Why Rex American Resources Could Be Worth 70% More

| About: REX American (REX)

Rex American Resources (NYSE:REX) recently reported Q4 results with some important updates. These include the closing of an underperforming plant and strong results from Rex's Nugen plant. I believe the results point to much higher earnings for 2011, despite weaker ethanol crush margins. Based on the higher earnings as well as its book and market value of assets, REX could be worth $28.

REX reported Q4 results that looked quite strong. EPS from continuing operations (excluding asset write downs) were up almost 10% from last year to $0.59. The change can be explained by the impact of derivatives, which were a drag last year but helped earnings this year. Excluding the derivatives, EPS would have fallen about $0.04, from $0.60 to $0.56. Given that crush margins were cut in half from last year (roughly $0.25/gallon, down from $0.50/gallon), this was a surprisingly strong report.

Earnings appeared down from last year at all the underlying plants, but REX had a major boost from its recent investment in the Nugen plant, which I estimate contributed nearly $4 million to pretax income. This was incremental income, showing the potential for Rex's earnings as it puts its substantial cash to work. Additionally, the Nugen plant showed significantly improved profitability over Q3, despite lower industry margins. Even assuming the further reductions in industry crush margins that have occurred in Q1 so far, Nugen could contribute close to $10 million incremental pretax profits in 2011, or over $0.60 to 2011 EPS.

Q4 results also included a drag from the Levelland-Hockley plant of about $1 million, but also the announcement that Rex was shutting down this plant and taking an $18 million impairment charge. As I have previously written, Levelland-Hockley had been struggling to make money since in its inception and problems with sourcing feedstock became significantly worse in 2010. Closing the plant should be accretive to 2011 EPS by approximately $0.23.

Based on the current lower industry crush margins, the accretion from Nugen, the Levelland closure and assuming continued share repurchases ($15 million for year, including over $2.5 million already bought back), I believe EPS from continuing operations could reach $2.50, up from approximately $1.40 in 2010 (ex-Levelland write down). Before Rex's Q4 report, the stock was trading at about 11x 2010 earnings. Using the same P/E on the higher assumed 2011 earnings would mean a $28 stock in a year, or a 70% price increase.

The $28 share price is also supported by the book value and market value of assets. Book value is currently $23.30/share and should grow to $25 by year end. I estimate the market value of the assets currently at $24/share ($11/share in corporate cash and tax assets, $3/share in real estate, $10/share in ethanol assets). These could also increase in 2011, primarily if valuations on ethanol plants were to increase. For more details on this analysis (with slightly different values), please see my previous article. The $28/share would be only a 12%-17% premium to book value or market value of assets.

Its hard to point to a specific catalyst beyond quarterly earnings that will keep REX shares rising, but any increase in industry crush margins from the current break-even should help the valuation as well as provide upside to earnings. I'd say the biggest risk would be further erosion in industry crush margins. However, this seems unlikely to me over the long term as many less efficient plants cannot operate profitably at this level. Like the Levelland-Hockely plant, further margin erosion would likely cause more industry plant closures, reducing supply and supporting ethanol prices.

With the closure of Levelland-Hockley, management has begun to take strategic actions to enhance shareholder value and realize the value of its assets. While I continue to believe there are other strategic actions management can take, I also believe the trajectory of earnings growth makes REX an excellent investment.

Disclosure: I am long REX.