Ethanol Stocks: Two Ways To Profit As America Shifts Toward this Alternative Fuel

by Karim Rahemtulla

Ethanol Stocks: Two Ways To Profit As America Shifts Toward this Alternative Fuel

by Karim Rahemtulla, Chairman

Wednesday, July 5, 2006: Issue #554

With July upon us, there's a good chance you'll be packing up the car soon and heading off for a few days' vacation.

But as Americans whiz down the highway, they'll be doing so knowing that the national average price for a gallon of gasoline is $2.94 - 80 cents higher than this time a year ago.

But is help on the way? By now, you might have heard about how ethanol could change the future of our energy situation. It's something the government is promoting heavily, for several reasons:

  • It makes the U.S. a little less dependent on Middle East oil and inches us closer to energy self-reliance.
  • It's less polluting than gasoline - not by much, but every little bit helps.
  • The technology to run cars on ethanol already exists.

Look at Brazil, for example. General Motors and other manufacturers are already making cars for Brazilians that can use any combination of ethanol and gasoline.

So, why aren't we doing it in America? Well, we are

In 1980, total U.S. ethanol production was just 175 million gallons. But by 2005, the total leapt to 3.9 billion gallons - a 2,130% surge. And ethanol demand this year alone is expected to jump 50%.

The problem is that there are not enough ethanol stations here to pump out pure ethanol. But as gas stations add new ethanol pumps, this will change. And here's how to profit

How To Profit: 2 Ethanol Stock Plays

The first is Archer-Daniels-Midland (NYSE: ADM). Members of my Income Trader options service, which employs a covered call strategy, recently took a position in this company when it pulled back - and watched it then set new 52-week highs.

Using a covered call strategy basically allows you to own a company well below current levels. If you want to play ADM, then consider doing the same in order to reduce your cost. At current levels, shares are pretty fairly valued (not expensive, but not cheap either).

Another stock for you to look out for is Pacific Ethanol, Inc. (Nasdaq: PEIX).

Pacific Ethanol is currently trading at mind-boggling levels, though, thanks largely to Microsoft owner Bill Gates buying a huge chunk of it a couple of months ago (when the price wasn't so mind-boggling).

And it's volatile, too. The stock went from $42.39 on May 11 to $30.23 on May 24. That's some heavy fluctuation! And all in just 10 trading days.

What you've got here is the "Gates Factor" at work. He paid about $84 million for just under 25% of Pacific Ethanol. That valued the company at about $10 to $12 per share. But shares of its stock now trade around $25.20, down sharply from a 52-week high of $44.50 as recently as May 11.

My advice: Wait for a pullback of around 40%. This is what it will take for the "Gates Factor" to wear off and for shares to be more reasonably priced in the high teens to low $20s.

Ethanol vs. Oil: Don't Do It

There are other ethanol-based plays. For example, you could buy some of the major oil companies that are thinking of branching out and setting up ethanol service stations.

But that would mean you own oil, too. And I'm not fond of oil at its current price.

But what if ethanol doesn't take off and you're stuck with a stock you don't really want? Well, that's where ADM in particular is a good bet. It's a diversified company that could make big bucks from ethanol on the coming months and years, but it relies on more than the ethanol business for its profits.

Conclusion: Bone up on ADM and PEIX. These are two "free" plays that are worth getting excited about at the right price. ADM also has LEAPS available for an options play.

Good trading,

Karim

comments powered by Disqus