At $15.25, Rex American Resources (NYSE:REX) continues to trade well below its book value (BV) at $23/share and, more importantly, the estimated market value for its assets. In my opinion, there are at least three approaches the company can take to realize the value in the stock: (1) liquidate assets that the market has refused to value and return that cash to shareholders via stock buy backs or dividends, (2) significantly increase earnings per share (EPS) and Return on Invested Capital (ROIC) by using a excess cash to buy back stock via a tender offer or (3) taking the company private.
Tangible BV per share at the end of 3Q for Rex was $22.77 and should approach $23 by year end. This represents a 10-year core average growth rate (CAGR) of 9%, but only about 10% in total over the last three years. Rex’s assets can be broken down by the divisions used in its SEC filings, with book values assigned as follows: corporate=$95 m ($10/sh), real estate=$25 m ($2.50/sh) and ethanol=$315 m ($22/sh). However, BV may not be the best measurement for Rex as market values are likely quite different. Like Goldilocks’ adventures, real estate book value is likely too low, ethanol too high and corporate just right.
Corporate assets are the easiest to value as they are almost entirely cash ($73.4 m) and tax assets ($16.7 m, almost half in the form of a tax return) and therefore market value is about the same as BV at $10/share.
Real estate assets include a distribution center (DC) and connected office space (466,000 sq. ft.) in Dayton, Ohio, and 34 former retail stores (350,000 sq. ft.). The DC was appraised in 2007 at $14.5 m, but since then prices have come down. According to an industry report by Prologis in early 2010, U.S. warehouse rents had come down 15% from the peak, but the most recent report estimates vacancies are now coming down as well. Rents do not move in lockstep with prices and local markets will obviously vary, but a 25% haircut to $11 m seems appropriate for this asset. This is the approximate discount to peak appraisal the last DC sold for and, at $23.30/sq. ft., this also equates to the midpoint for the estimated sale price of the last large DC to sell in Dayton ($20-$25, per local real estate website data). For the stores, I estimate a market value of $20 m, or just under $600k/store. This is roughly in line with book value and I think quite conservative given the gains on sale of prior stores. Also, when the company had temporarily entered a lease agreement with Appliance Direct for the majority of these stores in late 2008, the buyout clause on the leases was $884,000-$960,000 per store. So, adding up the DC ($11 m) and the stores ($20 m) less mortgage debt ($2 mm) and the market value for real estate is a healthy $4/share.
Even before I get into the ethanol asset value, with REX trading near $15/share and the corporate and real estate assets worth $14 (perhaps $15 by year end), in buying REX shares you are essentially getting the ethanol assets for nearly free. Ethanol assets may be more difficult to value given the uncertain outlook for the industry, but they are generating substantial income right now and, even assuming the worst, they do have a lot of value even in bankruptcy liquidation.
I like to look at the ethanol assets based on the enterprise value (EV) per gallon of production. This essentially assumes that a gallon of ethanol production in any plant in the market is worth about the same, which is definitely not the case. Plant profitability will differ depending on access to feedstock, transportation and ethanol market demand. I believe the vast majority of Rex’s production is worth more than the industry average as can be seen in Rex’s profit spreads (margin) that have consistently been above the market average. However, to keep the analysis simple, I stick with average market values for EV/production
Rex’s share of production in its plants at nameplate capacity is 202 m gallons. While these plants are on the books for about $1.80 EV/gallon (and at one point construction costs reached $2.20/gallon), market values are probably less than that. The handful of other public ethanol companies average $1.50 EV/gallon, but estimates vary greatly, some are arguably in distress and others have complementary businesses that distort the value. The most recent comparable purchase out of bankruptcy that I have seen (Murphy’s) was approximately $1.10 EV/gallon. Thus, the range of values using a reasonable liquidation price and cost to build is $9-$23, with an industry average ($1.50 EV/gallon) at $17/share. While my best guess would be the ethanol assets are worth an EV/gallon close to $1.25, or $12/share of value, I’ll stick with liquidation value for this analysis to be conservative.
Thus, the total market value of Rex’s assets I estimate near $23/share. Oddly enough, near the book value, but only a coincidence.
How to Realize the Value
While there is substantial value locked up in REX shares, this is not new. Management smartly conserved cash during the great recession, did not overpay for assets, did not simply liquidate its real estate at below market prices for quick cash and, most recently, made its first major investment in several years buying a large share in Nugen LLC. This looks like a smart investment, as I reviewed earlier.
However, the ethanol industry margins turned lower in December, weakening the outlook for 4Q EPS (I estimate up only 10%-15% from 3Q) despite Nugen’s accretion. Given more stable capital markets, extremely low returns from cash and the markets continued unwillingness to recognize REX’s value, smart management teams like Rex may be considering other actions to help shareholders (and themselves, since insiders own 33% of the company!) realize value. The three approaches I see to this are (1) recapitalization (2) asset liquidations or (3) simply take the company private.
Rex has far more cash than it needs to run its ethanol business and this is weighing down ROIC and not contributing to shareholder value growth. Rex has said it wants to use that cash for acquisitions but there have been few deals that met return thresholds over the years. Further, if you want to invest more capital in the ethanol business, why not your own stock? Buying back REX stock at 65% below its book and estimated market value would seem to be a near riskless, extremely high return investment. The company has been buying back stock this year, but it has only been modestly above the amount necessary to offset dilution.
A $50-million Dutch Auction could be used to immediately recapitalize the business. Even if the tender price went as high as $16.75, a sizeable 10% premium to today’s price, that would still leave the company with about $30 million, or nearly $4.50/share, in cash at the end of the year. The discount could be much smaller given how the low the liquidity is in the stock. The current EPS run rate at $1.30 this year would rise to $2/share on the new share count. If we use the current P/E on the stock at 11.5x 2010E, REX’s shares could be worth $23. This oversimplifies things though as clearly the stock is worth less without the $50 in excess cash. A more reasonable multiple might be 8x plus cash, or $20.50 share.
The basic idea here is to liquidate assets that the market does not value to raise even more cash for eventual accelerated stock buybacks or a dividend to shareholders. The company is already marketing its stores and DC for rent or sale. With a more stabilized commercial real estate market, renewed efforts could yield better results. Even if the company had to take a modest discount to the market value of these assets, it would still be well above book.
Beyond the real estate, it might be time to look at ethanol asset sales or closures. The money-losing Levelland plant, the only underperforming plant REX has a position in, would seem to be a prime candidate for this. Rex would have to take a non-cash write down on assets and loans to Levelland, but keep in mind that the market doesn’t assign any value to these ethanol assets today anyway. Even if REX didn’t receive a penny for its holdings in this plant, I estimate the closure/sale would be accretive to on going EPS by nearly $0.20.
Rex could be opportunistic with other ethanol plant sales also. This is a business the company is committed to, but with the market valuing these assets consistently at or near zero, a small sale that generates a good price would help re-establish the value their value. Other partners in the plants may be interested in this or independent refineries which have been keen to buy ethanol assets to help with vertical integration and to stabilize margins.
If the market fails to realize the value in REX’s assets, eventually taking the company private looks like a high-probability event to me. A transaction to sell the company to someone else could fall under this category as well, but then we have to assume another interested party when management already looks like the natural buyer.
Between the 33% of the company insiders already own and $9/share in corporate cash by year end, a $19-$20 take-out price (25%-33% premium) would only require $40-$50 million. This could be raised through a combination of real estate sales, mortgage debt, high yield debt or, if the company wanted one, a minority partner. Shareholders would get a 25%-33% premium on their stock, being bought out at a level near the stock’s 52-week high. From management’s perspective, if they believe in the viability of the ethanol industry for the long term, they could sell any remaining real estate and use cash flow to pay down debt. If they are right, they could go public again at some point at a much higher valuation, making a tidy profit. If instead they decide to cash out, they could slowly sell off the parts of the business and, based on even liquidation value for the ethanol business, still make a nice profit.
n summary, the value in REX shares is much higher than the market is assigning and management has many avenues it can take to realize this for themselves and the rest of shareholders.
Disclosure: I am long REX.