Friday, July 11, 2008

Engineering Engines

In the last post we named a few companies involved in developing engine technologies. They are trying to put some efficiency in the monster that soaks up the greatest amount of fossil fuels - the internal combustion engine. The group is a selection of recipients of U.S. Department of Energy grants for engine technology development. As such they present the potential for sustainable business models that are navigating the transition from the old “fossil fuel” economy to a new “environmentally friendly” economy.

There is no surprise that the list includes major automotive manufacturers. The problem is car makers are in financial trouble on slowing sales. General Motors (GM: NYSE) appears to set new 52-week lows with each passing day. So even though the stock offers a 9.6% dividend yield, it presents a high risk investment. That dividend could be in jeopardy if GM is not able to revitalize its product line.

For investors who are looking for a good dividend, Eaton Corp. (ETN: NYSE) is another less risky option. Eaton is a diversified industrial company, catering to the automotive, defense and power generation industries. It produces nearly $14 billion in sales annually and has profit margin near 7.5%. A price earnings multiple of 10.3 times suggests the stock is affordable. The stock is trading off its 52-week high and offers a dividend yield of 2.5%. Operations generated $1.1 billion in cash flow in 2007, suggesting the dividend payout is safe for the time being.

Another attractive option is Ricardo Technologies (RCDO: LSE), consultants to automotive OEMs for new product development. RCDO offers a 3.3% dividend yield and will only cost 10.4 times earnings to take a long position. The stock is up 11.8% from its 52-week low, but we believe the stock still has a ways to go. Ricardo’s technologies are aimed at minimizing the environmental impact of future motor vehicles. Accordingly, RCDO is nearly a “engine efficiency” pure play.

Two companies figuring prominently in the commercial vehicle market are Caterpiller Corp. (CAT: NYSE) and Deere & Co., (DE: NSYE). Both are trading well off 52-week lows but still offer good bargains in terms of price for earnings. Caterpiller offers and dividend yield of 2.5%. Caterpillar is a world leader in the production of diesel engines, so that whatever technologies it develops a fairly certain to have a significant impact on engines in use.

Navistar International Corp. (NAV: NYSE) is also on our list since its International Truck and Engine Corp. division is working one of the U.S. DOE grants. However, if the strategy is to invest in companies that are coming up with engine efficiency solutions since, we do not see NAV as a good option. We believe efficiency-creating technologies are more likely to support long-term economic sustainability. However, Navistar is primarily focused on selling old technologies to the U.S. military for deployment to hot-spots in Afghanistan and Iraq. We expect that “gravy train” to slow to a trickle after the 2008 election.

One last option is Cummins, Inc. (CMI: NYSE), a major producer of medium and large trucks as well as power generation equipment. Cummins is directly involved with the key components of combustion systems, including fuel systems, controls, air handling, filtration, emission solutions. Cummins is trading at 13.9 times forward earnings, so we do not necessarily see the stock as a bargain. However, its cash position is strong and the board just recently boosted the dividend payout rate.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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