Verasun Energy: Expect Future Growth and Profitability

VeraSun Energy (VSE) President and CFO Danny Herron presented at the William Blair 28th Annual Growth Stock Conference 2 weeks ago. I listened to the replay, checked out the slide show and took some notes. The presentation was very upbeat, as they usually are. This is a company that has gone from a couple of plants to the nation's leading ethanol producer in the space of about 3 years. I was most interested in the comments concerning the ethanol market in general and the specific growth and profitability prospects for VSE.

First, some notes on ethanol production overall:

• Every gallon currently being produced (9.4 billion gallons annual capacity) is being used to blend with gasoline. There is no excess capacity or inventory of ethanol.
• Gasoline blenders are reformulating their gas to require ethanol blending. This reduces the overall cost of the gas and increases the blender’s profits.
• In 2007, for the first time since 1977, oil imports from the Middle East decreased. This is due to the use of 6.5 billion gallons of ethanol, replacing 228 million barrels of [not] imported oil.
• Ethanol plants currently being built or planned will top out at 12 billion gallons per year production. No new plants have been proposed for the last 2 years, so additional capacity is a minimum of 2 years out.
• Note: Brazil could export to the U.S. at most 500 million gallons per year of sugar ethanol, they too would need a couple of years to get new plants built.

Positive notes on VeraSun specifically:

• Overhead cost is down to 5¢ per gallon. All of its plants are identical (and still under warranty) reducing training costs and allowing personal to be easily transferred.
• Next profit stream: Corn oil extraction from distillers grains (DDG). The company will be able to extract 175 lb. of oil from each ton of DDG. Oil extraction will add $20 million EBITA per plant. The resulting, dryer, DDG is of higher quality than soybean meal, which currently costs twice as much as DDG. First plant with oil extraction coming fall 2008.
• The merger with U.S. BioEnergy (USBE) will yield synergistic savings of $80 to $160 million per year by the end of 2009.

My belief is that ethanol blended into gasoline of at least 10% will be the standard for U.S. gasoline ,and in fact, is about 2/3 of the way there. VeraSun, as the largest, best managed of the ethanol companies, will stay profitable and grow its revenues and profits. I also think the market has no clue on the future profitability of VSE. The analyst estimates for 2008 earnings (courtesy of Yahoo Finance) range from -26¢ to +61¢ per share and we are half way through the year. VeraSun does not buy corn at the CBOT market rate and it does not sell ethanol at the spot rates. Most ethanol is sold to blenders at a contract price that is related to the cost of gasoline, and we know what gas prices have been doing.

Many of the factors that will help VeraSun’s profitability will not kick in until late 2008 and into 2009, so there may be no rush to buy the stock even if you think the company will do better in the next 2-3 years. However, a positive earnings release in the next couple of weeks could make hindsight of $4 VSE stock seem very attractive.

Note: I have a long position in VSE.

 

Comments

[rickrents:]

Great article. Let's not send any more dollars to people who are trying to destroy the USA. We CAN do it if we try.

2008 Jul 09 09:08 AM

[rickrents:]

Great article. Let's stop sending dollars to terrorists who are trying to destroy the USA. We CAN DO IT if we try.

2008 Jul 09 09:09 AM

[bzh1111:]

Very Good Article. However, there are few points missing. 1) The trouble with Ethanol first generation in the US is that there profitability is directly linked to Corn (also down from its highest level, is still above 6.5USD a bushel). VSE had to shut down a brand new plant recently because of this low profitability and this will probably hang over earnings for the quarter. 2) Sugar Ethanol from Brazil. I am working closely with people involved in Ethanol trading (physical) and the best trade recently was to ship the brazilian Ethanol in the US despite the 0.54c per gallon tax. Brazil has a fantastic track record with ethanol and is now building up capacity (much cheaper than in the states) to be sold in the US in the years to come. So the 500mg you mentionned is more 3bng now (nearly 25% of the first generation cap). 3) From the beginning, it is obvious that the first generation ethanol is an ecological disaster and I was personnally not surprised to see Bush pushing for that solution in the US...More importantly, politicians are now realising their mistake and voted the 2007 EISA Mandates on Cellulosic Ethanol. This mandate will cap first generation until 2022 and will benefit Cellulosic Biofuel (like VRNM). The only smart way for the VSE guys now is to buy or develop cellulosic ethanol...

2008 Jul 10 07:08 AM

[Chris Damas:]

"In 2007, for the first time since 1977, oil imports from the Middle East decreased. This is due to the use of 6.5 billion gallons of ethanol, replacing 228 million barrels of [not] imported oil"

Comments:
Crude oil and fuel are not the same.
1 barrel = 42 gallons so 6.5 billion gallons = 154.8 million barrels.
Ethanol has 67% energy value of gasoline so on a 1 Btu for 1 Btu basis, only 103.7 million barrels crude.
How much crude oil are required to produce a barrel of RBOB (gasoline blend stock)? You might want to check that.

2008 Jul 10 11:30 AM

[wheels14:]

Dear User 89305,

Your statistic of 67% energy value of ethanol. Are you quoting Potential energy or realized energy. Keep in mind your combustion engine only uses about 38% of the potential energy in gasoline but 98% of the potential energy of grain alcohol.

2008 Jul 11 03:53 PM

[wheels14:]

bzh1111

What ecological disaster are you refering to?

2008 Jul 11 03:55 PM