Caught Up in the Little Stocks

 | Mar 25, 2013 | 9:00 AM EDT
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Continuing my report from last week's Roth Conference, two more small-caps are worth commentary. The second night of entertainment featured 38 Special, and their 1980s anthem, Caught Up In You, provides the perfect theme for the little stocks vying to become big ones someday.

A new "Long Shot"-type small-cap name that caught my attention was Synthesis Energy Systems (SYMX). This Houston-based company has a proprietary coal gasification technology. It is developing its business by building gasification plants in China, where there is a burning need to move away from burning dirty coal, so to speak. The company has struggled because its first joint-venture (JV) plant in Shandong province was idled due to issues with the JV partner, a coal and chemical company that was supposed to use the syngas as a feedstock for its plant next door. That plant is idle while SES renegotiates the deal to free it to sell into other markets.

Meanwhile, SES started production on another JV plant in Henan province, named the "Yima" project that will use coal gasification to produce methanol. The plant produced its first methanol late last year, and is on track to ramp up to full run-rate production of 300,000 tons annually by this summer. Methanol currently sells for around $425/ton, so this plant will quickly ramp to a $128 million sales run rate. SES owns 25% of the Yima JV, so it is on track to start booking over $30 million of annual revenue, which is impressive for a development stage company that has booked no material revenue in its history.

Beyond immediate opportunities with the two JVs in China, the company is pursuing other opportunities to license its technology. Clearly, low natural gas prices would challenge the economics of gasification in the U.S., but in China, the offset is extremely cheap, low-grade coal and a high need to work with more environmentally-friendly materials.

SYMX is a former high-flier that is now in stealth mode. No one formally covers the stock, so positive developments are not being tracked well. The company's market cap of $64 million probably reflects the value of the technology as much as any near-term economics from Yima, since the stock has been trading around $1 since late 2009. An analyst does not need to stretch to forecast some earnings from Yima, to elimination of operating losses from the other JV as it redirects to other markets, and some high margin licensing revenue. That combination could easily put SYMX on the path to growth.

This was a $14 stock in 2008. As a current investor, I don't need it to go back to the old highs. Even tacking $0.25 or $0.50 on the stock price will produce an attractive return; however, I do believe the potential is high for a multi-year multi-bagger. I will continue to track this one, and do a deeper dive in a "Long Shot" column in the coming weeks.

At the conference, I got a quick update on Energy Recovery (ERII), which I first profiled last year and recently updated after the fourth-quarter earnings report. ERII presented at the conference, and I had the opportunity to spend some quality time with management as well. The company is blessed with high quality executives, who both perceive the vast opportunities for the company and its technology, but are also aware of -- and take seriously -- the risks inherent in their industry.

For instance, we discussed the potential for graphene-based reverse osmosis systems to disrupt the desalinization industry toward the end of this decade. While noting that the technology poses no risk near-term, management pointed out that even low pressure systems will still have some recoverable energy. Although fewer of the company's PX systems might be needed in any individual plant, a lower energy desalinization technology could result in an explosion of more plants as they become more economic. A management team that is aware of important developments and is thinking through the implications is always good for investor confidence.

During the presentation, the company offered long-term guidance, explaining that they see a revenue opportunity of up to $200 million annually by 2017, which would translate to approximately $1.00/share in earnings per share (EPS) if margins, etc. remain stable. That revenue target is based on $100 mil of desalinization work, which is not unreasonable considering they are doing a bit less than half that now. On top of that modest growth, the other half of the revenue target is the gas processing opportunity they are pursuing now. There are thousands of potential installations for gas processing, so a reasonable level of success in this new pursuit could translate into that level of sales. The outlook does not even include many additional high pressure fluid processing opportunities they are now researching; clearly they hope to develop other new markets that could provide upside.

ERII has had a good run since I profiled it last year. Investors should keep in mind that this is really a three year story, at least. (Keep in mind: Peter Lynch emphasized that of his huge winners, the biggest moves came in the fourth year that he owned them.) Growth for ERII is going to be lumpy, and 2013 is the final transition year in their multi-year turnaround. Like anyone I like to make a quick profit, but you are likely to be disappointed at some point if your time horizon for this one is measured in months. Think years -- but I believe they will be good years.

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