Pacific Ethanol Inc. (PEIX) updated this morning that ,it had retired nearly all of the convertible debt six months ahead of the scheduled maturity date of May 6th, 2012. This marks the latest in a series of positive news from the company on both improving operations as well as the convertible repayment. The stock as a result has responded well, up near 100% from the lows of 25 cents in early October. However, we believe that this may just be the start of a possibly strong run-up as the price initially catches up with its improving fundamentals and outlook, and may later be abetted by a possible resumption in coverage by Wall Street that was suspended earlier when the company’s plant subsidiaries filed under Chapter 11 bankruptcy in May 2009.
The convertible notes that were nearly retired today were first issued on October 6th, 2010, when the company raised $35 million through the issuance of $35 million in principal amount of secured convertible notes, as part of the re-structuring following its exit from bankruptcy earlier in June of 2010. The bankruptcy resulted in the elimination of $290 million of the company’s debt and other liabilities while transferring ownership of the ethanol plants to a newly formed holding company, with PEIX continuing to staff, manage and operate the plants for a negotiated fee and profit-sharing arrangement. In addition, PEIX was allowed to continue marketing ethanol for third parties as well as ethanol and related feed products produced by the plants. However, since the company did not actually file for bankruptcy (its plant subsidiaries did), common and preferred shareholders retained ownership of PEIX.
The aggregate unpaid balance on the senior convertible notes, originally at $35.0 million as of October 6, last year and at $8.4 million in the last company update October 3, this year, now stand at just $820,000. This includes, to date, the conversion of a total of $33.0 million in principal into 58.4 million common shares, at an average conversion price of 56 cents per share. The total share count now stands at 75.6 million, which at Tuesday’s closing price of 42 cents gives PEIX a current market cap of just under $32 million. With a reported EBITDA of $2.9 million in the latest September quarter, the company’s Enterprise Value of $128 million is now at just 11 times its annualized EBITDA based on the latest quarter. Further, it trades at a price-to-sales (PSR) ratio of just 0.04.
Both the EV/EBITDA and PSR ratios can be expected to improve going forward based on the improving fundamentals as reported in its latest quarter results for September 2011 that we reviewed in our most recent coverage on the company. During the September quarter, gross margins improved to 3.0% from 1.0% for the preceding two quarters combined, while revenue increased to $272 million from $215 million in the preceding June quarter and $46 million in the year-ago September quarter. Operating income improved to $4.7 million in the September quarter, which again is a big improvement over the $2.8 million and $1.6 million operating losses that it reported in the sequentially prior June 2011, and March 2011, quarters, as well as the $1.2 million it reported in the prior year September quarter. Furthermore, adjusted EBITDA improved to $2.9 million, a big improvement over the $1.2 million and $1.5 million in the June and March 2011 quarters, as well as the $0.9 million in the prior year September quarter.
Although analyst projections are not available, given that most analysts suspended coverage when the company declared bankruptcy earlier in May 2009, Zacks Investment Research does have a proprietary research report that was updated on October 4, prior to the current quarter report. While the full report can be accessed only by subscription at Zacks.com, the firm did put out an analyst blog last month that summarized its Outperform rating and $3 price target based on fundamentals prior to the reporting of the September quarter yesterday. Also, as a historical comparison, PEIX traded in the $250 million market-cap range (with over $300 million in debt) in 2008 prior to the recent bankruptcy and re-organization, when revenue was in the $150-$200 million range, and it had negative operating income. Furthermore, insiders have been heavy buyers (see prior article), and no insiders have sold PEIX stock this year. Since ethanol stocks often move as a group as the underlying economics are similar. You may also want to look at Green Plains Renewable Energy (GPRE) that is engaged in the construction and operation of dry mill, and fuel grade ethanol production facilities in the U.S.; and Biofuel Energy Corp. (BIOF), a holding company engaged in the production and sale of ethanol and distillers grain in NE and MN.
Please note that some risks to this position include that the ethanol subsidy is currently under review; and that the price of corn and natural gas, both of which are critical inputs to the manufacturing of ethanol, could go up. However, on the subsidy issue, we believe that it is unlikely that the subsidy will be eliminated in the current political climate, as doing so would encourage imports and kill the domestic ethanol industry, a news headline that would be suicidal to candidates from either political party amid the current theatrics in Washington.
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