Fuel Tech: Long Term Outlook Positive, Near Term Expensive

I started out writing this piece energized on the prospects for Fuel Tech (Nasdaq:FTEK) given the commitment the Obama administration has to enforcing clean air standards in the U.S., and given Fuel Tech's evolving opportunity in China, which is adding about 2 large scale coal plants per week. In addition, the company has recently commented on expansion in the Canadian and French markets.

I remain enthusiastically bullish on the company's long-term prospects. But from a valuation standpoint, given the widespread multiple compression in the broader markets, and expectations set by Fuel Tech's management for the Q4 which will show a sequential decline in revenue and likely, a net loss per share, it is tough to get enthusiastic near-term about the stock at current levels.

At present, the stock is trading at about 3x our FY08 estimated revenue of $80 million, and about 61x our FY08 estimate of $4 million in net income. While the market opportunities for Fuel Tech in both segments of its business are significant, and expanding, 2009 is likely going to continue to be slow going for business amidst tighter credit conditions. Against this backdrop, it is tough to build too much growth into FY09 forecasts – at least until management begins indicating that is warranted.

Here is what the pros are saying:

• Roth Capital rates at HOLD with a price target of $8 (1/14/09)
• Lazard Capital rates at HOLD (11/11/08)
• AmTech Research rates at BUY (10/27/08)

Recent acquisitions will provide increased market penetration and corresponding sales, and even new revenue streams – pace the company’s recent announced expanded capabilities in SCR-related design. The Advance Combustion Technology acquisition of assets was completed for about $22 million (plus performance-based contingent payments). In a prior release, Fuel Tech said ACT’s 2007 revenues were about $21 million and it had a backlog of $11 million.

Management has noted on several occasions that the acquisitions enabled the company to secure key leaders in consulting and optimization / efficiency flows for SCRs (Volker Rummenhohl), and credibility which should translate into increased sales and a wider, more receptive pipeline, and business (“ACT”) that gets them into the Low-NOx burner markets.

The stock hit a 52-week low in intraday trading back on November 21 at $6.05, and has comfortably moved back into the $10 range, which tells us that the Street is more than comfortable supporting the stock at fairly aggressive multiples.

In terms of where we would be inclined to buy the stock, multiples of 2x FY09 revenue and 20x FY09 income would be more compelling. We are forecasting 29% Y/Y revenue growth to $103 million for FY09, aided by the $11 million backlog which the ACT transaction brought. Our FY09 income estimate is $8.2 million – which may prove out to be a bit aggressive in the current market environment.

Based on our estimates, respectively, this would yield a target accumulation range of about $6.87 to $8.50 (assuming FY09 revenue of $103 million and net income of $8.2 million. The low end of the range is based on a multiple of 13x our projected FY09 income, which, in the current market, we think is reasonable.

Again, we remain mid to-long term bullish on Fuel-Tech. With the asset purchases and acquisition the company is better and more broadly positioned than ever before. Global attention, and legislative commitments have never been stronger to addressing climate change and NOx reduction is a key element. In the current market environment, Fuel Tech’s FUEL CHEM business segment economics (more efficiency and higher payback) will likely be even more compelling to prospective customers.

This is definitely a stock we would like to own for the long-term. We just don’t see urgency at current levels, and think that broader market weakness will likely set up a buying opportunity closer to our target entrance points. One strategy that we think is worth considering in getting into the stock is to sell puts into weakness and get paid to own a stock well-positioned for long-term growth (ask your brokers about this strategy). We also would think about selling out of the money covered calls on long-FTEK positions.

In the current market, we just don’t see stocks running away from anyone at this point. Moreover, the next quarterly (and year-end) report from Fuel Tech will likely show lackluster Q4 results, so this could cause near term weakness in the stock as well.

Disclosure: No position in FTEK.

Comments

[Graham Jervis:]

i am long this stock also, but i was waiting for it to fall sub 9.00 also. i believe long term it will do well. i like the getting paid to wait idea, gonna do that today.

Feb 11 09:37 AM