ADA-ES A Coal Story The Market Actually Likes

By Stephen D. Simpson, CFA | March 15, 2012 AAA

Thermal coal companies are getting pounded, as a warm winter left utility stockpiles higher than normal and utilities switched to cheaper natural gas. Amidst all that, though, ADA-ES (Nasdaq:ADES) is near its 52-week high as the company continues to ramp up its refined coal business and sees ongoing demand in its emissions control business. ADA-ES has risks that are well above average, but as a rare play on cleaner coal technologies, the stock could still continue to work.

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Momentum Coming out of the Fourth Quarter
ADA-ES certainly closed out 2011 on a strong note, as revenue was well ahead of expectation. Revenue jumped 174% to almost $25 million, driven by 20% growth in the emissions control business, over 150% growth in the tiny CO2 (carbon dioxide) capture business and 244% reported revenue growth in the refined coal operations (to over $20 million).

Although the timing and recognition of revenue in refined coal is likely to be more challenging to model, the magnitude of the beat (and the fact that revenue was strong across the board) is still impressive.

Operating results were also fairly solid. Gross margin plunged on lower profits in the EC business and the impact of the lower-margin refined coal revenue, but operating costs were quite low. While the company did report a net profit, this was due to non-operating items and the company still reported a small operating loss. For related reading, see Stoke Your Portfolio With Coal.

Ready, Steady, Go with EC
Utilities and engineering companies have been waiting on new EPA rules pertaining to air pollutants produced by coal-fired power plants, and those regulations are now in place. The Mercury And Air Toxins Standards (MATS) looks like they'll produce 400-600 in incremental activated carbon injection system demand, with $500 million to $600 million incremental revenue, exclusive of ongoing follow-on opportunities.

With relatively few companies directly in this market (Alstom being one of them) and roughly a one-third market share, ADA-ES should be in line to reap some meaningful benefits. Of course, where there is the opportunity for profit, sooner or later there will be competition. Fellow small-cap Fuel Tech (Nasdaq:FTEK) is more of a play on NOx (nitrogen oxide), but engineering and equipment firms like Foster Wheeler (Nasdaq:FWLT) and Siemens (NYSE:SI) could become more active both in ACI and other control technologies.

Refined Coal - Will This Be the One That Works?
ADA-ES has an intriguing, albeit complicated, opportunity with its refined coal business. This is actually run as a joint venture with NexGen and Goldman Sachs, and it involves building facilities on site for the customer that treats the coal ((with chemicals and additives (CyClean) developed by ADA-ES)). When it's all said and done, this treatment reduces the NOx, mercury and other byproducts that are produced by burning coal (especially Powder River Basin coal).

More important, though, is that the facilities and coal qualify for tax credits (presently more than $6/ton) under "Section 45," and ADA-ES will benefit through its share of prepaid rent, rent and royalties. There's no question that this can be a lucrative opportunity, and the installation of 26 facilities in 2011 speaks well to that opportunity.

Playing devil's advocate, though, whatever the Congress giveth, it can eventually taketh away. While CyClean and the ADA-ES refined coal business could, perhaps, stand on its own, the tax credits are a huge part of the economic model at present. I don't necessarily believe that Congress is going to reverse this anytime soon; I simply offer the point that clean coal tax credits have been a political pinata in the past.

The Bottom Line
Working with Arch Coal (NYSE:ACI) is certainly a positive for ADA-ES, as is its focused position on reducing the emissions and pollutants tied to coal-fired power. While there is a lot of news now about coal companies cutting production and utilities switching to natural gas, there is only so far this process can go. Coal is still the dominant power fuel source in America and that will not chance for a long, long time.

Said differently, there's plenty of business in the coal utility sector to support a growth thesis on a company of ADA-ES's size. The significance of the tax credits to the business model makes long-term forecasting difficult, but there definitely seems to be strong near-term growth potential. While this is apt to be a volatile, risky stock, investors who can take on a little extra risk could see that rewarded in ADA-ES stock. For related reading, see 5 Coal Stocks To Watch.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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