Is Capstone Turbine Ready to Turbocharge Growth?

Wall Street pros have nothing on retail investors who stake small sums of money monthly on undervalued small-cap stocks. Because the big guns mostly ignore them, these types of stocks offer the best, outsized opportunities for growth.

I screened for stocks with less than $3 billion in market cap, offering earnings surprises of 15% or more in the previous quarter, with forecast long-term earnings growth forecast of at least 15%. One stock that floated to the top was lt-energy producer Capstone Turbine , which has been selling its micro power plants to oil and gas drillers who use the microturbines.

It recently sold CONSOL Energy a methange gas-fire microturbine, the first of its kind in the country and an expansion of Capstone's portfolio of oil and gas applications, and posted narrower-than-expected losses of just a penny per share, compared with Zack's analysts forecasts of $0.02 per share. As they anticipate that its earnings will grow 25% annually for the next five years and sporting a $300 million market cap, Capstone Turbine comfortably makes it into our range for potential investment candidates.

Of course, don't jump on a stock just for those reasons. It should just be a starting point for more research, as we need to look more closely to see whether analysts' faith in them is well founded.

It's all wet
Although there are a lot of potential applications for microturbines, the oil and gas industry in particular has latched onto their capabilities so that more than two-thirds of Capstone's revenues now come from drillers, up from 25% just a year or so ago. Here in the U.S., drillers are using them to power the rigs in remote areas, but elsewhere in the world they're being used to meet tough emission standards related to gas flaring.

Flare gas is a form of natural gas that is a byproduct of the drilling process and is vented off as a safety precaution. Yet because it's both a feedstock and pollutant, it is seen as unnecessarily wasteful and harmful to the environment. Flaring gas is banned here in the U.S. and in several other countries, but until recently it was a relatively unregulated process in Russia. Of the total amount flared globally, Russia accounted for about 40% of the total gas flared off.

That's changing now, as Russia imposed tough new regulations last year requiring 95% utilization of petroleum gas or being subject to harsh penalties. Those penalties have already increased 12-fold since the start of the year, and they're expected to rise by 25 times next year. As a result, Russian oil producer Tatneft is embracing Capstone's technology and became the first driller to ensure that it meets the 95% threshold by deploying its turbines. Last year it installed more than 16 megawatts of capacity, and it plans on building out more on a project-by-project basis.

The Near East and Africa are also major flaring regions, but Capstone has had a tough time cracking their markets so far. Still, as it sells microturbines to major oil producers such as new customer Royal Dutch Shell , it believes it will act as a nose under the tent in getting its equipment deployed there.

An embarrassment of riches
The fact that it's able to run on a variety of fuels as the methane gas-powered one sold to CONSOL increases its value to end users, but it also drives change among its rivals. They've typically provided the industry with cheap reciprocating engines that are primarily relied upon as a backup source of power, but manufacturers such as Caterpillar , Cummins , and General Electric's Dresser are finding they need to offer more if they want to compete with Capstone.

Because recip engines are noisy, generate higher amounts of emissions, and require more maintenance, Capstone has been able to show that its microturbines are really the economical choice when the total cost of ownership is considered. It just won an order from a Chinese customer for that reason.

That's led its rivals to come up with some innovations, though they still lack Capstone's technological advantages. Cummins, for example, recently introduced a dual-fuel engine for land-based drilling applications, as did Caterpillar, which is also offering retrofit kits for engines already on the market. But dual-fuel capabilities don't offer nearly the same variability, since Capstone's microturbines can run on natural gas, propane, sour gas, kerosene, diesel, and biodiesel.

It's a gusher!
Shares of Capstone enjoyed a nice run up from their lows at the start of the year, jumping 35% even though they're still down 7% from a year ago. The microturbine maker is seeing strong growth from most markets, though Europe, unsurprisingly, has been weak. Capstone figures that had European business simply been flat year over year, it would have enjoyed 35% revenue growth in the quarter. As it was, Europe's revenues were down $15 million, so a rebound in the economy there will only serve to benefit Capstone's future growth initiatives, however unlikely that seems at the moment.

The continent remains a dicey situation, as sovereign finances are a hodgepodge of rectitude. The EU authorized the taxation of bank accounts in Cyprus as a requirement of a bailout (before the nation's parliament rejected the move), while Italy and Spain are still teetering on the brink and Greece and Portugal, of course, are always wildcards.

So Capstone may have a while for a recovery there, but so long as the rest of its business remains strong, I see it ultimately growing and winning more market share. Let me know in the comments section below if you agree that Capstone Turbine can continue to power higher.

A small price to pay
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Fool contributor Rich Duprey owns shares of General Electric. The Motley Fool recommends Cummins and owns shares of Cummins and General Electric. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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