April 21, 2014
The Opportunity Revisited
On May 1, 2012 we wrote a snapshot about Green Plains Renewable Energy which I described as an industry leader about to commercialize an exciting new “green” technology. Much has changed since then, not just the stock price which has more than tripled from $8.00 to $27.80 (down from a recent high of $32.60). I thought it was time to update our observations.
The ethanol sector has been characterized over time by unfulfilled promise and booms and busts. This winter a tight ethanol supply situation drove up prices while the cost of corn pulled back in response to a record harvest drove gross margins to historically high levels. While margins have started to contract they remain at healthy levels, and I continue to believe today’s ethanol industry, characterized by consolidation and innovation, offers prospects for sustainable growth for well-positioned producers of this renewable fuel.
Ethanol has been regularly attacked, mostly using misleading information supplied by the petroleum industry as it fights to maintain its slowly dissolving monopoly on vehicular fuel. Most recently the battle has focused on the level of ethanol use mandated under the Energy Independence and Security Act of 2007 through the Renewable Fuel Standard (RFS). An anemic economy and improved mileage per gallon has stalled growth of U.S. gasoline usage and the Department of Energy believes there will be no growth above 2013's 135 billion gallons consumption in 2014 and 2015. On November 15, 2013 the EPA proposed for public comment levels of renewable fuels to be blended into gasoline and diesel below those currently required. The new proposed levels represent a substantial reduction in the prior mandated renewable fuel volume of 18.15 billion gallons. The imputed level for corn-based ethanol was cut from 14.4 billion gallons to 13.0 billion gallons. In proposing this reduction, the EPA noted that "if gasoline demand continues to decline, as currently forecast, continuing growth in the use of ethanol will require greater use of higher ethanol blends such as E15 and E85." The proposal was open to a 60-day comment period and, while it is almost certain that some reduction will be put in place, the size of the reduction could be modified. A decision by the EPA is likely to be announced no later than June.
While the EPA decision has been a matter of concern for many, we believe the strength of the ethanol market during this time of perceived uncertainty has been instructive. Looking forward, in my opinion, ethanol demand will continue to benefit from the need for an oxygenate in gasoline to reduce exhaust emissions and boost octane and from its position as a low-cost fuel. I believe demand will continue to be supported by growing exports and minimal imports and the gradual, if slow, adoption of the E15 blend. In sum, we see the outlook for ethanol as favorable regardless of the outcome of the EPA deliberations.
In sum, I believe a negative decision on mandated levels would have a fleeting, if any, negative impact on ethanol stocks, while a decision to either not cut the mandate or cut it by a lesser than proposed amount could provide a spark for these stocks.
Omaha-based Green Plains Renewable Energy, Inc. is North America's fourth largest ethanol producer, operating twelve ethanol plants in Indiana, Iowa, Michigan, Minnesota, Nebraska and Tennessee with a combined operating capacity of about 1 billion gallons of ethanol per year. The Company also operates an independent ethanol marketing service that currently provides marketing services to its affiliated plants as well as well as an independent ethanol producer. Green Plains owns Blendstar, LLC, a biofuel terminal operator with nine facilities in seven states. Green Plains' Agribusiness segment operates grain storage facilities and complementary agronomy, feed, and fuel businesses in Tennessee, Missouri, Iowa and Minnesota.
Importantly, Green Plains is a vertically-integrated producer, marketer and distributer of ethanol. It focuses on generating stable operating margins through its diversified business segments and its risk management strategy. The Company believes that owning and operating assets throughout the ethanol production/distribution chain enables it to mitigate changes in commodity prices and differentiates it from companies focused only on ethanol production. Today, it has operations throughout this chain, beginning upstream with its agronomy and grain handling operations, continuing through its ethanol, distillers grains and corn oil production, and ending with its ethanol marketing, distribution and blending facilities.
Ethanol Production. Green Plains operates a total of twelve ethanol plants in Indiana, Iowa, Michigan, Minnesota, Nebraska and Tennessee, with approximately 1 billion gallons a year of total ethanol production capacity. At capacity, produce - as a byproduct of ethanol production - approximately 2.9 million tons of distillers grains used for animal feed annually.
Corn Oil Production. The Company was operating corn oil extraction systems at all twelve of its ethanol plants. Industrial uses for corn oil include feedstock for biodiesel, livestock feed additives, rubber substitutes, rust preventatives, inks, textiles, soaps and insecticides The corn oil systems are designed to extract non-edible corn oil from the whole stillage process immediately prior to production of distillers grain. The Company expects to produce over 275 million pounds of corn oil across its platform annually.
Agribusiness. Green Plains Grain, a wholly-owned subsidiary , is a bulk grain storage business. It has 4 facilities across Iowa, Missouri and Nebraska. Green Plains Grain buys bulk grain, primarily corn, soybeans, wheat and oats from area producers and provides grain drying and storage services to those producers. The grain is then sold to grain processing companies and area livestock producers.
Marketing and Distribution. Green Plains’ in-house marketing business is responsible for the sale, marketing and distribution of all ethanol, distillers grains and corn oil produced at its twelve ethanol plants. The Company also markets and distributes ethanol for another ethanol producer. Additionally, Green Plains owns Blendstar, LLC, which operates eight blending or terminaling facilities with approximately 7,750,000 gallons of total storage capacity and 830 mmgy of total throughput capacity in seven states in the south central United States.
The Extra Bonus
Green Plains continues to support its 60%-owned BioProcess Algae joint venture, which is focused on developing technology to grow and harvest algae, which consume carbon dioxide, in commercially viable quantities. Through multiple stages of expansion, BioProcess Algae has constructed a five-acre algae farm next to Green Plains' Shenandoah, Iowa ethanol plant where it has been operating its Grower Harvesters™ bioreactors. The joint venture is currently focused on verification of growth rates, energy balances, capital requirements and operating expenses of the technology , which are considered to be some of the key steps to commercialization. If Green Plains and the other BioProcess Algae members determine that the joint venture can achieve the desired economic performance, a larger build-out will be considered , possibly as large as 200 to 400 acres of Grower Harvester™ reactors. Such a build-out may be completed in stages and could take up to two years to complete.
BioProcess Algae announced on April 22, 2013, that it had been selected to receive a grant of up to $6.4 million from the U.S. Department of Energy as part of a pilot-scale biorefinery project related to production of hydrocarbon fuels meeting military specification. The project will use renewable carbon dioxide, lignocellulosic sugars and waste heat through BioProcess Algae’s Grower Harvester™ technology platform. The objective of the project is to demonstrate technologies to cost-effectively convert biomass into advanced drop-in biofuels. BioProcess Algae is required to contribute a minimum of 50% matching funds for the project.
While the algae project can be viewed as a way of improving the economics of ethanol production, we believe it has a larger potential as an environmental solution for a broad spectrum of industries.
Earnings Outlook and Valuation
As previously noted, lower corn prices in the wake of a record crop drove down corn prices and enabled gross margins to expand in the ethanol industry starting in the fourth quarter of 2013. Fourth quarter earnings per share of $0.65 for Green Plains enabled the Company to report full year 2013 EPS of $1.26 as compared to a depressed level of $0.39 in 2012. Although historically wide margins during the first quarter have already begun to narrow, we believe 2014 will be a solid year of earnings growth for Green Plains. The Company will benefit from its acquisition of two plants 115-million gallon a year capacity plants late in 2013 as well as profitable corn oil production . The current expectations for 2014 are for Green Plains’ to achieve EPS of $2.40. Recognizing that after its dramatic price advance the stock may be in for a period of consolidation, we would note that based on the Company's growing earnings power, analysts have raised their price targets for Green Plains to as much as $40.
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I, Paul Resnik, the research analyst of this snapshot report, hereby certify that the views expressed in this report accurately reflect my personal views about the subject securities and issuers; and that no part of my compensation, was, is, or will be directly, or indirectly, related to the specific recommendations or views contained in this report.