A Third Pick for my $100,000 Real-Money Portfolio

By David Sterman,

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We're less than a week into my $100,000 real-money portfolio undertaking, and we've already seen plenty of excitement.

I committed more than $12,000 to my first pick, Ford Motor ( F ) , which jumped nicely in the days after my initial analysis . If you had the chance to get in ahead of me (I make all of my trades 48 hours after I tell you about it), then you got a nice little bump, asshares have been on the upswing.

Then I introduced my second pick, Alcoa ( AA ) , which I told you about Wednesday.

(Many of my loyal readers have signed-up to get these articles delivered to their email inbox as soon as they're published. If you haven't already, I highly encourage you to do this. [ Go here to sign up. ] It comes at no cost to you, and you'll be able to invest right along with me -- if not ahead of me -- if you wish.)

Now to today's pick...

Steel has played a major role in the globaleconomy for more than a century. It's the most important material in cars, planes, household appliances and scores of other products.

Yet steel also has a major shortcoming: it's heavy. Car makers bemoan the fact that today's technology-laden autos can exceed two tons. Jumbo jets need huge amounts of thrust just to get airborne, and makers of wind turbines know that you need a stiff wind before heavy blades will start to rotate.

Fortunately, there's a solution for these problems.

It's a material that is up to 10 times stronger than steel, but is also far lighter in weight. I'm talking about carbon fiber, which was an exotic material 20 years ago, drifted into the more advanced industrial applications over the last decade, and is now on the cusp of becoming a mainstream, everyday material.

The key factor is cost. Back in the 1990s, making carbon fiber was an expensive process because engineers couldn't figure out how to shape the material and then cure it in high volumes at a reasonable cost. Through trial and error, recipes were tweaked, curing ovens were refined and carbon fiber suddenly became a feasible choice for many industrial designers.

Consider these data points:

•    BMW, among other automakers, is expected to roll out a range of new cars in the next three years that will come with carbon fiber doors, bumpers, trunk lids and chassis. These light-weight vehicles will deliver superior fueleconomy and improved handling dynamics.

•    Boeing ( BA ) is using massive amounts of carbon fiber in its new 787 Dreamliner plane. Its partners, which make jet engines for the plane, can dial in more efficient designs thanks to thousands of pounds that have been shed.

•    Wind turbine manufacturers have replaced steel with carbon fiber, and the current generation of turbine designs now spins more freely than the previous steel-based blades.

In the years ahead, look for carbon fiber to find a home in place of concrete and steel in new high-rise buildings. The fact that it is extremely strong but not especially stiff makes it an ideal material for buildings in earthquake-prone regions. Civil engineers are looking at using carbon fiber in underwater sewers, since the material is not prone to corrosion.

Today's portfolio investment will have a big part in all of this...

Indeed, carbon fiber is finding a home in an expanding number of applications, simply because it is becoming cheaper and cheaper to make. But it can't yet compete with steel on acost basis , as we learned in the most recent economic downturn. Demand for carbon fiber had been rising in the middle of the last decade because companies were willing to spend more to take advantage of the material's beneficial qualities. But the slowdown of 2008 and 2009 led many designers to scrap plans for further use.

You can see that trend in the results of carbon fiber maker Zoltek (Nasdaq: ZOLT) , today's $100,000 Real-Money portfolio investment. From fiscal (September 2006) to fiscal 2008, sales doubled, from $92 million to $186 million. The economic slowdown really hurt demand, and sales fell to $128 million by fiscal 2010.

Yet demand for carbon fiber is rebounding: Zoltek's sales grew 18% in fiscal 2011 to $152 million, and sales could top $180 million in thefiscal year that ends this coming September.

I base that assumption on the most recent trends. In the fiscal fourth-quarter of 2011 (ended September), sales surged 39% from a year earlier to $43 million. Simply maintaining a $45 million quarterly sales rate gets you to $180 million for the full year.

How realistic is that? I'll let founder andCEO Zsolt Rumy explain: "We are seeing significant expansion in our sector of the wind energymarket -- using our carbon fibers in the construction of the world's biggest and most efficient wind turbines... We are actively executing our plans tocapitalize on several important opportunities to support this expansion in 2012 and 2013," said Rumy in a statement  in late November.

I encourage you to read the company's 10-K filing from early December. In the10-K , the company discusses a half-dozen other burgeoning opportunities beyond the wind turbinemarket .

It's important to note that Zoltek has a large amount of unused manufacturing capacity (thanks to a previous ill-timed expansion), and higher salesvolume wouldyield significant gains in terms ofprofit margins. Right now, Zoltek looks to be moderately profitable in fiscal 2012, perhaps earning around $0.25 a share. Yet with further sales gains,EPS could grow sharply, perhaps reaching $1 a share by fiscal 2014.Shares , trading under $8, don't begin to reflect that kind ofearnings potential.

The downside protection --> Meanwhile, most investors assume the sales strength seen in the most recent quarter will have proven to be the exception to the rule, and they anticipate more choppy quarters ahead. That's why this company, with amarket value of $264 million, trades below tangiblebook value of $281 million. Said another way, if you wanted to build a carbon fiber business from scratch today, you'd do it cheaper by simply buying this company. The stock is at 94% of tangiblebook value now, and could easily fall to 80% or 85% of tangible book if Zoltek delivers a weak quarter. Investors need to be prepared for such a possibility. But in my view, that is the likely extent of the downside.

The upside triggers--> I really like the risk/reward set-up here. If sales pull back from that recent lofty pace,shares are supported by that tangiblebook value . Yet if sales in the December and March quarters simply match the September results, then I think this stock can quickly move up to the low teens.

We'll get a clear read on the latest business trends in about three weeks when fiscal first-quarter results are released. I want to own this stock ahead of that event, because I think investors would really warm to Zoltek if it can deliver a second straight quarter of solid results.

Action to Take --> Two trading days after you read this (Monday, Jan. 9), I will be buying 1,000shares (worth roughly $7,500) for my $100,000 portfolio.

Here's the Latest Snapshot of my $100,000 Real-Money Portfolio...

-- David Sterman

P.S. -- If you're enjoying the ride, there's more to come. Now that we have a few slots filled in the portfolio, I'll begin bringing you periodic updates on my holdings in addition to new investments. Make sure you don't miss a thing by signing up to have these articles sent straight to your inbox as soon as they're published. Click here to sign up.

David Sterman does not hold positions in any securities mentioned in this article. StreetAuthority owns shares of F in one or more if its "real money" portfolios.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.

This article appears in: Investing Investing Ideas
Referenced Stocks: AA , BA , F , ZOLT

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