By Brendan Coffee, Editor of Cabot Global Energy Investor
From Cabot Wealth Advisory 8/22/11 Sign up for free Cabot Wealth Advisory e-newsletter
If you're looking to build a watch list of stocks to buy sooner rather than later, I suggest looking at some of the companies that are performing well in Brazil's robust ethanol market. As the world's second-largest ethanol producer after the U.S., Brazil producers would benefit from removal of the three-decade old 54-cent per gallon tariff on ethanol imports.
Cosan (CZZ), in particular, is worth taking a closer look at.
Cosan, one of the larger, more established companies in Brazil, was founded in 1936 as a sugar cane producer. In 1976, when Brazil jumped headlong into ethanol production by requiring a blend of up to 22% of ethanol in gasoline, Cosan became one of the leading makers of the fuel. Today, many Brazilian vehicles can run on pure ethanol, helping cane-based ethanol now command 50% of the auto fuels market in the country. Cosan has expanded with ethanol's influence, buying up ExxonMobil's (XOM) retail filling stations business in 2008.
Last year, Cosan entered a 50-50 partnership with Royal Dutch Shell (RDS) in a new company, called Raizen, to produce ethanol, sugar and power (by burning cane husks) from sugar cane. In its latest quarter, reported last week, Cosan's sales grew 25% to 5.19 billion reals (equal to $3.3 billion) with a net profit of 2.3 billion reals ($1.5 billion), although the bulk of that eye-popping net profit came from accounting for the merger of a number of company assets into the Raizen venture. Setting that aside, profit would have been a lot less, at $106 million.
It is Raizen that makes Cosan worth considering. The new company will produce 528 million gallons of cane ethanol a year, 9% of Brazil's demand, and distribute them through Shell's retail network in Brazil. Shell expects the global demand for low-carbon biofuels like ethanol (and cane-based ethanol is believed to have a lower carbon footprint than corn ethanol) to triple worldwide by 2030 ... and for Raizen to grow with it. Should the ethanol tariffs expire at year's end, it's a good bet that a lot of Cosan's and Shell's growth will come from exports to the U.S.
Editor's Note: Brendan Coffey is the editor behind Cabot Global Energy Investor, which selects the top energy stocks each month and combines them with Cabot's proprietary market timing indicators to score winning results for subscribers. With ethanol subsidies possibly on the way out and oil prices rocketing around, now is THE time to profit from the top stocks in this sector. Learn more now!
From Cabot Wealth Advisory 2/22/10 Sign up for free Cabot Wealth Advisory e-newsletter
Lately, we're seeing increasing strength in the shares of ethanol-related companies. Commodity broker Archer Daniels Midland (ADM) has built up its position as an ethanol refiner, building its own plants and buying up other capacity. It's now the largest producer in the U.S., and is in a position of strength if gasoline prices surge and demand for ethanol materializes. Similarly, second-tier ethanol players, like The Andersons (ANDE), are seeing good relative performance lately, too.
But in this environment, I'm not sold on investing in any U.S. ethanol producer just yet. There are a few reasons for that. Let me talk about the macro ones I believe could drive long-term movement in ethanol.
One is the global economic uncertainty: The debt troubles of Greece, Spain and other countries in Europe have increased the risk of the common euro currency taking a beating. And if investors flee the euro, that almost certainly means the dollar will strengthen. And when the dollar strengthens, there is a strong inclination of oil prices to fall.
That's because oil is priced globally in dollars, meaning OPEC can ease its pricing to placate its best customer (us) while still going home with as much money in their own currency as always. (It's no coincidence that 10 years ago 99-cent gas coincided with the unrivalled strength of the U.S. dollar.) If oil prices drop, ethanol is a lot less attractive to refiners, retailers and ultimately us drivers.
Another reason I'm not convinced about domestic ethanol just yet is the concern that using up edible crops (or at least arable land to grow inedible, ethanol-producing corn) will spark another wave of outrage if food prices spike again domestically. And that is a significant possibility if the dollar doesn't strengthen and the U.S. middle class continues to get squeezed from all directions.
Food supply shocks like that are also why China mandates that no biofuels in its country be derived from edible crops. The leading biodiesel maker there, Gushan Environmental (GU), collects waste cooking oil for restaurants for its product and eventually will make fuel from a non-edible pistachio plant that grows well on land otherwise unsuited for farming.
(We had some success investing in GU at the Cabot Green Investor a couple of years back, but low global diesel prices and tariff issues in China make the stock one to be wary of right now).
Lastly, perhaps the primary reason I'm wary of domestic ethanol stocks is that I expect Brazil will be the most effective ethanol producer. For one, Brazil is the dominant grower of sugarcane in the world, producing about one-third of all cane.
Ethanol can be made from sugarcane, and in fact cane is a superior raw material for ethanol, since more of it converts into energy, and does so more easily. By one measure, sugarcane ethanol returns eight times the energy used to produce it, while corn ethanol returns just 1.3 times the energy used to make it. Now add in the fact Brazil not only exports a lot of sugar, but also makes a lot of ethanol too.
In 2009, Brazil is estimated to have produced 28 billion gallons of ethanol. Most of that was used domestically, accounting for half of Brazilian automobile fuel. But exporting it to markets that offer a greater return, like the United States directly, or through intermediary countries that sidestep trade barriers, is hardly unrealistic. And if you project an export market for American ethanol, consider that it is China and Brazil which have just inked a deal to start sending Brazilian ethanol east.
In this environment, I'm putting the odds favoring a company called Cosan (CZZ), the largest sugar producer in Brazil and also the biggest ethanol producer. The company just signed a deal with Royal Dutch Shell for co-generation and marketing of each other's fuels in a bid to lay the groundwork for a global ethanol giant.
CZZ has more than doubled in the past year, jumping from 4 to nearly 9, giving it a market cap of $2.8 billion, and it has held up well in the recent market retracement.
Cosan should also benefit from strong prices in the world market for raw sugar this year too (Brazil sells its crop into the world market this summer). I don't think it's time to buy it just yet, and commodity-based stocks can be very volatile, but if you're interested in profiting from biofuels, keep your gaze to the south.
Editor's Note: In addition to biofuels, a lot is changing in the automobile industry. Cabot Green Investor Editor Brendan Coffey offers his expert analysis of the technologies that will lead the way. For more information, click here.
Analyst and Editor of Cabot Green Investor
Brendan Coffey is a member of the Cabot investment team and editor of Cabot Green Investor. A veteran financial journalist, Brendan has spent more than a decade writing about investing for publications including Barron's, Forbes, The Wall Street Journal and a number of private-client brokerage newsletters.
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2/22/10 Cosan (CZZ): Brazilian Biofuels Maker