I'm a math person but I'm also a skeptic. Though these two traits have nothing to do with each other, they are both at the forefront of my internal dilemma regarding ethanol. You see, my math side is telling me that VeraSun (VSE) is a ridiculously cheap stock, while my skeptical side is whispering a different tale. So, I decided to see who's right.
First, let's establish that, at the end of the June 2007 quarter (Q2), VeraSun had three operational plants capable of producing 340 millions of gallons of ethanol per year (MMGY), or 85 MMG per quarter. During the June quarter, the company produced a slightly smaller-than-capacity 81.5 MMG, and of that, sold 63.4 MMG, or roughly 75% of capacity. These sales yielded $169.6 million in revenue, and $15.1 million (19 cents per share) in net income (both revenue and income also include sales of distiller grains, but let's assume that this is directly proportional to the amount of ethanol sold).
During the current September quarter (Q3), VeraSun expects to start up its newly acquired Linden, Indiana facility, and produce and sell 95 MMG of ethanol (roughly 85% of the new, 112.5-MMG quarterly capacity, and 33% higher than the 63.4 MMG it sold in the June quarter).
I hope I haven't lost anyone yet, because here comes the fun part. Using this 33% growth projection, we can now estimate that the company will make $20.1 million (or 25 cents per share) on revenues of $226.5 million for Q3. Both of these forecasts are higher than the current analyst estimates of 23 cents per share on revenues of $225.5 million. Ah, but my skeptical side reminds me that ethanol and corn prices are constantly changing, and that 33% gallons-sold growth does not necessarily mean 33% earnings- and revenue-growth. Nevertheless, since these variable prices can fluctuate to benefit the company as well as to hurt it, let's assume for now that these estimates are more or less accurate. Thus, we can expect VeraSun to slightly beat analyst estimates when it reports its September-quarter numbers.
That's all and good, but a positive surprise of only a penny or two per share shouldn't be convincing enough for you to start buying up VeraSun shares. So, let's look deeper into the future, all the way into the year 2008. In the fourth quarter of next year, the company plans on starting up its ninth plant for a total ethanol capacity of one billion gallons per year, or 250 MMG per quarter. You'll notice that this new capacity will be exactly twice that of September, 2007. Thus, we can estimate Q4 2008 earnings and revenue to equal $40.2 million (50 cents per share) and $453 million, respectively. Assuming no new plants are opened in 2009, we can in turn expect full-year 2009 earnings and revenue of $160.8 million ($2 per share) and $1,812 million, respectively.
So how do we translate all this into a share price? Let's assume that VeraSun's $13 shares are currently fairly valued with a forward P/E of 12.5 (this number is based on full-year 2008 expected EPS of $1.04). Starting on January 1, 2008 (in four months), however, its forward P/E will start to be based off 2009 full-year earnings. If our 2009 estimate of $2 per share is accurate (or at least if that's what analysts will be predicting on 1/1/08), then VSE will have to trade at $25 per share to sustain its forward P/E of 12.5! This is a 92% hypothetical share-price gain in the next four months.
Moreover, the company reported that its production for the month of June 2007 was actually greater than its capacity, so it's very possible that the above estimates are somewhat conservative. Additionally, the 2009 estimate of $2 per share assumes that VeraSun will sell 85% of its 1 billion-gallon potential. If they end up selling the full billion, VSE's 2009 earnings can be estimated at $2.35 per share, and will need to jump to $29/share to sustain the current 12.5 forward P/E.
But wait a minute; my skeptical side is reminding me that VeraSun's recent acquisition of additional plants from ASAlliances will cost the company $725 million -- $200 million of which will be through the issuance of 13.8 million VSE shares. Additionally, the company will need to take on an additional $275 in debt, on which it will undoubtedly need to pay interest. The resulting dilution and expense will likely have a material affect on future EPS -- by as much as 20%. On the other hand, the forward P/E of 12.5 that we've been working with is somewhat conservative; competitor Pacific Ethanol, for instance, is trading at 20 times forward earnings, and at $15 per share, VeraSun itself was trading at 14.5 forward P/E just a few week ago. Also, this purchase from ASAlliances is not just for three plants, but for two development sites as well. So, it's very conceivable that VeraSun will build two more production facilities on these sites in the not-so-distant future, thus perhaps positively impacting 2009 sales and earnings.
Now I'm no Miss Cleo, but when you show me a company whose stock is trading at all-time lows, and whose production and sales are poised to double in 12 to 15 months, I will advise you to consider buying its shares. With VeraSun, it's time to shut out the skeptic and trust the math.Disclosure: Author has a long position in VSE
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