Trucking is a $700 billion-a-year industry, but too often investors and media ignore it. And while it's starting to make some headlines with Tesla's (NASDAQ:TSLA) new semi, Tesla is only a small part of the story, and a drop in the bucket of opportunities.

In this week's episode of Industry Focus: Energy, Sarah Priestley and Jason Hall dive into how alternative fuels will change the heavy-duty transport industry and share a couple of companies that investors might want to take a closer look at. Find out why the truck market is so different from the individual auto market, how technology around engines is already starting to change, some of the biggest concerns Tesla is going to face with their semi; and more.

A full transcript follows the video.

This video was recorded on Dec. 14, 2017.

Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking energy and industrials. It's Thursday, the 14th of December, and we're going to be discussing alternative fuel sources. Joining me on Skype is senior Motley Fool contributor Jason Hall. Jason, thank you for coming on the show today!

Jason Hall: Hi, Sarah! How are you?

Priestley: I'm good. You're at home with Paulie, a sick child. I'm sorry.

Hall: Yeah, it's not fun with a 10-month-old running a fever. My son is tough, though. He's one of those kids that tries to ignore the fact that he's sick and plays through it. He's doing pretty good. He's pulling out of it.

Priestley: Good. We hope he does.

Hall: Thank you.

Priestley: As I said today, we're going to be talking about alternative fuels, which was actually Jason's idea. We spend a lot of time on the show talking about oil and gas and conventional fuels, so Jason suggested that we spend some time discussing alternatives. Jason, what piqued your interest generally around alternatives?

Hall: For me, it goes back to a number of years ago, when David Gardner, one of our leaders and founders of The Motley Fool, recommended a company called Clean Energy Fuels in the Stock Advisor service, maybe five years ago -- it's been a number of years ago. To be blunt, this stock has performed spectacularly terribly. It's lost over 90% of its value from the peak. It's gone horribly. But there's some really interesting things that have happened in the business.

At the same time, we've seen things like the advent of the EV, as Tesla has established a clear market and demonstrated demand. Technology has improved. There's some things that have happened on the industrial side. I just got really interested in it. I've been to a number of industry conventions. I've met executives for a handful of companies. It's a really exciting dynamic space that I don't think really, on the industrial side, for the commercial and heavy transit, really gets enough -- before this Tesla semi was released, there was very little you would see in the popular press about what's happening on the industrial side of transportation.

Priestley: Absolutely, and that's really where the big lever to pull is -- it's absolutely in that space. The U.S. has relied on gasoline for over 100 years, diesel for over 60 years. The country is trying to reduce its reliance on volatile crude sources. And we've all seen over the past few years just how volatile they can be. And they're focusing on becoming energy independent, which means considering some of these alternative fuels.

Before we get going, I'm going to do a brief primer -- I say brief -- on alternative fuels. Feel free, if I miss anything, to interrupt me. The ones we're touching on today are the big ones, so biofuels, natural gas, electric, and hydrogen. Biofuels or biodiesel, for the sake of our discussion, is a renewable biodegradable fuel manufactured from vegetable oils, animal fats, or recycled grease in a process called esterification. I hope I'm pronouncing that right.

Hall: Perfect.

Priestley: It burns more cleanly than diesel. The key factor with this is it can be used in current diesel vehicles. Natural gas, which we discussed fairly recently on the show, I think Taylor and I talked about it on the 16th of November, is domestically abundant now thanks to the advances in fracking. It's predominantly methane, and it's an odorless, gaseous mixture of hydrocarbons. It currently accounts for 30% of energy used in the U.S., but only 0.2% of vehicles use natural gas for transport. So, as we conventionally know, it's not renewable. However, there is a renewable natural gas called biomethane, which is produced from organic materials.

There are two forms of natural gas relevant to the discussion around transport fuels -- CNG, compressed natural gas, and LNG, liquefied natural gas. Electric is what gets most of the headlines thanks to Elon Musk, who we'll be talking about later. Electric is considered an alternative fuel under the Energy Policy Act. Plug-in electric vehicles store energy and batteries and produce no tailpipe emissions. Finally, hydrogen, hydrogen-powered fuel-cell electric vehicles. Hydrogen is abundant in our environment, and water and hydrocarbon fuel cells are coupled on an electric motor, making it two to three times more efficient than internal combustion engines. So although extracting hydrogen from the environment can be harmful, when it's in operation, it's by far cleaner than conventional gasoline.

So hopefully you're still with us, because I realize that was a lot. There are a ton of different options, and many potential applications. Putting a number on the opportunities is pretty tough. But as you said, Jason, for the purpose of this discussion, we're going to be talking about commercial and heavy transport, which is often overlooked. It's often overlooked by investors from every angle. The trucking industry is huge. It's a $700 billion business. And according to the Federal Highway Administration, a Class 8 truck average is about 26 times the average fuel usage of a car. So it's huge, low-hanging fruit. Jason, when we were prepping for the show, you suggested starting looking at Cummins (NYSE:CMI), the diesel engine manufacturer. What are they doing in this space that's interesting?

Hall: Before we talk about Cummins, let me preface for reference some numbers to help explain what makes the industrial and heavy transport sector more of that low-hanging fruit. If you think about fuel consumption, your daily driver -- cars, automobiles -- consume about 150 billion gallons per year in North America. Heavy-duty and medium-duty transit consumes around 50 billion gallons a year. So these are pretty massive markets.

Here's the thing. You hear those numbers, and, well, the heavy transit is a third of the size of the private transit market. But here's the thing: There are tens and tens and tens of millions of automobiles with tens and tens and tens of millions of individual buyers who are often buying a car based on emotional and personal decisions, right? Now, when it comes to heavy transit, for example, Class 8 trucks, which you mentioned, which is a massive portion of that 50 billion-gallon consumption, there are around two and a half million of those trucks, and it's a very small group of buyers who are making business-based, return-on-investment, generally, decisions, when they're making those decisions about what they buy. So that's what makes them the low-hanging fruit, if there's some type of financial return for some of these different kinds of fuels.

Now that I've said that, we'll come back to Cummins, where Cummins comes into play. Cummins is the big player in diesel engines. They have been for a very, very long time. They have somewhere between a quarter and a third of the diesel engine market in the heavy-duty trucks. They've actually started losing market share over the past few years as some of their bigger customers -- think about a company like Paccar, which is Peterbilt and Kenworth heavy trucks; they have almost 30% of the North American truck market. They started putting more emphasis on their OEM engines. So they've sold less Cummins diesel engines in their trucks.

So one of the things Cummins has done, a number of years ago, they partnered with Westport Fuel Systems, a company we're going to talk about, and have become the leader in natural gas engines. Essentially, what it is, is a Cummins diesel engine that has some Westport injection technology, and also some hardened parts of the engine due to the different nature of the way that natural gas combusts. The key thing with Cummins is, they're such a leader in the industry. And in a big part because of their focus on emission systems, because emissions, not just in North America, even more so in Europe, become such an issue with diesel engines. Go back to the '80s and the early '90s with acid rain from the particulates -- diesel and coal were a big source of those pollutants. Cummins has been a real leader in helping to remove those particulates.

The other thing that's really exciting about Cummins is, Cummins is developing electric-fueled trains. We're talking about one of the biggest producers of diesel engines in the world. They've acknowledged, their CEO has acknowledged, that electric powertrains are going to be the future. The question is, how long is the future going to be from now? And Cummins management is under the impression that it's going to be a number of years before the technology really gets to a point where it's really feasible to supplant diesel or natural gas or any of these other liquid fuel, carbon fuel sources, just in terms of getting enough fuel in the vehicle to be practical.

Priestley: Absolutely, and I would agree with that, too. The CEO of Cummins, in the previous quarter's presentation, he said that the future would require a broad portfolio of power solutions. In this, he includes diesel, powertrain, natural gas, hybrid electric, battery electric, and fuel cell electric. So as you said, they're laser focused on that, and it's paying off for them, because their stock is up 24% this year. They had record sales last quarter, record earnings per share, so they're doing very well. I actually had the pleasure of visiting the Columbus engine plant as part of a Lean Six Sigma training exercise a few years ago, and I have to say, they have incredibly slick operations. So if anybody can do it, I think that they can, and they may actually give Tesla a run for their money considering how well refined they have their manufacturing processes now.

Hall: Here's my question, I'm going to be the devil's advocate here a little bit with Cummins. One of the things that has been a huge part of Cummins' success is, these engines require a significant amount of regular, routine maintenance. Cummins makes a pretty significant amount of money selling parts, accessories, consumable things that have to be replaced in these engines on an ongoing basis. One of the major benefits, especially for commercial operators moving to electric, is the major reduction in maintenance and that sort of thing. You remove the heat, remove all these moving parts. My question is, when this shift happens, and again, we're looking years down the road, how is Cummins going to be able to replace that recurring revenue that they stand to lose when their diesel engine sales begin to start getting replaced with EVs? I don't have an answer for that. Cummins is definitely one of the companies I would not count out. I think you can unequivocally say they're almost certain to be a leader in electric powertrains.

Priestley: That's a great question. Cummins, I know Westport, we're going to talk about Westport, their joint venture, they said the sales were up 8% in the first half of 2017, but that was a modest engine sale growth and a strong aftermarket. I don't know how they're working the system. It's an incredibly valid question, and it's something that a lot of industries in our sector are facing. Airlines, too. They're under a lot of pressure to reduce maintenance, for the engines to become more efficient, but a part of this means that they're losing a lot of the back-end revenue. So yes, definitely something to keep our eye on and see how they structure those deals going forward.

Hall: It's kind of a double-edged sword, too, because not only is that recurring revenue important because it's incremental profit, but it also helps smooth out the overall business, because we're talking about an incredibly cyclical industry. Class 8 truck sales, a great year is 275,000-280,000 truck sales in North America. That can fall to 185,000 at the valley, at the trough. So we're talking a massive shift in sales over a two- to four-year period. So losing that recurring revenue has other impacts on the company as well besides just the income.

Priestley: Absolutely. As we mentioned, Westport Fuel Systems, as you said, is in a joint venture with Cummins. Their stock is up 155% year to date, and that's mostly due to their involvement in the natural gas industry. They're a natural gas injection systems manufacturer. And as we've talked about before, natural gas is having a renaissance.

Hall: The good news is, the stock is well up. The bad news is, it's well up from a point where there were legitimate concerns about the company's financial future, to be frank, earlier this year. It's another stock that, we're talking about a stock that was over $50 this year at its peak. If you go back to five years ago, and the mania around natural gas was $100 a barrel, diesel prices were over $4 a gallon. The short version of what's happened with Westport is, it's a company with great potential, with some really innovative technology, especially its HPDI, high-pressure direct injection, technology that really gets natural gas to diesel-like performance and diesel-like fuel economy. So they have this great technology.

I think one of the things the market is really excited about is, CEO Nancy Gougarty, over the past couple of years, has done a really good job of driving a lot of costs out of the business, selling off some assets that are really not part of the core business, and refocusing as they're moving toward taking HPDI to commercial manufacturing. Westport, beyond their joint venture with Cummins, which has been actively selling natural gas engines for a decade and is the leader, you look at industries like solid-waste trucks, so trash trucks that come by and pick up your trash can once a week, transit buses, a few other industries like that, they're the absolute leader. Those are industries where more than half of the vehicles sold every year have natural gas engines, and the majority of them are Cummins-Westport engines. So they have a really strong market share there.

But again, the HPDI is the big one. And they're partnered with Delphi Automotive, which is an industry leader in manufacturing injectors. So they have a really big, strong multibillion-dollar partner in their corner that they're going to be manufacturing HPDI with.

Here's what makes this really exciting. It's HPDI 2.0. It's the second iteration of HPDI. And the big change is pretty huge, in that these systems are designed for the engine manufacturers, so a Cummins, a Paccar, Freightliner, Volvo, for these companies to be able to take these injectors and put it in their own assembly line and do the actual completion of a natural gas engine in their factory. HPDI 1 was a Cummins engine that Westport transported all the way to its facility, incomplete, finished the manufacturing and then shipped it to the truck maker to put it in its trucks. So significantly higher costs, big bottleneck in throughput. So for the OEMs to have that in their factory lines significantly reduces the costs, increases the throughput, increase in potential for profits for the OEMs. So there's a lot of benefit there. The concern, obviously, is control.

So the big question right now is, what is adoption going to look like? What is demand going to be for the end users of these trucks? And we're not going to know that for another several months before we really see commercial sales of this product.

Priestley: Yeah, it will be interesting. I think Volvo has said that the tech gives them about 15% better energy efficiency than dedicated natural gas. And now they're a tier-one supplier, as you said, to a lot of these heavy-vehicle manufacturers.

Hall: Yeah, it's a big deal.

Priestley: As you mentioned, their stock up at 50% at its heights; it's now down to $3, so it's really a small-cap, volatile company that investors need to be aware of.

Hall: Right. Still not profitable. Has been profitable on a cash flow basis at times, but it's still right on the cusp of that.

Priestley: To circle back, then, something that we're hearing more and more about is electric. Countries like the U.K. and France have said they're going to ban the sale of petrol and diesel engines by 2040. So there's a huge emphasis on OEMs, which is original equipment manufacturers, to find alternatives. There's a lot of talk about electric. General Motors has heralded and all-electric future, and of course, Tesla is the big player in the space.

Now, most of this discussion has been focused on personal vehicles, but as you mentioned at the start of the show, there's a lot of low-hanging fruit in commercial and heavy-goods transport. Tesla recently made headlines for unveiling its semi with two models of the semi-truck, either the 300- or 500-mile range. Apparently, it does naught to 60 in 20 seconds. I'm not sure what variables that's taking into account. The design is pretty clever, too, because it uses a lot of parts that are already in manufacturing. I think the four motors that it uses are the same as what it uses on current models of its personal vehicles, which I think is smart given the issues that they're having with manufacturing, production hell, as Musk called it.

What do you reckon, Jason? Do you think this is viable? Apparently, it has orders from Wal-Mart, AB InBev, and Pepsi already. Do you think that's more of a publicity stunt?

Hall: I think it's, like most of these things, it's never just one thing or the other. It's clear, for anybody that saw the launch, Musk honestly wasn't talking to truck drivers. He was not talking to anybody who makes a living driving a truck, because the things he was talking about, frankly, they're not the things that drivers are really focused on. They're things that get investors excited. That's the reality. He's talking about acceleration. Truckers are a lot more concerned about braking. He's talking about giant LED monitors. Truckers want to know where the mirrors are. So there are a tremendous amount of questions that are going to have to be answered about the Tesla product.

Now, full disclosure, I'm a Tesla investor. I'm a Tesla shareholder. I've done incredibly well, and I intend to hold my Tesla investment. I've learned you don't ever count Elon Musk out. But I think there's a few things we have to talk about. And what I would like to do is combine the electric and hydrogen together, because we're talking about electric drivetrains with both. The only difference is, with full electric, you have batteries, and with hydrogen, hydrogen is the energy source. So I think we can bundle those two together.

Here's the thing. The difference, when you start talking about a semi-truck versus a car, is the physics get completely different in terms of the energy storage. Making a car go 200-300 miles is one thing, a 4,000- to 4,500-pound car. When you start talking about a tractor-trailer, you're talking about an 80,000-pound vehicle from bumper to bumper fully loaded. Everything that I've read, and I've studied this industry for a long time, is that the physics at this point do not support being able to get a 500-mile range with the kind of payload, the actual amount of goods, that a classic truck carries today. The physics just don't support it right now.

So at this point, Tesla is talking about having a vehicle to market in a couple of years. I can't remember a single time when Tesla has ever met its own announced goal for launching a vehicle. They're typically a year to two years late to market, and I think that's going to be the case again. I think they've set an incredibly aggressive market, and I think the technology is not going to be there to accomplish the range goals that they've put out there with these vehicles, especially at the prices that they're talking about. I think it's going to be another typical Elon Musk over-promise, under-deliver to the market, but also bring an incredibly innovative, super capable product to market when it does come to market a little bit later than we all expect.

So the other part of it is, the industry with trucking is divided up into very different kinds of applications. All of the companies that have ordered products, that have ordered the Tesla semi, are ideal, super easy, what they call line-haul stuff, where they take a load, they run it 100-200 miles down the road to another point, they drop it, turn around, go back, they take another load and go back the other way. So that's great for organizations that have those kinds of needs. You think about a Wal-Mart or some of these other companies that have made these big orders; they're going from point A to point B. The problem is, 90% of the trucking market is small or independent drivers that, they have to get every bit of work that they can, and they never know where they're going to be going next week. So when you're talking about an electric powertrain, where, even if you can go 500 miles, these are vehicles that can sometimes go over 1,000 miles before refueling.

Priestley: The infrastructure really isn't there to support them right now, even if they wanted to do that. And frankly, at the recharge time, which I know Elon Musk mentioned, but I think a 30-minute break for truckers is probably too much, too.

Hall: Not necessarily, again, because they can carry so much fuel, when these guys are stopping, they're often stopping for a pretty long period of time. But they're not going to grab a soda and hang out. They're going around and checking their vehicle and checking air pressure in tires, they're doing safety inspections, they're doing other things to make sure their vehicle is still safe for operation, because the reality is that the fines get pretty extensive if there's a problem and they get stopped. So especially with some of the shorter-route stuff where they might have to stop for fuel, where they have to turn around quick.

But the infrastructure is a real concern. But again, the bigger issue, as much as that's an issue, the bigger issue is, how much weight are they going to have to add for batteries, and how much weight is that going to take away from actually being able to move goods? Because they make their money based on how much goods they move. If they can't put as much goods in the trailer because of weight restrictions, that's a real issue. So the companies that have all signed up, they control every end of what's happening going on the truck and coming off the truck. But that's not how most of the trucking industry works. That's what makes this less of a concern.

Priestley: You pointed me in the direction when we were prepping for the show of Nikola.

Hall: You have Nikola and Tesla, Nikola Tesla.

Priestley: I see what they did there.

Hall: It's horrible. But it's what we have.

Priestley: [laughs] It's a private company that's doing exactly what you said about introducing hydrogen and electric and is actually potentially going to have incredible results, a range of up to 1,200 miles is what I saw superficially.

Hall: Right. With hydrogen, like with diesel and natural gas, you can get more of the actual fuel onto the vehicle. Again, the issue there is current infrastructure. It's not in place. Nikola has a really interesting model, because their idea is, for a fixed payment, supply the vehicle, supply a certain amount of hydrogen for a certain number of miles. So there's a lot of interest in that, and a lot of potential value.

I think one of the issues that Nikola and Tesla at this point would deal with is, because of the limitations on access to fuel and the higher sticker prices of their vehicle, that's a limiting factor for the independents. So, what, for either of these technologies to become established is going to require is, what we've seen already with Tesla, where we've seen some of the large shippers, some of their big retailers, the big trucking companies, have signed up for significant orders. If those companies that have the financial clout to support enough trucks that it'll pay for infrastructure to get built in places get involved, that's what we'll see in the market, so that then the small independents can get in, and that's when you're going to see a major disruption. It could be a decade before that happens, but that's what drives it to create the situation where you can see full disruption of the industry.

Priestley: I think that's kind of the timeline horizon that we're looking at. We're likely to see more electric adoption in cities such as London, where there's congestion charge fees and all those kinds of things that make it really prudent to use electric. But on a mass scale, you're talking 10-20 years in the U.S. And in some regions, you're talking Africa and South America, you may leapfrog a lot of diesel with some of these technologies. It's really an interesting space to keep your eye on.

Jason, thank you so much for suggesting it for the show. Do you have any other points for us?

Hall: The one thing I want to leave with is, circling back to natural gas, I think natural gas still has a great window of opportunity because it's incredibly available. There's a pretty significant infrastructure with our natural gas pipeline already. Even as diesel prices fell and fell, natural gas has remained cheaper. I think people are still kind of sleeping on it. You look at Clean Energy Fuels, you look at Westport Fuel Systems; I really suggest that listeners pay close attention, because I think we're looking at a decade window of opportunity where those companies can continue to grow and could be great investments over the next five to 10 years. I think investors should not sleep on those two companies.

Priestley: Awesome! That's a very good ending point. That's it from us today. If you would like to get in touch, please feel free to email us at industryfocus@fool.com or tweet us on Twitter, @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For Jason, I'm Sarah Priestley. Thanks for listening, and Fool on!

