Disclosure: I am long APGI.OB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
A TWO-PRONGED STRATEGY
When it comes to American energy consumption, what are the biggest issues on the minds of the U.S. government, businesses and the general public? Clearly, one of these is finding ways to use less petroleum-based fuel, in order to reduce energy costs and decrease dependence on foreign oil. Another is to reduce emissions, including carbon, from vehicles that consume diesel fuel and gasoline. Through extensive hardware and software development, and Detroit automotive engineering ingenuity, American Power Group (APGI.OB) has created cost effective systems enabling it to address all of these issues for most large diesel engines produced in the past two decades.
We have all read articles indicating the abundance of natural gas in the U.S., which has transformed the global energy landscape. American Power Group Corporation ("APG") based in Algona, Iowa, has patented dual fuel conversion technology, which enables diesel fuel users to take advantage of the disparity between diesel fuel costs and lower natural gas prices. The company is currently focused on two primary application areas: the first applies to a potential $5 billion market for heavy-duty truck engines, with a particular focus on the long-haul Class 8 "semi" truck market. These are diesel turbocharged trucks that are compression ignition based, not spark based. There is the potential for penetration into the mid-sized diesel trucks down the road. The second area addresses a smaller yet also very profitable market: stationary power generation. This includes primary and standby power generators, oil and gas drilling rig diesel engines (1500-2000 HP) as well as high pressure diesel pumps for oil and gas hydraulic fracturing (fracking) rigs (2000-2500 HP).
In each case, the company's "Dual Fuel Turbocharged Natural Gas™ System" allows the aftermarket diesel engine to displace a large percentage of diesel fuel with natural gas without making any modifications to the componentry or fuel injectors of the existing engine. Instead, the system is a non-invasive retrofit upgrade that uses digital electronics and 3D natural gas engine software mapping from Detroit to meet the EPA's new safety and environmental conversion requirements. APG's main product lines have undergone extensive testing and subsequent emission approval by the EPA for heavy-duty trucks as well as drilling rigs. As of this writing, the company has received EPA approvals on 88 different truck engine families and anticipates many more over the next several months.
APG is on the front end of a major paradigm shift by utilizing natural gas with diesel fuel in a non-invasive way to solve a wide range of government and consumer concerns. Given the abundance of natural gas due to recent shale gas discoveries throughout North America and the advent of "fracking" technology, which allows economic access to that gas, the price of natural gas has declined substantially. U.S. natural gas production is up 28% between 2005 and 2011, according to U.S. government figures, and this is expected to be just the beginning of a massive increase in domestic gas production.
In April of this year, by way of a flight to Minneapolis and a 2.5 hour drive southwest in a rental car, I, along with a now current member of the company's Board of Directors, arrived at the company's headquarters in Algona, Iowa, to meet with management and see a live demonstration of the technology in action. While riding in the passenger's side of a truck with the APG system installed, it was self-evident that there is a paradigm shift going on in the industry: in real time, I could see the ratio of natural gas to diesel increase along with the miles per gallon improvement over using diesel fuel alone.
The proprietary technology seamlessly displaces up to 80% of the normal diesel fuel consumption with the average displacement of diesel gas ranging from 40% to 65%. The energized fuel balance is maintained with a proprietary read-only electronic controller system, ensuring the engines operate at original equipment manufacturers' (OEM) specified temperatures and pressures. Installation on a wide variety of engine models and end-market applications require no engine modifications, unlike the more expensive and invasive systems in the market, which require modifying the engine block with high-temperature parts and designing custom high-pressure natural gas fuel injectors. The key breakthrough is that this non-invasive system allows existing diesel truck engines to run either on both diesel fuel and natural gas simultaneously but still have the flexibility to return seamlessly to run only on diesel fuel if needed. APG's system does not change the OEM engine, and as important, this APG system can be removed and re-flashed to be used on another approved engine family. APG has a significant competitive advantage for the following reasons:
It is one of the least costly solutions in the marketplace, with a relatively short breakeven period. Because APG's system does not modify the existing engine structure, the engine can switch to 100% diesel gas when natural gas is unavailable. APG's conversion system does not increase maintenance costs. Unlike its competitors, APG's solution does not require costly, high pressure fuel injectors. Because the company's solution: [I] replaces less than 80% of the diesel gas used; [ii] does not use high-pressure fuel injectors; and [III] has a proprietary software platform that monitors the amount of natural gas introduced into the engine, the engine operates within OEM guidelines.
Competitors' conversion systems run outside of OEM guidelines, which means that the engines run hotter and therefore require additional maintenance, special high-temp parts and high-temp oil.
APG has first-mover advantage, with 88 out of 200 approvals in the OUL (Outside Useful Life) market, comprising heavy-duty trucks older than two years and greater than 435,000 miles. The company expects to be the first company to have approval in the Intermediate IUL (Inside Useful Life) market, which is made up of heavy-duty trucks with engines at least two model years old but with less than 435,000 miles.
APG's non-invasive system can be removed from the engine at any time (for example at the engine's end of life) and reused on another engine.
The company is very far along in its testing and EPA approvals, which is a major competitive advantage as well as a barrier to entry.
KEY STRATEGIC VALIDATION IN THE MARKETPLACE
On November 28, APG and Wheel Time Network LLC ("Wheel Time") announced a joint venture (pdf). Wheel Time is a multi-billion dollar organization with high quality installation network made up of 18 member groups, which provide installation and warranty support via 200 centers throughout North America. With over 3,000 factory-trained technicians, 2800 service bays, and 30 training centers, Wheel Time is an optimal joint-venture partner for APG to execute on its long-term business plan.
Why is this announcement significant? First, it is a true independent, third-party validation of APG's dual fuel system, as Wheel Time did its own extensive due diligence and concluded that this is the superior product in the marketplace - now and for the foreseeable future. Wheel Time also received warrants to purchase shares in APG. It is interesting that a large, private company would ask for warrants in order to strike a deal to market a company's product, and I view it is a major endorsement with respect to the potential upside of APG. Second, Wheel Time is a leader in the industry, and it allows APG to "scale" immediately without spending significant amounts of time and capital outlays to build out its own installation network. Third, it confirms the importance of natural gas for truck fleets as an alternative (and complement) to diesel fuel in a low risk, cost-effective way.