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This 'Green' Stock Is Undervalued By 25%

Daniel Cross

The cost of energy production isn't just about money. There are also environment effects.

Last year, according to one environmental group, hydraulic fracturing (commonly known as fracking) alone generated an estimated 280 billion gallons of toxic wastewater, enough to flood Washington, D.C., to a depth of 22 feet. It's no wonder that there's a strong push to institute cleaner practices.

Green initiatives have come to dominate the corporate landscape and are attracting investment flows in record numbers. The performance in alternative energy this year is evidence of this growing trend -- the iShares S&P Global Clean Energy Fund (Nasdaq: ICLN) is up more than 50% year to date. While most of the attention has been focused on renewable energy and clean coal, environmentally friendly sectors like pollution and treatment controls have gone relatively unnoticed.

Calgon Carbon Corp. (NYSE: CCC) is a small-cap stock involved in the purification and treatment of water, air and food, as well as the poisonous emissions from coal-fired power plants. The company has been making tremendous strides in cost reduction, improving operating margins to around 20% from 13.6% just a year ago. (Calgon's leaner operation is one reason the research staff at StreetAuthority's Top 10 Stocks advisory recently named CCC a Top 10 small-cap stock.)

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Calgon reported earnings on Nov. 5 and the results were right on line with expectations at $0.22 per share. Gross margins continued to grow, to 33.3% in the most recent quarter from 27.3% a year ago. The demand for activated carbon cloth, used in water, food, and other specialty markets, contributed to a 28.2% gain in consumer sales. The company's cash position climbed 65% from last year to about $30 million, while long-term debt increased only 8.7%, to $48.3 million.

Calgon's stock looks like a value in comparison to CECO Environmental Corp. (Nasdaq: CECE), its closest competitor, trading at around 25 times earnings while CECO trades at over 38. It also looks better from a debt standpoint, with a debt-to-equity ratio of just 0.54 compared to CECO's 1.09. While Calgon's stock is up 44% year to date, CECO's is up 58% and could be due for a pullback.

Looking to the future, Calgon sees opportunity in the mercury removal business. The current annual demand for mercury removal stands at 130 million to 180 million pounds and could grow to as much as 765 million pounds by 2016 as the EPA begins enforcing mercury removal regulations on industrial boilers and cement manufacturers.

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The company has been positioning itself to take advantage of the new market by landing long-term contracts in February and September of this year for deals worth an estimated $50 million.

Even better for investors, the company -- which just wrapped up a successful $50 million share buyback program -- may initiate a far more aggressive $150 million to $200 million plan at the suggestion of Starboard Value, which owns about a 10% stake.

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Risks to Consider: Like most "green" companies, Calgon is depending upon continued trends in corporate sustainability and tax credits for businesses purchasing their environmental controls. While the company expects the demand for mercury removal to increase by 2016, supply exceeds demand and could continue to do so for the short term.

Actions to Take --> The stock was upgraded to "buy" by BB&T Capital Markets on Nov. 11, suggesting that Wall Street may have finally caught on to Calgon's performance. The stock is currently trading at just over $20, which based on future earnings potential, placing it at about a 25% discount.

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