In the first installment I discussed the industry background and macro trends for natural gas engines. In this second installment I discuss the best investment opportunity that I have found in this space.
Power Solutions International, Inc. (PSIX) is a leader in the design, engineering and manufacture of emissions-certified, alternative-fuel engines. A significant portion of their sales are natural gas engines. Their focus is on engines for industrial applications but they also are moving into the on-road market with an 8.8L engine that they recently released. Their customers are mostly OEMs that incorporate the engines into their products. They have three main competitive advantages including:
- They have agreements in place with many OEMs (e.g. 8 of the 12 top fork lift companies) which would be difficult for someone else to replicate. They estimate that over 70% of the power systems they supply are provided to major OEM customers on a sole-source basis.
- They have emissions certifications on their engines and have expertise in obtaining certification.
- They have been in this industry for a long time and thus have a first mover advantage.
PSIX’s sales have been growing rapidly as they were $83M in 2009, $101M in 2010, and $155M in 2011. The two analysts that are following them expect revenue to grow to $204M in 2012 and $267M in 2013. Furthermore, non-GAAP earnings are expected to grow from $0.56 in 2011 to $0.80 in 2012, and $1.15 in 2013. The latest investor presentation on PSIX can be found here.
PSIX seems poised for many years of growth as the US market for natural gas engines is rapidly increasing and they have a strong foothold in that market. Companies with long term rapid growth often obtain very high PE multiples especially when they are in appealing industries with long term growth. PSIX’s earnings are predicted to grow roughly 43% in both 2012 and 2013 and a PE of 40-50 wouldn’t be at all unusual for this growth rate especially if the company uplists to Nasdaq which I expect will happen in Q2 of 2013 when an uplisting is allowed by regulation. In short, I expect both earnings to grow and the PE multiple to grow.
While I almost never invest for the possibility of a buy out, I think there is a reasonable chance that a company tries to buy out PSIX and thus a buy out is a possible wildcard in my investment thesis. As I have stated, there aren’t many profitable companies in this space and there aren’t many companies with a foothold. Often acquisitions happen in new industries such as this as companies scramble to position them in the space. Westport Innovations Inc. (WPRT) is one company that I think might find a buyout of PSIX attractive. WPRT is the most well-known company in the natural gas engine space. There isn’t much overlap in the target markets for the two companies as WRPT primarily focuses on the on-road market and on the biggest engines whereas PSIX focuses on the industrial/off-road market and on relatively smaller engines. WPRT would also benefit from the many OEM relationships that PSIX has established. An additional company that might be interested in a buy out of PSIX is Briggs and Stratton Corp. (BGG). BGG has a very similar business model to PSIX as they also sell primarily to OEMs. However, BGG sells mainly gasoline engines for outdoor power equipment. An acquisition of PSIX by BGG would give them access to a different market that is growing more rapidly. Furthermore PSIX could be branded with the well known Briggs and Stratton name. I’m sure there are many other companies that might find acquiring PSIX attractive but WPRT and BGG are the two companies that seem to have the most synergy and least overlap.
Disclosure: Mike King is LONG PSIX
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