Clean Energy Building It; Will The Customers Come?

By Stephen D. Simpson, CFA | March 16, 2012 AAA

There are a lot of pieces that have to lock into place, more or less simultaneously, for any sort of large-scale conversion to natural gas as a vehicle fuel in North America. Engine manufacturers have to know that truck builders (and buyers) will buy the engines, fleet operators need to know that they'll have a place to fuel up and fueling station operators need to know that there will be enough vehicles out there to pay for the fueling infrastructure.

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Oddly enough, while there has been a lot of hot air over the years about the conversion to natural gas, it seems to actually be in the process of happening, and Clean Energy (Nasdaq:CLNE) is playing a major role. Now the question remains: Can Clean Energy earn long-term economic rents on its infrastructure, or will competitors let Clean Energy take on the risk and whittle away their rewards?

Mixed Results for the Fourth Quarter
At the top line, Clean Energy reported revenue growth of just 4%, though this number is a little misleading. The company saw significant benefits a year ago from tax credits, and those contributions declined 72% to this quarter; on a net basis, revenue was up about 12%. Fuel volume was up 26% annually, but down a bit sequentially and gross margin weakened a little.

Not surprisingly, the company has not yet reached sustained profitability, and adjusted EBITDA was slightly negative this quarter.

Ducks Lining up
A lot of key pieces are falling into place for Clean Energy. Navistar (NYSE:NAV), one of the country's largest truck builders, has made commitments to offering natural gas engines for every one of its addressable truck classes. Some of these trucks will use engines/engine technology from Westport Innovations (Nasdaq:WPRT), while the company will also develop its own.

As part of this commitment, Navistar has also formed a joint marketing/fueling agreement with Clean Energy. This agreement will largely help to subsidize the incremental costs of buying natural gas vehicles in exchange for long-term fueling commitments. This is very analogous to the "give the box away, and make money on the disposables" model that has been so successful for decades in the med-tech world.

Navistar is not the only ally in this transition. Chesapeake Energy (NYSE:CHK) is aggressively promoting the adoption of natural gas as a vehicle fuel and has created a large ($1 billion) fund to accelerate vehicle conversions and fueling station buildouts, and the company has invested in Clean Energy.

And there's still more beyond this. Waste Management (NYSE:WM) has commented that roughly 80% of the trucks it intends to buy in 2012 will be natural gas-fueled. The CEO of Swift Transportation (Nasdaq:SWFT), the largest trucking company in the U.S., has said that he believes natural gas fleet penetration could reach 40% in just four years' time.

The $64,000 Question
The biggest question is the extent to which Clean Energy (and its investors) can expect to reap significant free cash flow from these investments in capacity. Clean Energy has more then 250 facilities in place around the country already and will likely double that before too long.

If you look at companies like Casey's (Nasdaq:CASY) or Pantry (Nasdaq:PTRY), though, you see that the margins on fuel retailing are very tight. Certainly this won't be an immediate problem for Clean Energy, as there simply won't be many CNG/LNG competitors, and it's also true that Clean Energy's model is not identical to those gas station/convenience store operators. The point is, though, that fueling services (whether retail like Casey's or commercial like World Fuel (NYSE:INT)) just isn't a sustainably high-margin business, and if natural gas vehicle fleets reach critical mass, the competition will be coming.

The Bottom Line
It will be very interesting to see what sort of long-term margins Clean Energy can achieve. The arguments in favor of natural gas-fueled vehicles are compelling and it looks like the transition is finally underway. I am simply worried that ultimately there's no "magic" to what Clean Energy offers and that eventually they become a vendor of an indistinguishable commodity.

In the meantime, I don't expect bulls to care. Clean Energy should be able to post many years of impressive growth before competition becomes a real issue, and there's at least an outside chance that Clean Energy can lock in decent margins with long-term fueling contracts. Moreover, as one of the relatively few legitimate pure-plays on natural gas, there's some definite scarcity value to these shares.

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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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