Environmental Investing: Stock Picks For Going Green

Includes: ADM, AVR, BP, GE, GM, HMC, PEIX, TM, XOM
by: Erik Dellith
Leading climate scientists said on Friday that global warming was "very likely" man-made, largely as a result of burning fossil fuels. President George W. Bush broached the environment topic in his State of the Union Address, calling on Americans to slash their gasoline use by 20 percent over the next decade. His initiative includes a significant increase in domestic fuels, such as ethanol. Investors looking to make some green moves of their own have many options, from companies involved in biofuels, such as ethanol, to hybrid automobiles.

Many of these "green" companies are already attracting attention. In the days leading up to the State of the Union Address, investors flocked to call options on companies related to ethanol , including Aventine Renewable Energy Holdings Inc. (AVR) and Pacific Ethanol Inc. (NASDAQ:PEIX). Additionally, Vinod Khosla, Silicon Valley's biggest alternative energy investor, recently forecasted a rapid rise in cellulosic ethanol production and utility-grade solar power.

With all of the attention on global warming, it should not be surprising to see that many companies are touting their environmental initiatives, including such firms as General Electric Co. (NYSE:GE) and BP plc (NYSE:BP). Even Exxon Mobil Corp. (NYSE:XOM), which Thursday announced record profits thanks to high oil prices, indicated a possible move into ethanol, if it can see a viable business reason.


There is nothing new to the idea of using ethanol instead of or in addition to gasoline in automobiles. Brazil is perhaps the largest success story in terms of reducing its reliance on foreign fuel, as it has shifted towards deriving energy from domestic production of ethanol. The country has been using ethanol for years, as it has sought ways to reduce its dependence on foreign oil since the oil-price shocks of the 1970s. Investors looking for exposure to Brazil's ethanol market might want to take a look at Cosan S.A. Industria e Comercio [CSAN3.SA] - the nation's largest producer of ethanol.

Efforts to use ethanol in the United States are already underway. According to the U.S. Department of Energy, all gasoline vehicles are already capable of using fuel that is 10 percent ethanol and the rest gasoline. And, some states already require at least seasonal use of ethanol up to 10 percent.

Still, there are issues that need to be tackled. The Energy Department explains that, at present, there are more than 1,000 public ethanol fueling stations across the country, but most are located in the Midwest.

Several agricultural products can be used to produce ethanol. Brazil's ethanol is derived mostly from sugarcane. By comparison, much of the current ethanol produced in the United States is based from corn. A key player in this market is Archer Daniels Midland Co. (NYSE:ADM), a leading agricultural processor of grains and oil seeds. The processing of corn for ethanol provided a boost to the company's earnings in its fiscal first quarter ended September 2006 and helped it post better-than-expected results in the second quarter, which were released on Thursday. And the company has its sight set on dominating the global ethanol and biodiesel industries. ADM's ethanol capacity stands at about 1 billion gallons - about 20 percent of the total U.S. production for 2006. The company has plans to ramp this up another 550 million gallons.

Archer Daniels has beaten estimates in each of the last five quarters.

Historical EPS surprises

These better-than-expected results have helped the company post earnings growth rates that surpass the averages for the food processing industry in the trailing 12-month [TTM] period. The company has also outpaced its peers over the last five years, as well.

Archer Daniel Growth Rates

Archer Daniels's price to earnings [P/E] ratio of 14.6 is below the average of 22.3 for the food processing industry. Its P/Sales ratio is similarly lower, standing at 0.6 versus the industry norm of 1.48.

Of course, ethanol is not a panacea and many experts point to problems here, too. On the one hand, there is concern about how much of the U.S. corn production can be turned into ethanol. Andy Karsner, assistant secretary for energy efficiency and renewable energy at the U.S. Energy Department, said at the Reuters Global Biofuel Summit in Washington in January that there is a limit to the amount of ethanol fuel that can come from the U.S. corn crop. He indicated that the country could hit this limit in the next five years. Further, there are environmental concerns here, as well. Thus, a shift to ethanol is only part of the solution; improved fuel efficiency is another part.


Many foreign-based multi-national automobile manufacturers have embraced enhanced-fuel-efficiency technology. Japan's Honda Motor Co. (NYSE:HMC) hit the car market with low-emission vehicles in the late 1990s, including the launch of the hybrid Insight in 1999. The Civic hybrid hit the market in 2001, followed by the Accord hybrid in 2004. Japan's largest car company Toyota Motor Corp. (NYSE:TM) similarly has a footprint in the fuel-efficient and hybrid market. It has several models that get more than 40 miles per gallon, including the hybrid Prius, which gets more than 50 mpg.

Both Honda and Toyota are also leaders in the auto & truck manufacturers industry in another way: superior profit margins. As indicated below, both companies have operating, pre-tax, and net profit margins that are much wider than the industry averages over both the TTM and five-year periods.

HMC TM profit margins

Honda is priced about on par with the industry average in terms of P/E, but Toyota commands a richer price tag, at least partially as a result of its continued pressure on U.S. giant General Motors Corp. (NYSE:GM) for the top spot.

HMC TM Valuation Ratios

After losing market share to international competitors, U.S. companies including GM, are also taking steps to get in on the fuel-efficient and hybrid market. At the Detroit auto show in January, GM unveiled its Volt concept car. The Volt is designed to use little or no gas, running up to 40 miles on electric power.

Disclosure: At the time of publication, Erik Dellith did not directly own shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

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