Karim Rahemtulla
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