Wanna make a bet on biofuels?
Investing in ethanol is risky, but here are a few ways that small investors can get a piece of the action.
NEW YORK (FORTUNE) - Trying to invest in ethanol and biofuels today is a bit like Internet investing in the '90s. Most of the publicly traded companies are pint-sized crapshoots, and it's not yet clear whether the early-to-the-game blue chips are pursuing the best strategies.
So there are going to be many, many more pets.coms than eBays in agrifuels. More Time Warners than Microsofts. Indeed, many of the venture capitalists bankrolling tomorrow's ethanol IPOs (see "How to Beat the High Cost of Gasoline Forever!") are the same folks who funded the '90s dot.com debacle.
Okay, okay, you say. You know there's risk, but you still want the lowdown on how small investors can get a piece of the ethanol action. One approach is agricultural futures -- at least if you have a financial advisor well versed in commodities trading. Bill Nelson, a grains-market analyst for A.G. Edwards, thinks that over the next five years, ethanol-related demand could push corn prices from $2.05 a bushel to $2.50.
If futures trading isn't your cup of tea, there are a handful of stocks with varying degrees of ethanol exposure. Probably the safest choice is Archer Daniels Midland (Research), the agricultural giant whose growth is being turbo-charged by its ethanol business. (The stock has climbed 22 percent, to $28, since we recommended it in our 2006 Investor's Guide.)
Another agricultural company with big biofuel exposure is Bunge (Research), which recently announced plans for a biodiesel plant in Germany and is also a big processor of soy beans, rapeseed and other biofuel feedstocks. Monsanto (Research) sells genetically modified soy and corn seeds, some strains of which are especially well suited to the production of ethanol and biodiesel.
And Royal Dutch Shell (Research) has a large venture capital investment in Iogen, a Canadian company with a potential break-through ethanol technology. The Holy Grail of ethanol has been making low-cost fuel from straw, wood chips, cornstalks and other agricultural waste. Iogen's genetically engineered enzymes accelerate the breakdown of plant waste, making the fermentation process considerably more efficient.
The only real pure-play ethanol stock is Pacific Ethanol (Research), a California startup that made headlines last November when it received an $84 million investment from Bill Gates. Pacific has plans to build five West Coast ethanol refineries by mid-2008. Paul Resnik, an analyst with Dutton Associates who rates Pacific a "speculative buy," believes the company will be profitable in 2007. The location of its plants, he says, will give it a cost advantage over Midwest ethanol producers selling to California, since corn is cheaper to transport than ethanol. (Dutton's research is paid for but not controlled by Pacific and the other companies it tracks.)
If Resnik's earnings projections prove correct -- a big "if" for a company that's yet to produce a drop of fuel -- Pacific would be trading at 56 times next year's earnings and 11 times 2008 earnings. Not cheap, but not pets.com territory either.
Find out why Paul Ho, director for global project finance at Credit Suisse First Boston, says biofuel investing is interesting, but risky.