Pacific Ethanol: West Coast Ethanol Margins Indicate Large Profits Starting Q4 2013

| About: Pacific Ethanol, (PEIX)

Pacific Ethanol (NASDAQ:PEIX) is the leading marketer and producer of low-carbon renewable fuels in the Western United States. It controls four ethanol plants located in Magic Valley ID, Columbia OR, Stockton CA, and Madera CA (idled) with a total operating capacity of 200 million gallons a year.

Since coming out of bankruptcy in June 2010, the company has slowly regained its footing, fighting through an adverse environment with corn feedstock costs as high as 8 dollars a bushel, and weak ethanol consumption from a slumping US economy.

The first half of 2013 finally brought signs of improvement when the price of Renewable Identification Numbers (RINs) increased from a few cents to well over a dollar. RINs are created and attached to every gallon of ethanol produced, hence demand for RINs raised the price of ethanol to the point that it became profitable even with eight dollar corn, the main feedstock cost of the PEIX plants. The RINs price has since decreased to a range between $0.30 to $0.50, due to the EPA proposing a reduction in the ethanol blending mandate.

Nevertheless, the Ethanol industry has prospered because of falling corn prices, nearly cut in half to ~$4.50 a bushel by the time the 2013 crop was harvested. Ethanol prices held steady due to strong demand based on ethanol's high octane, and clean burning properties combined with its low cost compared to gasoline. The cost of ethanol production in the US is now low enough that international exports provide a strong price support.

Multiple ethanol companies have reported large 13Q4 earnings. Two examples are: Green Plains (NASDAQ:GPRE) reporting ~$0.30 operating income per gallon of ethanol, and Valero (NYSE:VLO) reporting $0.82 of operating income per gallon of ethanol.

Pacific Ethanol greatly benefits from the momentum of the industry, but its unique position as a producer in the West Coast enhanced its 2013-Q4 earnings and will continue to do so through 2014. For example, last week the cost of corn delivered to Stockton, CA was $10.65 per cwt (100lb); distilled grain animal feed, a major product of ethanol distilleries, sold for ~$300 per short ton; while the ethanol spot price in California was near ~$2.63. Just the ethanol plus distilled grain production implies a crush margin of $1.25 per gallon, assuming 5 gallons of ethanol and 25lb of feed are produced from a cwt of corn. A conservative estimate of operational costs is $0.50 a gallon; that leaves an operating income of $0.75 per gallon for PEIX. This does not include revenue from corn oil production, California carbon credits generated from the low carbon intensity of PEIX ethanol, or the expected gain from processing sugar purchased from the federal government at a steep discount. PEIX currently produces roughly 40 million gallons of ethanol a quarter; that implies an EBITDA per quarter of ~20 million is likely. Currently the number of PEIX shares outstanding is ~17 million, meaning EBITDA per share could be well above a dollar per quarter. The current stock price is near $9, greatly undervalued given the positive outlook.

In the near term, any PEIX cash flow most likely will go to diminish the company's long-term debt and/or improve its terms, while at the same time increasing production through efficiency improvements, and finally restarting the Madera plant. The main risk in my opinion to PEIX or any other ethanol producer, would be weakness in liquid fuel prices, unlikely in the near term given the recovery of the US and world economy demonstrated in oil prices greater than $100 a barrel. An increase in corn prices would have a negative effect on the industry, but currently USDA projects the opposite, with corn prices falling below $4 per bushel for the next couple years. Finally exports, particularly to Asia, are an important catalyst for pushing ethanol margins even higher. PEIX is uniquely well positioned to take advantage of this possibility given its proximity to West Coast ports.

Disclosure: I am long PEIX, VLO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.