Ethanol Is Oversold: Three Bounce Stocks - Barron's

 |  Includes: AVR, PEIX, VSUNQ
by: SA Eli Hoffmann

Once-in-vogue ethanol stocks have taken a beating over the past year as investors went from wildly bullish to wildly bearish due to concerns about a production glut, and claims ethanol is a driving force behind rising food prices -- which could threaten its coveted government subsidies.

But Barron's Andrew Bary thinks the ethanol rally will resume. "The stocks are depressed, the businesses are profitable and the companies generally trade below the replacement cost of their ethanol plants."

Oil refiners get a $0.51/gallon credit when they blend ethanol with gasoline. Local ethanol producers are also helped by a $0.54/gallon tax on imported ethanol. The government mandates that 9B gallons of ethanol be used this year, 10.5B in 2009 and 15 billion by 2015. Critics say ethanol is an inefficient way to fuel automobiles, and that the industry would collapse without federal subsidies. They may be right, but with strong bipartisan support on Capitol Hill, that's unlikely to change. Then there's this: At current gasoline prices of $3.50+ per gallon, mixing in ethanol at $2.50 (or $2 after the subsidy) is making gas cheaper.

While capacity will rise from 9B gallons to 13B in early 2009, there's not much on deck after that. A once-feared glut now looks unlikely as plans for new plants fell apart amid tumbling valuations for ethanol producers and the credit crunch.

Shares of Verasun Energy (VSE), -61% this year, Aventine Renewable Energy (AVR) -59% and Pacific Ethanol (NASDAQ:PEIX) -60% all trade at a discount to their book value.


Hard Assets Investor asks: Are We at the Bottom of the Ethanol Barrel?

Recently, four times as many calls as puts are being scooped up by ethanol traders, yet another sign the market may be rethinking the sector.