Natural gas prices have risen over 30% in the last two months to current levels of around $3.30 per million British thermal units (MMBtu) from $2.50/MMBtu at the beginning of November 2016. This rally in natural gas pricing is expected to continue this year, which will prove to be a tailwind for Clean Energy Fuels (NASDAQ:CLNE).
I am saying this because Clean Energy Fuels will be able to take advantage of an increase in natural gas prices and an increase in gallons delivered to improve its revenue and earnings. The improvement in the company's top and bottom lines will lead to strong upside going forward. Let me explain how.
Higher natural gas pricing will be a tailwind for Clean Energy
The rally in natural gas prices seen over the last few months looks sustainable in 2017 and beyond. According to the EIA, the average price of natural gas will increase 31% in 2017 as compared to 2016, driven by growth in domestic consumption and higher pipeline exports to Mexico. In fact, the momentum in natural gas pricing is so strong that the NYMEX contract values for March 2017 have risen to $5.04 per MMBtu. This exceeds the estimates of the Henry Hub Natural Gas price for March 2017 at the 95% confidence level.
The increase in natural gas pricing will be a tailwind for Clean Energy Fuels. This is because Clean Energy usually enters into fixed-price contracts with its clients, which are dependent on benchmark prices such as the Henry Hub Natural Gas. Since the Henry Hub natural gas price is expected to increase substantially this year as pointed out above, Clean Energy should be able to enter into contracts at better prices. This will allow the company to take advantage of an increase in volumes delivered.
In fact, Clean Energy Fuels has witnessed strong growth in its volumes in the first three quarters of 2016, as shown below, and it is likely that the trend will continue.
Source: Clean Energy Fuels
Growing adoption of natural gas trucks and buses will be a tailwind
There are a number of growth drivers fueling the transit bus and refuse truck markets, such as lower greenhouse emissions and the increased the availability of both fuels and vehicles. However, the recovery of the cost of natural gas-powered vehicles is the primary growth driver for Clean Energy.
According to the American Oil and Gas Reporting, natural gas powered vehicles have significantly lower costs in the long run as compared to diesel or gasoline-powered vehicles. Although the incremental cost to purchase a refuse truck or transit bus remains nearly 15% to 40% higher than the diesel-equipped version, based on the type and fuel capacity of the vehicles, the incremental costs can easily be recovered.
For instance, to convert a heavy refuse truck to run on the CNG platform may cost approximately $32,000 to $33,000. However, this cost can easily be recovered within a couple of years. Considering that a refuse truck that runs on natural gas travels an average of 13,632 miles per year, this can result in savings of $7,289 per year because natural gas remains cheap as compared to diesel.
This indicates that the cost of the truck can be recovered within four years. In fact, the report from the American Oil and Gas Reporting claims that a higher mileage truck or bus can recover the incremental cost within three years. Moreover, the fuel savings for the rest of the life of truck will allow the fleet operator to recover the infrastructure costs as well.
Source: American Oil and Gas Reporting
Due to the above-mentioned positives, Clean Energy Fuels should experience a significant improvement in its volumes delivered, apart from an increase in natural gas prices. According to Busworld Academy, the bus transit market is expected to grow at a compound average growth rate of 8.4% to 201,000 by 2020 from 111,000 in 2015.
More specifically, the bus transit market in North America is anticipated to increase to 6,900 by 2020 as compared to 5,200 in 2015. This is on the top of the 25% growth in transit buses that currently operate in the U.S. Due to the strength of these two markets, Clean Energy's addressable volume opportunity in the bus transit market is 1.5 billion gallons annually, with the company's infrastructure able to fuel around 8,000 buses on a daily basis.
Additionally, Clean Energy should benefit from the growth of the refuse truck market because around 60% of the new refuse trucks are now operating on natural gas in the U.S. This gives Clean Energy a market size of nearly 2 billion gallons per year. Hence, due to strong growth in the end-market, Clean Energy Fuels should witness consistent growth in volumes and this will lead to growth in the top line.
Impact of the end-market growth on the stock price
Since Clean Energy Fuels is still a loss making company, we will use the company's projected sales to judge its potential upside going forward. For instance, in 2017, the company's sales are expected to rise to as much as $501 million. In comparison, over the past twelve months, Clean Energy has generated around $420 million in revenue.
This means that as compared to its current performance, Clean Energy's top line is expected to rise around 20% in 2017, which is not surprising as the company will benefit from an increase in both volumes and natural gas prices. Now, Clean Energy Fuels has a price to sales ratio of almost 1 as its sales in the trailing twelve months are almost identical to its market capitalization of $418 million.
Now, if Clean Energy Fuels is able to sustain its price to sales ratio in 2017, then its market capitalization will increase to $501 million given its projected sales forecast. This means that Clean Energy's stock price will rise 20% in 2017 due to an increase in sales.
Therefore, a combination of strong natural gas prices and higher volumes will allow Clean Energy Fuels to deliver strong upside this year. So, in my opinion, it will be a good idea for investors to continue holding this stock for more gains going forward.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.