Ethanol Stocks: MGP Ingredients (MGPI)

| About: MGP Ingredients, (MGPI)

Background: For background on the ethanol market see here and here.

Story: MGP Ingredients is a bit different than the other players we have highlighted (here, here, here and here, and who have largely been pure-play fuel ethanol producers), in that they have a long operating history, have ethanol production as just one branch of their business, and have fuel ethanol as just one branch of their ethanol business. They also produce food-grade ethanol for vodka and gin, etc. sellers. That's a higher grade of ethanol (i.e. fewer allowed impurities, although water is ok) than necessary for fuels, but not spectroscopic grade like specialty chemical manufacturers produce. The point - they have ethanol refining skills that exceed those necessary for fuel production, as well as fuel production experience.

Company: From their latest quarterly filing for calendar Q4 2005 ending 31Dec05, they had $76M in revenue, with $54M (71%) of that coming from ethanol production. Of their $1.682M in operating income (pg 10-11), $3.86M, or 229% was from ethanol production, and their other operations accounted for a $2.17M loss. Since ethanol is the only profitable portion of their business, we would expect them to enhance that segment going forward.

But still, even though it is better than their other segments, the ethanol segment only had a margin of 7% ($3.856M/$53.659M). That's not thrilling. There is also quite a bit of haphazardness to their performance, which likely has to do with market ethanol prices, but clearly has not been hedged or otherwise smoothed by them through forward contracts. For example, Y/Y their quarterly ethanol revenue went up by 27% ($53.6M/$42.3M), while their income from that segment went down by 10% ($3.856M/$4.301M). On the other hand, their 6-month Y/Y comparisons show the ethanol segment revenue increasing 22% ($108M/$88.4M) and income increasing 108% ($10.8M/$5.18M). So, while their ethanol business top line seems to be growing consistently at >20%, their bottom line is a bit more problematical, which they attribute to their increased costs for natural gas.

From their annual report from 30 Jun 2005, although this data is outdated, we can see that of the $183M in ethanol related revenue, 54% came from fuel grade ethanol, 31% came from food grade ethanol, and 15% came from distiller by-products (Distillers Grain). They verify that they do hedge their corn costs, have some longer-term ethanol contracts, and are active in trying to hedge and/or manage their energy costs, so we do not find their later explanation of inconsistent performance due to natural gas prices particularly convincing.

You would think that somewhere in their literature, preferably front and center, they would list their ethanol production capacity. I can't find it, and I'm tired of looking for it, but it can be had from a completely different souce as 45M gal/year.

In their quarterly reports they generally break out the distillery segment revenue and operating income, although in their annual report they do this only for the year, and not for that current quarter. I thought that was odd, but now that I have gone and back-calculated it, I understand why. Using the annual report, and subtracting out the values from the 3 preceding quarterly reports, we can get the calendar Q2 2005 ethanol revenue of $47.313M ($182.682M-$46.941M-$42.304M-$46.124M) and operating income of -$0.227M ($8.524M-$3.576M-$4.301M-$0.874M). Now I understand why they didn't highlight it, since they somehow managed to lose money even though they had consistent revenue. Weird.

For ethanol production in calendar year 2005 (abstracted and calculated from their last 5 quarterly reports and their last annual report) they had revenue of $202M ($53.6M+$54.6M+$47.313+$46.9M) and operating income of $14.2M ($3.856M+$6.949M-$0.227M+$3.576M), for an OP margin of 7% ($14.2M/$202M), $4.49 revenue/gal of ethanol capacity ($202M/45M), but only $0.32 of operating income/gal of ethanol capacity ($14.2M/45M).

Again, weird. They have significantly more revenue/capacity than VeraSun or Aventine, which are between $1.03 and $1.38, but their operating income/capacity is squarely in the middle of those company's ranges of $0.18 to $0.47. The only way I can see that that is possible is that they make much higher revenue for each gallon of ethanol since they have significant sales to the beverage industry, and those sale prices may not compare to the fuel sale prices. But if that is the case, then their fuel production costs are also much much higher. If they were the same, we would expect their 4x greater revenue to translate to 4x greater income - as it is, it looks like their production costs are something like 4x higher than the other players.

Again, we're surprised, but Blah, even borderline Dog given their superior competitors.

Stock: Like all the ethanol players, MGPI trades on the idea that a ramp-up in ethanol production is favored by the current market forces. But these guys are different. There are no market forces driving an increased demand for beverage ethanol (insert depression jokes here), only fuel ethanol. So, if these guys were to ramp up production for the fuel industry, their seemingly hugely higher production costs would prohibit their competitiveness. Their processes are good for the beverage industry, but poor for the fuel industry. And the rest of their business is a loser. The ethanol growth story just doesn't apply here. Pass, or wait for a peak and short.

* Related: All articles on ethanol and alternative energy stocks