Tom Konrad
I'm more than a little obsessed with finding investments
which will increase with the price of oil, but not contribute to global
warming. This is quite tricky, because most forms of renewable energy
produce electricity, which we cannot use in our current fleet of cars.
Biofuels ( even cellulosic)
can be used in cars, but are limited by supply of feedstock, and by the environmental
degradation that growing and collecting biofuel feedstocks can cause.
Not to mention the impact
on food prices (despite the fact that this may help poor farmers even as it
hurts poor city-dwellers.)
A Drastic Peak Oil Scenario
When the supply of oil cannot grow to meet increasing demand, the price must
increase to keep demand in check. However, the fastest growing consumers
of oil are countries where the government
subsidizes oil as an attempt to avoid civil unrest or political
discontent. That means that demand destruction in developed markets must
make up the difference for markets where demand destruction will not occur due
to the lack of price signals.
How elastic is gasoline demand in North America? While there is some
evidence that we are already responding
to the long term rise of gas prices, demand is almost always much more
elastic in the long term. Most people are more
willing to skip going out to eat once a month than they are to start riding the
bus. That means that a slow, gradual rise in the price of oil might be
accommodated through a shift to more efficient vehicles, the construction of
light rail systems, and people choosing to live more densely. On the other
hand, it will take a much more drastic oil price spike (say $10 per gallon
within 3 years) to pry Americans' white knucklrideres from the steering wheels of
their SUVs.
That is precisely what I expect to happen.
$10 Gas Would Mean...
People who have been cutting back on other things in order to keep up with
the increasing cost of driving will not be able to afford a new Volt
or Prius
Plug-in Hybrid Electric Vehicle, or even my favorite, the Aptera.
For people forced out of their cars by pure economics, the only options will be
those that cost no more than a few thousand dollars, or even no down-payment at
all.
Of all the options, mass transit has the lowest up-front cost for the user,
and the only option which can be expanded quickly is bus rapid transit.
Busses can typically be ordered and delivered within a year, the upfront cost is
fairly low (the largest component cost of bus operation is the driver, not the
cost of capital), and new routes can quickly be added by converting lanes of
existing roads to dedicated bus lanes.
Long
haul bus operations are already taking off in the United States.
Mass transit ridership reached a new 50
year high in 2006 (I have not been able to find 2007 numbers yet.) Bus
mass transit is additionally likely to be a response of municipalities to peak
oil because 80%
Federal funding for bus purchases to meet increased ridership or replace old
busses has been available since 2005.
New Flyer
New Flyer Industries (NFI-UN.TO,
NFYIF.PK) is the largest
supplier of heavy duty busses in North America (42% delivered market share in
2007, and a 50%+ market share in terms of new orders in the last year.)
They have a broad product
offering, and including a wide variety of alternative fuel options,
including LNG, CNG,
Hybrid, and Electric
options. They even have an exclusive agreement with Ballard
(NASD:BLDP) to develop Hydrogen
Fuel Cell busses.
The Company has a strong position in the North American market, a market
which has high barriers to entry due to the need for many US buyers to "Buy
American" (New Flyer qualifies), and the fact that US fleet operators are
interested in an established brand with good local service. Since many
American buyers only pay 20% of the capital cost (but all the service costs),
service and maintenance is likely to be more important in the buying decision
than the initial purchase price. This should also help push purchasers
towards cleaner running busses such as New Flyer's natural gas and hybrid
versions, despite the increased capital costs.
Securities Details
New Flyer's available securities are Income Deposit Securities (IDS), an
approximate 50-50 hybrid between high yielding (but not well secured) debt and
equity. Because of Canadian withholding (I have not been able to determine
if this applies, but I suspect it does,) these may not be the best choice for US
based tax-advantaged investors, but for Canadian and US-based taxable investors,
these income deposit securities should be an excellent hedge
against the rising price of gasoline. Unlike most gas price hedges
available, the income from the security can directly be used to buy gas without
selling even part of your original position. (Although it does have the
slight disadvantage as a hedge because the mechanism is not direct, and higher
gas prices may take 1-3 years to flow through to higher earnings at New Flyer.
On the subject of hedging, the company runs a very sophisticated financial
operation. The unusual nature of the securities arises from their sophisticated
use of the US tax code to allow deductibility of the interest part of the
monthly distributions. They have fully hedged their exposure to exchange
rate changes between the Canadian and US dollar (something I wish another
favorite, Carmanah Technologies (CMH.TO,
CMHXF) had done in recent
years.) They are also taking advantage of the strong loonie (C$) to buy
back some previously issued securities using excess cash and the proceeds of a new
offering of additional IDS in Canada. Because of the exchange rate
terms of the class B and C shares they are redeeming, this will have an
immediate positive impact on cash flow.
Conclusion
From listening to the most recent conference call, I get the impression that
management is very conservative, and has not built a rising oil price into their
projections for market growth. None of the analysts on the call asked
about the effects of rising oil prices either. In fact, management had
expected the current strong market for bus orders to slack off towards the end
of the year, and they were surprised that they see no signs of slackening
growth.
Since management and most analysts have not incorporated peak oil into their projections,
we can expect unpleasant surprises at the pump to lead to pleasant surprises
during earnings announcements.
Note
Since I wrote the above, one of my New Years Speculations, Capstone
Microturbine (CPST), received
an order for 150 turbines for use in a fleet of hybrid busses.
Although this is not a new application for their microturbines, it was one I had
forgotten when looking for bus stocks.
DISCLOSURE: Tom Konrad and/or his clients have long positions
in NFYIF, CMHXF, CPST.
DISCLAIMER: The information and trades provided here are for
informational purposes only and are not a solicitation to buy or sell any of
these securities. Investing involves substantial risk and you should evaluate
your own risk levels before you make any investment. Past results are not an
indication of future performance. Please take the time to read the full
disclaimer here.
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