Even with summer driving season upon us and $67 crude oil, ethanol stocks continue to drift out of favor. Verasun (VSE), Aventine (AVR), U.S. BioEnergy (USBE) and Pacific Ethanol (NASDAQ:PEIX) are all trading at multi-year lows after experiencing all-time highs in 2006. Fears of over supply of corn and international ethanol competition have caused alternative energy investors to take pause in their bullishness. Here is a summary of the poor performance in June alone:
Verasun: down 7.37% Aventine: down 11.47% U.S. Bioenergy: down 13.66% Pacific Ethanol: down 5.20%
In the face of this bearishness Rex Stores Corporation (RSC), a consumer electronics retailer with an emerging ethanol development business, has bucked this trend and rallied 18.98% in less than three weeks.
Rex Stores Corporation has come alive with activity since I last reported on the name earlier this month. Three notable events have occurred:
Sale of their interest in the Millennium ethanol plant to U.S. BioEnergy An upbeat first quarter earnings call Announcement of an increased stake in the upcoming One Earth ethanolfacility
The sale of the Millennium plant was significant for several reasons. First, it validated Rex as a legitimate ethanol investor. Rex funded this investment in 2006 and more than doubled their money in this short time period. Second, the transaction provided a data point for valuing future transactions (this was the first major ethanol transaction in recent times). Since it was the first notable transaction of this sort it has the potential to ignite a further wave of M&A activity as seen in other industries. Finally, it was a visible news story that has finally attracted attention to the stock.
The first quarter earnings call was notable because it provided unparalleled visibility into Rex’s ethanol strategy. Management took the opportunity to express explicitly that, while they are not closing their doors on consumer electronics, ethanol is where they will be dedicating capital pursuant to high shareholder returns. In the same vein, shareholders got confirmation that the company will continue to close unprofitable stores.
Finally, the company announced on Monday, June 18th that it will take an increased, majority stake in its latest ethanol pursuit, One Earth. This higher allocation allows Rex to better capitalize on the cost advantage outlined below that will likely result in high return on investment.
This note updates my earlier guidance based on the recent earnings call and further communication with management. As I did last time, I will breakdown the valuation in terms of the ethanol business, real estate holdings and liquid assets. I am still very positive on the story and see an opportunity for at least 20% appreciation.
The key to Rex Stores Corporation’s ethanol investments is a cost advantage. At present, a 100 million gallon (annual capacity) ethanol plant costs the average developer between $200 and $250 million to build. The buy vs. build parity in the market was confirmed by the $235 million transaction to sell the Millennium plant to USBE. Rex, however, has legacy agreements enabling them to build first-rate plants for $165 million. While the $235 million implies a 2.35x multiple (enterprise value to annual production capacity), I will use 2.25x as this is more commonly quoted as a standard replacement cost multiple. As far as capital structure, developers can typically borrow $0.90 - $1.00 cents on each gallon of ethanol production. For a 100 gallon plant, I will estimate $95 million in debt.
Rex’s Big River investment is already producing ethanol. This is currently a 52 million gallon plant of which Rex owns 6.9%. Rex is making another $10 million investment to maintain their interest in what will ultimately be a 230 million gallon plant. Using a 2.25x enterprise value multiple, the value of such a plant is $517.5 million. After subtracting debt, Rex’s stake is worth an estimated $20mm. (Rex recorded $1.1 million net income during first quarter from this plant; $660k from continuing operations).
Rex also has a 56% effective stake in the Levelland/Hockley County plant. This is a 40 million gallon plant. The associated enterprise value is $90 million. There is no debt associated with this investment. Rex’s stake is worth an estimated $50 million.
Rex has additional investments in two 100 million gallon plants: Patriot and One Earth. Their stake in Patriot is roughly 23.6%. The stake in One Earth, announced Monday, is a minimum of 50.1%. Again using the 2.25x multiple, these plants are worth $225 million apiece. Accordingly, Rex’s stakes are worth $30 and $65 million.
Combined, Rex has an estimated stake of over 110 million gallons of annual ethanol production valued at $165 million.
At the end of first quarter, the book value of Rex’s real estate was $76.102 million (real estate plus assets for sale). $20 million of this must be subtracted as it is part of the Levelland/Hockley business combination. This leaves 62 stores and 3 warehouses carried at $56.102 million. (The warehouses are carried at $7-10 million and the stores at roughly $700,000 a piece). Assuming a similar market/book multiple to the properties monetized in the Coventry deal earlier this year (~1.25x), this real estate is worth an estimated $70.128 million. This is slightly less than the $75 million in my earlier piece. This amendment is based on added management guidance.
At the end of first quarter, Rex had $105.355 million in cash. There are several deductions that must be made to this figure before we can consider it unencumbered margin of safety:
Deduct $7.7mm (Levelland/Hockley majority stake combination)
Deduct $22.64mm (Long-term debt)
Deduct $10mm (committed investment in Big River)
Deduct $35.1mm (committed investment in One Earth)
Finally, deduct $10mm for excessive increase in accounts payable as of quarter end
These deductions leave $19.915 million in cash. In addition to this cash, the company will receive roughly $36 million in cash and publicly traded stock (up to 3.3 million shares) in U.S. BioEnergy from Millennium sale. These sales proceeds combined with current cash equates to $55.915 in cash and marketable securities. This is a downward adjustment from my earlier valuation driven by further announcements of ethanol investments.
Adding $165 million in ethanol businesses, $70 million in real estate and $55 million in liquid assets results in a debt-free enterprise value of $290 million. Split amongst the 12.7 million diluted shares, my floor valuation remains $23 per share ($10 attributable to cash/real estate). This is the same figure reached in the last valuation, although the split between parts is slightly different.
Bear in mind that in this latest valuation employs even more conservative estimates than last time. First, I applied a 2.25x EV/production multiple (versus 3x last time). This is well below the multiples of other public comps. Second, Rex’s investment in One Earth could end up being much bigger than the 50.1% stake used above. Finally, I deducted $10 million for the rise in accounts payable. In reality, inventory and accounts payable should recede in line.
High insider ownership: CEO Stuart Rose owns 9.39% of the company Share buyback: during the last earnings call the company announced a 1,000,000 share buyback program. Synthetic fuel cash: the company reported first quarter income of $6.7 million attributable to their synthetic fuel business that is being phased out. Management suggested during the call that the remaining quarters of 2007 would experience similar profitability (assuming stable energy prices). Ethanol rebound: as stated above, ethanol stocks are out of favor. This valuation assumes that they stay out of favor. Any rebound in ethanol stocks would increase the above valuation of Rex Stores.
Public market ethanol valuations continue to depress Rex’s consumer electronics business weighs on profitability Production capacities do not meet expectations Millennium was a fluke and Rex cannot make the transition from electronics to ethanol
Disclosure: The author has a long position in RSC.
RSC 1-yr chart