Some technologies, even some industries, seem to be always on the verge of a breakthrough. The energy sector is particularly prone to this. If you believe the hype, then we are always about to experience some fundamental shift that will change our lives forever, and if you just buy in to one of the struggling companies seeking to exploit this wonderful new technology, you too can be fabulously wealthy! The truth in these predictions, at least to date, can best be gauged by the fact that Exxon Mobil (XOM) made $9.1 Billion in the first quarter of 2014.
For that reason I hesitate to talk positively about a stock in one of those industries that we have probably all been told are “revolutionary”. This is especially true when the stock is extremely volatile and is on the way back down after nearly tripling in a three and a half month period. While we are on reasons not to trust this thing, how about a market cap of less than $220 Million, or a recent dilution of the stock by a $17.1 Million private placement of shares that caused a one day 14% drop.
All of these negatives apply to Vertex Energy (VTNR) but I still like it. Vertex is in the oil re-refining business. They provide recycling solutions to businesses and take used oil and other waste products and make them into something useful. The green nature of this business makes it a candidate for over hype, and I for one have been told before that re-cycling industrial waste is the next big thing, but there are three things that make this different.
Firstly, this is not a case of buying into an idea in the (probably forlorn) hope that the company will one day make money. Vertex has turned a profit in every quarter since the beginning of 2010 except one, and that was a break even quarter.
Secondly, the recent price rise, as spectacular as it has been, has been based on valuation, not speculation. Indeed, by conventional valuation metrics, VTNR is actually cheap at current levels, with a forward P/E below 14.
Finally, the company’s purchase of Omega Holdings, another re-refining company, in March of this year has expanded their capacity and paves the way for further significant earnings growth.
The biggest problem with buying into a volatile stock like this on the way down is timing an entry. It is all too easy to buy in for long term potential but then be squeezed out within a few days or weeks. Thursday’s close at $9.74, however, is close enough to a significant level to make buying here a reasonable bet.
The $9.15 level (marked on the above chart by the gold horizontal line) offered resistance twice on the way up, both at the end of April and then a week and a half later. As you would expect, once it was broken it became a support level and has held twice on the way back down. It will likely provide some support again if today’s drop continues. It is too close for a stop-loss level in a stock with this much recent volatility though, and the May low around $7 would be more appropriate. Obviously, this means risking over 30% of your investment, so this is not something on which to risk a chunk of your capital.
Given the current valuation, just a return to average earnings multiples would give close to a 50% profit, so the risk/reward ratio is not too far off, but the real potential is for serious earnings growth over the next couple of quarters and some upward revisions. If that happens, or the seemingly re-invigorated EPA further tightens regulations for disposal of industrial waste, there could still be serious pop in the stock that would allow stop losses to be re-set in order to lock in a profit.
Generally I don’t like trendy stock and prefer to look for something that is out of favor and is therefore cheap, but value is value. There are reasons not to buy VTNR, but to my mind the opportunity to own a company that has a proven profit record, is trading at a discount to the broad market, and has serious growth potential is just too good to miss.