Investing in the Renewable Energy Revitalization

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Last week I wrote a three part series in SmallCapInvestor Daily about the coming renewable energy revitalization that I believe will be a driving economic force for several decades to come, both in the U.S and abroad.  This can be both an exciting as well as a challenging space to invest in since emerging technologies are often unproven.  The risks can be big, but the gains can be huge.

I like companies that are generating profits from their renewable energy solutions because strong financial performance shows me that a company is likely to have a future, and unlikely to go belly up.  A-Power Energy Generation Systems (Nasdaq: APWR) is one such example of a company with a profitable history and a bright future.  But often, renewable energy products are a non-profitable segment of a larger company, or are owned by a small company that has yet to achieve profitability.

In these cases, I often pass on the investment, but if I like the company I'll continue to watch for signs that it has broken out of the development stage.  Timing the investment properly can mean the difference between making, or loosing, a lot of money.

This brings me to the topic of today's issue. A reader wrote in about an exciting company that just reported its first profitable quarter.  However, when I looked closer, the company's operation is actually funded by a subsidiary in an entirely different business.  This is a case where it really pays to do your homework: investors who jumped into this stock at its recent high are now down 50% in a period of weeks.

That's not to say the stock won't go higher – it very well may.  But like I said, timing is everything, and this company makes for a good example of how to do your homework.  Since the company is interesting and may be a future pick, I'll share with you what I found.

The company is Rentech (AMEX: RTK), a clean energy fuel producer.  One of my subscribers wrote the following…:

"…you might check out RTK on the American [Stock Exchange].  They … appear to be making a move into electrical generation and biofuel.  They have an operating fuel plant and are associated with UOP, United Airlines, U.S. Airforce, and others in producing clean fuel." – John B.

Thanks for your request John.  Like John wrote, Rentech's business is compelling, and the stock's recent performance is extraordinary. The stock jumped 82% after the company reported Q3 2009 results on August 11, and between August 5 and August 18, the stock soared 390%.

Rentech is a California-based company that has developed a proprietary process for converting a variety of waste, biomass, and fossil resources into clean burning synthetic fuels and chemicals.  The company produces these products at its own facilities and is working with global partners such as UOP, Jacobs Engineering (NYSE: JEC) and Denbury Resources (NYSE DNR) to expand its operational footprint.

Rentech's ultra-clean synthetic fuels include military and commercial jet fuels, ultra low sulfur diesel fuel, and specialty waxes and chemicals. The company claims that fuels produced through the "Rentech Process" are, "significantly cleaner than those available today from petroleum refining and have lower emissions of all regulated pollutants, including nitrogen oxides, sulfur oxides and particulate matter."

Now the big news.  Rentech recently signed a deal to provide eight U.S. airlines with a multi-year supply of its synthetic fuels to be used for ground operations at Los Angeles International Airport.  This agreement, as well as recent approval of their fuel for commercial aviation, has spurred speculation that the company may be on the verge of major expansion.

In a recent interview on CNBC's Kudlow Report, Rentech's CEO Hunt Ramsbottom also stated that the market price of its synthetic fuels is competitive with conventional fuels.

However, Rentech currently only has demonstration scale production capacity.  Given that the airlines require 1.5 million barrels of jet fuel a day, the company has a way to go before its process can be relied upon for any meaningful supply of fuel.

But the future may be bright for this ambitious energy company.  Rentech is trying to expand U.S. operations - including a proposed facility in Natchez, Mississippi that could produce approximately 30,000 barrels per day of synthetic fuels and chemicals.  Also on the horizon is a future plant in Rialto, California that could produce 600 barrels per day of synthetic fuels, and electric power. 

In order to get these projects off the ground Rentech is going to need cash – and lots of it.  The company has proposals in front of the U.S government that aim to cash in on federal initiatives to grow the renewable energy sector.  If approved, this funding from the feds could help fuel future growth for Rentech. However, the company isn't relying only on the government to fund its growth, and recently raised $20 million through an equity financing in September.

But here's where my spirits dimmed.

Rentech's latest quarterly report filed with the SEC on August 11 showed that the company funded 2008 operations primarily with cash flow from its wholly owned subsidiary, Rentech Energy Midwest Corporation (REMC).  REMC is an agricultural fertilizer company.

REMC will also fund 2009 operations.  According to the company, "Rentech's non-REMC operations are expected to have no material revenue during fiscal year 2009, and will need additional funds to provide for their liquidity needs."

Unfortunately, the attractive clean energy operation that I was excited about is not what is driving revenues. 

Rentech's ability to run a profitable business producing fertilizers does not guarantee that it will be able to operate a profitable synthetic fuel operation.  If I want to buy a fertilizer company, then I'll buy a fast growing fertilizer company like China Green Agriculture (AMEX: CGA), which I cover in the SmallCapInvestor PRO portfolio.

But because I'm not a buyer here, doesn't mean the stock is not worth watching.  Despite its reliance on REMC, Rentech did just report its first profitable quarter in the company's history – a fact that propelled the stock higher by 390% between August 6 and August 18 (the stock has retreated 48% since).

But it still has an unproven business model funded by a separate operation and a ton of debt – Rentech's debt/equity ratio is 4.56.
 
Take a look at Rentech's revenue, net income, and EPS history and I think you'll agree this investment is too speculative at this point, especially when the stock's trailing P/E is 33. 

I love investing in small-cap stocks because of their massive growth potential, but Rentech doesn't make the cut (yet) because it is simply too risky of an investment at this stage.  The company needs to prove its business model before investors should jump in – in the meantime there are simply too many more attractive opportunities out there.

Thanks to John for suggesting this stock.  I hope you found this to be an educational example of how to dig into a company before investing.  Let's keep and eye on Rentech and see how the company performs in the coming months.

***Now, I want to discuss a housekeeping subject.  As you know, I occasionally include a stock recommendation here in SmallCapInvestor Daily - and I love to hear that readers have managed to make money on these recommendations.

But this brings up an important issue about how SmallCapInvestor Daily operates. I spend several hours every day to make SmallCapInvestor Daily a valuable source of free investment information. To offset my costs, I allow select advertisers to run advertisements to the SmallCapInvestor Daily list. I try to make sure that you know that these are third party advertisements by including text that says "paid advertisement" or "special offer" at the top of the email. I receive occasional emails from readers who have purchased the stocks discussed in these advertisements.

As with any investment, sometimes these stocks perform well, and other times they don't. I never want to see anyone lose money on an investment. But I also don't want to be held accountable for a stock that I haven't personally recommended. So I encourage you to check out the emails that you receive from SmallCapInvestor Daily, and if it says "paid advertisement," than you should know and understand that this is a third party marketing message.

As a SmallCapInvestor Daily reader, you also receive advertisements for my own advisory services, like SmallCapInvestor PRO and Top Stock Insights. I stand behind every recommendation that appears in these publications.  Please understand that I can't be responsible for stocks that are recommended by outside advertisers.

In all cases, I strongly encourage you to do your own research before buying any stock so that you match your investing strategy with your own investing goals and risk tolerance.

Thank you for your understanding.