The Corn Conundrum By Bill Alpert
Highlighted companies: Archer-Daniels-Midland Co. (NYSE:ADM), Pacific Ethanol Inc. (NASDAQ:PEIX), VeraSun Energy Corp. (VSE), Aventine Renewable Energy Holdings Inc. (AVR), Bunge (NYSE:BG)
Summary: Surging demand for ethanol, joined with bountiful harvests that have kept corn prices low, have driven investor enthusiasm for ethanol stocks such as Archer Daniels Midland and Pacific Ethanol. Recent IPOs of ethanol companies VeraSun and Aventine Renewable Energy, meanwhile, have raised more than $700 million in total. Some industry executives speculate that ethanol use could triple in the next year, but there's an important limitation to consider: 'America's entire corn crop would satisfy just 12% of gasoline consumption, leaving no corn to feed livestock and humans. So there just won't be enough corn for corn ethanol to grow from a fuel additive into a large-scale substitute for fossil fuel.' While other crops can make motor fuel, corn is the best-proven technology, and the Energy Policy Act of 2005's Renewable Fuels Standard stipulates that gasoline blenders must raise the amount of ethanol mixed into gasoline from 4 billion gallons last year to 7.5 billion gallons by 2012 (about 5% of expected gasoline consumption in that year). Ethanol pure-play Pacific Ethanol has an enterprise value that's twice the replacement cost of the plants that it's building. It's a similar story for VeraSun, the number 2 national ethanol producer behind ADM, whose enterprise value is twice the replacement cost of its planned refining capacity. Aventine stock also appears considerably overvalued in relation to its refinery replacement cost. Bottom line for the whole industry: 'Unless gasoline prices continue their steep rise, tight corn supplies will clamp down on the huge crush spreads [difference between corn price and ethanol price] that started the stampede to invest in ethanol refineries.'
Quick comment: Market Participant, another critic of the ethanol stock craze, explains what this industry lacks from a growth investor's perspective. See more on ethanol stocks, and for those with technical interests, here's Everything You Wanted To Know About Ethanol Production But Were Afraid To Ask.