Microcap Looks Set to Deliver 25%-Plus Gains by the End of Summer

David Sterman
April 24, 2013

In an effort to differentiate their top-selling pickup trucks and SUVs, the big automakers have been seeking a keen edge when it comes to engines and fuel economy. Ford's (NYSE: F) small displacement eco-boost engines deliver decent highway mileage with 21-22 mpg, and Ram (formerly known as Dodge) goes one better, with a six-cylinder engine mated to an eight-speed transmission that can deliver a car-like 25 mpg on the highway.

GM (GM) is upping the arms race, rolling out all-new bi-fuel trucks this summer that can run on either compressed natural gas (CNG) or gasoline, depending on what's available. CNG will often be the preferred choice, simply because it is so much cheaper than traditional gasoline. According to Consumer Reports, CNG costs about 30% less than gasoline on average. The fact that CNG burns cleaner with fewer carbon emissions is an added benefit.

GM won't actually be making these bi-fuel engines. It is turning to Fuel Systems Solutions (FSYS), a microcap that provides alternative fuel components and systems to more than 170 original equipment manufacturers (OEMs) worldwide.


Despite its global reach and extensive industry presence, Fuel Systems Solutions has recently been mired in a deep slump. The company's sales peaked at $450 million in 2009, and slipped below $400 million by 2012.

The ongoing implosion in the European car market gets most of the blame. Adding insult to injury, this used to be a nicely profitable business, with operating margins in the mid-teens near the end of the past decade. Yet in the past few years, those margins have nearly evaporated due to lower absorption of overhead.

However, at this point, a series of budding relationships in China, India and Thailand look set to bear fruit in coming years after Fuel Systems spent heavily to establish relationships in those countries. That could make this stock a compelling long-term investment, as it trades at just five times EBITDA, on an enterprise value basis, according to analysts at Lake Street Capital Markets.

And it's the relationship with GM that also makes this an intriguing short-term trade. As truck sales begin this summer, and as some buyers opt for the bi-fuel engines, Fuel Systems may again be seen as a growth stock. Quarterly sales have been stuck below $100 million in both of the last two quarters of 2012, and are estimated to remain below $100 million in the first quarter of 2013 as well (the company is scheduled to release Q1 results on April 29).

Yet in the current quarter (ended in June), analysts expect sales will rise to around $105.6 million. And analysts believe that sales may keep rising in subsequent quarters as the GM relationship builds, setting the stage for an anticipated 10% jump in sales in 2014 to around $451 million, from an estimated $412 million in 2013.

Make no mistake, the GM relationship will likely only account for roughly $50 million in sales this year. CNG engines are still unfamiliar to most buyers, and GM is counting on word-of-mouth, along with an expansion into SUVs in 2014 to fuel higher sales in the future.

But there are a series of events that could get this stock moving higher, long before the GM relationship comes to full fruition. First, both Fuel Systems and GM will be reporting quarterly results (on April 29, and May 2, respectively). In each instance, expect to hear a more focused discussion about the timing and potential size of the CNG rollout.

Then, as the actual sales of these vehicles begins this summer, a number of fleet buyers will have a chance to test drive these trucks, and hopes are high that reasonably large orders will follow. We'll have a clear read on this dynamic by June or July, right before these two companies provide their next quarterly outlook.

Risks to consider: CNG engines hold a great deal of appeal when gasoline prices are in the $3 to $4 range. If oil prices keep dropping, and gasoline falls below $3 per gallon, then the logic of CNG engines will become less compelling.

Assuming the above-cited catalysts play out, it's wise to have a three to four month time frame for a Fuel Systems trade. 

Recommended Trade Setup:

-- Buy FSYS up to $16
-- Set stop-loss at $12.50
-- Set initial price target at $20 for a potential 25% gain in four months 

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