By David Sterman
Whenever assessing a stock's long-term growth potential, investors also need to focus on the hurdles the company must overcome before growth can take off. If you're talking about a major technological or regulatory change, for example, then an ample amount of ground work needs to be laid before the stars align.
For environmental services company Calgon Carbon (NYSE: CCC), that groundwork has been laid for the past four years, and the company should soon reap the benefits. Meanwhile, shareholders have yet to benefit. The stock has traded a few dollars north or south of $15 during the last four years, though a move up into the mid-$20s appears increasingly plausible.
Meanwhile, downside appears quite limited -- just my kind of stock. That's why I'm adding this company to my portfolio.
Air and water
As its name implies, Calgon Carbon produces carbon in various forms to either scrub power-plants of key airborne pollutants or disinfect both drinking water and waste water. Across the map, countries have been seeking to clean up their act, which has fueled decent, though unspectacular, growth for this company.
Growth in each of the company's two main segments has actually been a bit more erratic than that trajectory implies. Demand for air scrubbing carbon spiked nicely higher as power plants were retrofitted to cut emissions of mercury, sulfur dioxide and other airborne pollutants. But the company's UV-based water filtration systems have seen relatively flat demand as municipal budgets were slashed during the recent economic slowdown.
These divisions carry disparate profit margins, which helps explain why Calgon Carbon's profit growth has been more subdued in the past two years.
Yet both of these segments stand to benefit from looming regulatory changes that were announced in December 2011. The most important move: The Environmental Protection Agency (EPA) announced on Dec. 21 that it will implement the Mercury and Air Toxic Standards Act (also known as the Maximum Achievable Control Technology Act, or MACT).
This could impact up to half of our nation's 1,300 coal-fired power units. (One power station can have several units.) The act gives utilities up to four years to comply, though incentives are in place to act much sooner. Calgon Carbon's powdered activated carbon (NYSE:PAC) should see steadily rising demand late this year and into 2013 and 2014.
The company also stands to benefit from an EPA decision to require all ships that navigate U.S. waters to implement water ballast treatment systems . This comes after the devastation of sensitive ecosystems in the Great Lakes and elsewhere from Zebra Mussels and other organisms that are inadvertently picked up in other parts of the world.
The decision is now open for public hearing and is expected to be finalized before the end of 2012. Calgon Carbon's decision to buy water ballast treatment firm Hyde Marine in early 2010 now looks quite savvy. Calgon Carbon's ultra-violet water purification technology , coupled with Hyde Marine's systems engineering provides the company with arguably the most robust technology platform in the industry. Investors are watching the decision process by major countries as they seek to mirror the U.S.' ballast water initiatives. For example, Russia is contemplating a similar move, and may award the entire fleet upgrade process to just one vendor. Such a move would be a game-changer for Calgon Carbon.
Good now, better later
None of these developments is likely to impact Calgon Carbon imminently. Indeed, the company is likely to see sales rise in just the high single-digit range in the first and second quarters of 2012, compared with a year earlier. And right now, analysts are only modeling for roughly 10% sales growth in 2012 and 2013, awaiting a better sense of timing as to when these regulatory moves will boost sales. To make a rough guess, look for sales growth rates to build slowly with each passing quarter, exiting 2013 at a more brisk pace. It's the anticipation of such an upward trajectory that should enable this stock to start rising in advance.
By that logic, Calgon Carbon's earnings power should exceed $1 a share by the end of 2013 on an annualized basis (i.e.EPS will likely move above $0.25 a quarter by then). Though few are talking about it now, this company is capable of earning close to $1.50 a share by 2014 or 2015. If that comes to pass, then shares will likely be rewarded with a forward multiple of 20 times earnings, which is why I think this stock, which currently trades at $15, could move toward $30 ($1.50 * 20 = $30) within 12-18 months.
The Downside Protection: There is a high degree of recurring revenue in this business model, because carbon filters wear out and fully-engineered systems need to be replaced. It's notable that this company has seen sales decline only once since 2003 (when they fell 2% in 2005). This explains why the stock has mostly remained above $12 during the past four years, even with the occasional quarterly miss. That appears to reflect the potential downside for this stock.
Upside Triggers: The timing of the revenue surge is a bit unclear. It may not take place for a year or more. Yet it's the anticipation of an upward trajectory that will boost shares. And this is where Wall Street comes in. Most analysts have yet to fully digest the changing regulatory environment that should boost this stock. As analysts warm up to the company's opportunities, target prices should steadily rise.
I will buy 400 shares (or roughly $600 worth) of Calgon Carbon two trading days after you read this. I suggest investors put in a stop-loss order at $13, in the event that a market rout sucks this stock down with the pack. Shares can be bought under $18, though that is a fluid target and could rise as the turnaround takes shape.
Disclosure: David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.