Fuel-Tech's flagship product line, NOxOUT, provides customers with a highly proprietary and cost-effective solution for the reduction of nitrogen oxide emissions generated during fuel combustion. The NOxOUT line is used principally in coal-based plants but is also effective for a variety of other fuels such as gas, solid waste and biomass. Fuel-Tech addressable market is expanding to new verticals, such as cement kilns and municipal waste plants, and through broader application at coal-based power plants as customers switch among coal sources.
The Company has also embarked upon a strategy to expand internationally where economic growth is accompanied by pollution abatement efforts.
It is not suprprising then that the Company's revenue ramped to $52.9 million in 2005, providing $7.6 million in net income or $0.33 per share. Fuel-Tech has no debt and ample cash reserves ($18.9 million in March 2006) that are replenished from significant free cash flow from operations ($8.7 million in 2005)
Through our earnings model, we tested the upper end of the Company's 2006 sales and EPS guidance and believe it could be conservative given recent successful sales in China and Mexico. Accordingly, we have forecast $70.1 million and $87.7 million in total sales and EPS of $0.26 and $0.35 per share in 2006 and 2007, respectively.
We initiated coverage of Fuel-Tech with a Buy rating and a 12- to 18-month price target of $16.00 per share. Our price target is based upon a multiple of 45 times our 2007 EPS estimate of $0.35, which includes the impact of estimated non-cash compensation expenses and a full provision for income taxes. On a cash-EPS basis our price target represents a multiple of 25 times our 2007 non-GAAP EPS estimate of $0.65, which excludes non-cash compensation and non-cash income tax provisions. This target multiple is in line with our estimate for the Company's EPS growth rate of 26%.
While we believe there is more to the Fuel Tech investment thesis than near-term earnings growth, the strength of year-over-year comparisons should draw investors to FTEK. Furthermore, although Fuel-Tech benefits from trends in the industrial sector, it is more than just a cycle play.
Fuel-Tech recently moved to reincorporate in the U.S. in an attempt to simplify its corporate structure. Although the Company's name will change to Fuel Tech, Inc., the stock will continue to trade under the FTEK symbol. The move to a U.S. domicile should help attract institutional investors who are precluded from owning foreign firms.
The stock's risk/reward ratio looks favorable for risk-tolerant investors. We estimate that FTEK has a $3.00 to $4.00 per share upside from the current price level of $12.00 over the next twelve to eighteen months, with a downside risk of $2.00 to $2.75 per share.
Should negative economic news or any misinterpretation of Fuel-Tech's business prospects occur in the coming months, we would use possible price pullbacks in FTEK shares to establish or add to positions. We also note that at least some of the potential in the domestic market stemming from the imposition of environmental regulations may already be reflected in the share price. Accordingly, we view news of success in foreign markets to be a strong catalyst for trading volume and stock price.
Full disclosure: Author is long FTEK