Headwaters is a construction materials and alternative energy company that has nearly been cut in half since its April 2006 high; currently it trades around $24. Headwaters' precipitous fall is largely due to the uncertainty surrounding revenues associated with the Section 45 tax credit, which benefits the production of coal-based synthetic fuels.
What happened to Headwaters' stock is equivalent to what happened when Research in Motion (RIMM) shares fell from $100 to $60 following a patent lawsuit from NTP that threatened to eat into a percentage of earnings: investors began to discount the company's entire growth prospects and still profitable operations.
Headwaters' most steady operating division is its Construction Materials unit, where I expect profits to be flat year-over-year due to fallout from the housing market, at around $150 million in gross profits. The Coal Combustion Products division should earn about $85 million in gross profits, although its recent growth could lead to a positive upside surprise. Synfuel-related revenues from reagent sales and licensing fees will continue to contribute to the bottom line, but are not included as part of future valuations. This is apparent from a discounted cash flow analysis, where the implied growth rate from the market price of the stock prices in only mid-single digit growth over the next decade.
Headwaters' Technology and Innovations Group has many interesting potential applications for patents and licenses which could contribute significantly to future earnings. Another aspect of Headwaters' business that is not apparently priced in by the market is their Heavy Oil upgrading technology, which increases the output value of a barrel of refined petroleum products upwards of 5%. The estimated value of a more efficient heavy oil catalyst to the refining industry is approximately $50 billion, and having already completed several successful commercial runs, management expects recurring revenues to commence sometime in Fiscal 2007.
Headwaters' involvement in coal-to-liquids fuels could also prove highly profitable, as a huge majority of America's energy reserves are in the form of coal (over 90%), turning this domestic fuel source into gasoline could become an important part of energy policy as it did in South Africa with Sasol (SSL). The diversified approach to alternative energy makes Headwaters an appealing play on the industry, as does the financial position. Unlike many competitors which are relying on unproven and unprofitable technologies such as solar power, Headwaters has significant positive free cash flow and a stabilizing balance sheet.
Short-term worries aside, I believe Headwaters presents a compelling valuation to investors looking for an investment in energy technology. The market expects nearly nothing from Headwaters, while great (and diversified) growth opportunities appear within the company's reach. When investors realize that near-term profit worries pale in comparison to Headwaters' potential, I expect to see the shares appreciate significantly - perhaps even surpassing RIMM's double following the resolution of its issues.
HW 1-yr chart
Disclosure: Author has no position in HW.