The only 5 biofuel stocks worth owning

Higher federal mandates are creating a big opportunity in this alternative energy industry. Here are the best stocks in the sector.

By StreetAuthority Feb 22, 2013 1:28PM
Woman pumping gas into car © Hybrid Images, Cultura, Getty Images
By Michael Vodicka                                                          

Investors looking for clues about the future of the U.S. biofuel industry need to take a look at Brazil. That's because many analysts believe the leading emerging market in South America has the world's first sustainable biofuels economy.

There are a few very good reasons for this.

The first is age. Brazil's ethanol fuel program is 37 years old, giving the local industry, economy and infrastructure time to adapt to this new energy source. The second is government fuel standards, which include a federal mandate that domestic gasoline contains an 18% mix of anhydrous ethanol. Finally and probably the most important element in the success of Brazil's biofuel industry is its prodigious agriculture industry, enabling it to source biomaterials to convert into ethanol.

The success of the country's biofuel industry is a mirror image of what's currently happening in the U.S. Much like Brazil, the U.S. biofuel industry is mature, experiencing a resurgence during the late 1970s energy crisis and steadily growing ever since. This trend has lifted the U.S. to become the largest biofuel producer in the world. Also like Brazil, the U.S. has massive agricultural production capacity that will enable it to further supply biomaterials for energy consumption.

But the key difference between the two countries is the government. Although I'm not a big fan of government involvement in the private sector, the biofuels industry is definitely set to gain on government regulation.

The current National Renewable Fuel Standard (RFS2) program, established under the Energy Policy Act of 2005, requires most refiners, importers and non-oxygenate blenders of gasoline to replace 10% of their gasoline with renewable fuels such as ethanol. This requirement is designed to ensure that at least 11 billion gallons of renewable fuel is sold annually. The U.S. Environmental Protection Agency is targeting 36 billion gallons sold annually by 2022.

The biofuel industry also got a boost on the fiscal cliff deal, keeping intact a $1.01 per gallon tax credit for the remainder of the year. It also retroactively activates a $1-per-gallon production credit for biodiesel (that ended in December 2011) through the end of the year.

When you factor growing federal regulation and subsidies in the domestic biofuel industry, the U.S. looks a lot like Brazil 20 years ago: On the cusp of a sustainable biofuels industry.

This means early investors in young and growing biofuel companies stand to see big gains as more and capital flows into the sector. As it is, there are 21 publicly traded companies in the biofuel sector. Only five are profitable.

Here's they are:

From the group, these two stocks stand out for their attractive valuations and surging estimates:

1. Renewable Energy Group
With a market cap of $225 million, Renewable Energy Group (REGI) refines and markets biodiesel in Canada and the U.S. With the fiscal cliff deal renewing biofuel subsidies, shares have been hot in the past three months, up a market-beating 52%.

Estimates have also been surging, with analysts projecting full-year earnings of 78 cents a share in 2014, a bullish 306% year-over-year growth projection. Long term, analysts are looking for annual earnings growth of 15% in the next five years, ahead of the industry average of 14%. And when you factor in a forward price-to-earnings (P/E) ratio of just 10, a discount to the S&P 500's P/E of 15, Renewable Energy Group has a unique combination of growth and value.

2. Green Plains Renewable Energy
Green Plains Renewable Energy (GPRE) refines and sells ethanol, distiller grains and corn oil in the U.S. It has been red hot in the past six months, up an amazing 131%.

This bullish movement has been fueled by surging estimates, with the full-year 2014 estimate almost doubling from 50 cents a share projected for 2013 to 95 cents a share. Analysts are now projecting earnings of 65 cents in 2013, which would be a 239% increase from last year.
This has shares trading with a forward P/E ratio of 15, directly in line with the S&P 500 in spite of the bullish growth projection.

Risks to consider: Any industry benefiting from government regulation and subsidies is vulnerable to fluctuations in federal and fiscal policy.

Action to Take --> The biofuels industry is set to gain on growing federal subsidies and regulation, which has already sent many stocks from the sector soaring in the past three months. But looking forward, the real gains are still to be made as the U.S. continues to mandate higher usage of biofuels.

Of the five companies above, my two favorites are Renewable Energy Group and Green Plains Renewable Energy because of their bullish growth projections and very attractive valuations.

Michael Vodicka does not personally hold positions in any securities mentioned in this article

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