Two High-yield Energy Efficiency Stocks with a Free Call Option on Housing

It's no secret that the housing market is in the doldrums. New housing starts in August fell to an annual rate of 571,000, and fewer homes were under construction since record keeping began in 1970. This has taken a toll on energy efficiency stocks in the housing sector, leading to some very attractive pricing in two of my favorites.

Waterfurnace Renewable Energy (WFI.TO / WFIFF.PK)

I've long been fan of Waterfurnace, an Indiana-based manufacturer of ground source and water-source heat pumps.  A note from a reader Wednesday prompted me to poll my list of green money managers to see what they thought about the stock when it was trading at $17.50, since I could see little reason for the decline beyond the general cleantech sell-off and Waterfurnace's low liquidity.  I'm glad I did, as the company promptly fell another $2 on Thursday.

While heat pumps have traditionally mostly been used in new construction, the company has done a "very good job shifting to the replacement market," according to Brad Tirpak of Locke Partners.  Tirpak sees Waterfurnace as a high yield stock with a "free call option on housing," meaning that if housing does recover, we can expect to see significant price appreciation.   

Waterfurnace has also been cushioned from the housing downturn by its "deals to provide systems to the military and other larger entities, partially through its partnership with Johnson Controls (JCI)," according to Garvin Jabusch, chief investment officer at Green Alpha® Advisors. He also likes the company's international distribution and the vertical integration of its systems and controls.

There are downsides for this company though.  Rafael Coven, the manager of the Cleantech Index which includes Waterfurnace as a component (about 0.55 percent of the index), sees problems in the highly competitive nature of the industry, the stocks poor liquidity, the prospect of reduced subsidies for energy efficiency, and narrow geographic scope (Waterfurnace sells almost exclusively in the US and Canada).  Coven thinks the company "would be a much better fit inside a bigger HVAC or water heating manufacturer, such as Electrolux, or AO Smith."

All that said, I was buying aggressively on Thursday because of the over five percent dividend which is still covered by earnings and cash flow despite the horrible housing market.  While a cut in Federal subsidies for energy efficiency would certainly hurt the stock, energy efficiency subsidies tend to gain much more bipartisan support than renewable energy subsidies because conservative arguments that renewable energy is too expensive simply do not apply to energy efficiency measures such as ground source heat pumps.

PFB Corporation (PFB.TO/ PFBOF.PK)

If anything, PFB Corporation is even more closely tied to the North American housing market than Waterfurnace.  The vertically-integrated manufacturer of insulating building products such as Structural Insulated Panels (SIPs) and Insulating Concrete Forms (ICFs) sells mostly to the green building market in the US and Canada.  I profiled the company in detail here. The downturn has cut PFB's revenues, with sales having dropped from a peak of $83 million in 2007 to $66 million in 2009 and 2010.  Despite this drop, PFB has managed to remain profitable with enough income and cash flow to support the C$0.06 quarterly dividend, which makes for a dividend yield of just under five percent.

Part of PFB's resilience has been its presence in the green building and high end sector of the housing market, both of which have been relatively robust during the downturn.  The company's large presence in Canada has also helped, as Canada's housing market has borne up better than that in the US.  

Earlier this year, PFB used their strong financial position to expand its market share by acquiring Idaho-based Precision Craft Homes, positioning the combined firm for rapid growth when the housing market eventually picks up.

In addition to the dividend, PFB  has an ongoing share buyback program funded with the company's cash from operations.  In the first six months of 2011, the company purchased 7,250 shares for an average price of $6.07.  While these purchases remain small, they have increased in the third quarter, most likely in response to the fall in the company's share price to well below book value of $6.37.  The company's purchases of stock should help provide a floor for the share price near current levels.

Data From Yahoo! Finance, Waterfurnace & PFB Corp financial statements

Conclusion 

I find both of these stock to be extremely attractive at current prices, given the large dividend streams, low debt, and the potential for significant gains when the housing market eventually begins to recover.  That said, both stocks are very illiquid.  This liquidity probably contributed significantly to the current buying opportunities, but it also means that buyers should be cautious about bidding, and stick to limit orders to ensure that they get the prices they expect.

DISCLOSURE: Long WFIFF, PFBOF.

DISCLAIMER: Past performance is not a guarantee or a reliable indicator of future results.  This article contains the current opinions of the author and such opinions are subject to change without notice.  This article has been distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.  Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

This article was originally published on AltEnergyStocks.com and was republished with permission.