Pacific Ethanol (PEIX)

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Pacific Ethanol (PEIX)
Stock Price: $3.93
Diluted Shares: 16MM (includes effects for post quarter convertible conversion; there are 8MM warrants outstanding at an avg exercise of approx. $7; currently non-dilutive)
Market Cap: $63MM
Working Capital Surplus: $44.2MM
Debt: $107MM (due June 30, 2016)
EV: $126MM

*Note: this write-up was done on 20-Dec-13.

Why would anyone want to invest in a once-bankrupt, cyclical and hated business like ethanol production with a stock chart that looks like the one above?

Because after this year’s bumper crop, corn prices look like this (corn is the biggest input cost for ethanol producers):

1 Year Corn Chart

BUSINESS

Pacific Ethanol is in the business of taking corn and turning it into ethanol. In order to convert corn into ethanol the processing plant uses natural gas, chemicals and enzymes. So the four direct input costs are corn (corn being by far the largest cost), natural gas (2nd biggest cost), chemicals and enzymes. The outputs you get from the production process are ethanol, wet distillers grain and corn oil.

Here’s some quick math:

PEIX is unhedged on the cost side and largely unhedged on the revenue side (they don’t hedge corn input costs and only hedge ~10% of their ethanol production as the market for West Coast ethanol is fairly shallow). This makes it vulnerable to volatile commodity prices, but can be a boon if you get the timing right (and I believe this is the time PEIX will be making large profits).

ASSETS & ASSET VALUE

The company operates four ethanol production facilities, three of which are currently active (160MM gallons of capacity) and one of which is idle (40MM gallons of capacity).

PEIX shareholders own 91% of the facilities, not 100% (bondholders assumed ownership in the 2009 bankruptcy and PEIX has been repurchasing its equity interest from the bondholders since the recap).

PEIX Ownership Interest

PEIX has spent $0.32 per gallon buying back its interest. Add the lenders debt on top of that and the all-in cost to PEIX is roughly $1 per gallon – consider this the acquisition cost for their processing facilities. The company says the replacement cost of these plants is $2.25 per gallon, or $450MM. PEIX currently owns 91% of this value (or $410MM).

Here’s the math:

Assuming it takes $10MM to get Madera into production (~50% more than expected), the asset value to PEIX shareholders is $400MM. Take out the debt ($107MM) and add in the working capital ($44MM) and you are left with an equity value of $337MM – versus today’s equity value of $63MM.

In mid-Dec, Murphy USA sold its Hankinson ethanol plant in North Dakota – which has a 110MM gallon / year capacity – for $170MM. That price would imply a value of $1.55 per gallon or an unencumbered asset value of $209MM to PEIX shareholders ($1.55 / gallon x 200MM gallons x 91% – $10MM – $107MM + $44MM) – versus the market value of $63MM.

Whether the value per gallon is $1.55 or $2.25 or somewhere in between, there appears to be a significant margin of safety here.

OTHER INVESTMENT POINTS

US ETHANOL MARKET

Ethanol is a growing industry, not only in the US but internationally as well. In the US, ethanol production mandates from the EPA are 13.8BN gallons for 2013 and 14.4BN for 2014 (look at the column labeled “Cornstarch”).

Ethanol Mandates

I like to think of the EPA mandate as a floor for demand; the reality is the industry sells more than the EPA mandates – you might be surprised to read this, but ethanol is the lowest cost transportation fuel in the market. And demand is increasing globally (source: 3Q13 conference call).

The current US ethanol production capabilities are 13.7BN gallons. With demand exceeding supply, ethanol inventory levels are being drawn down – now at the lowest levels in 3 years. 

Weekly Ethanol Stocks

With stocks being drawn down, things look pretty good for ethanol prices in the near term.

A quick note on the EPA – a few days ago the EPA came out with their proposal for 2014 standards which brought the ethanol mandate down to 13BN gallons (from 14.4BN). It’s now open for public comment with a final ruling expected soon. You can read some of the conflicting opinions / interests here (farmers / ethanol producers want more than 10% ethanol in every gallon of gas sold in the US; oil companies want less): http://agrinews-pubs.com/Content/Default/Illinois-News/Article/EPA-proposes-lower-RFS-volumes-for-2014/-3/78/8875.

 

CONCLUSION

This is a trade, not an investment. And it doesn’t come without risk – ethanol is a cyclical industry where costs and commodity prices can change quickly, so sizing and timing are critical. I believe the timing is right for this trade but I wouldn’t recommend a large position given the nature of the business.

I see the stock chart of GPRE as a prologue.

You can see these details in my model here.

 

Sources

Mike Kramer, Treasurer / IR: 916.403.2738; mkramer@pacificethanol.net

Company presentation: http://www.pacificethanol.net/site/_documents/investors/PEIXLDMicroConferencePresentation.pdf

Factsheet: http://www.pacificethanol.net/site/_documents/investors/PEIX_Fact_Sheet_December.pdf

Presentation: http://wsw.com/webcast/ldmicro5/PEIX/

S-1: http://www.pacificethanol.net/site/_documents/investors/PEIX_Form_S-1_as_filed_June_2013.pdf

Renewable fuel standards overview: http://www.fas.org/sgp/crs/misc/R40155.pdf

3Q13 earnings: http://www.sec.gov/Archives/edgar/data/778164/000101968713004209/paceth_10q-093013.htm

3Q13 call: link


2 Responses
  • Pulp Reply

    Wow you nailed this one on the long side.. could it be a short at these levels?

  • der kampfer Reply

    Pulp. What is the forward P/E of PEIX? Then ask yourself what is the forward P/E of REX and GPRE?

    PEIX has a way to go to “catch-up” to these P/E levels. Expect PEIX to move into the mid $30s and low $40s with Q3 as the catalyst. Be aware of how FVAs affect Q3 results headlines before you pull the trigger. Those selling and walking away after Q1 results left a lot on the table.

    However if you feel the SP has reached or over-reached its FMV then please short away. It will only help us longs.

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