Aventine Hasn't Fallen Far Enough To Offer a True Discount


Ethanol makers were all the rage, that is until they began to offer their stock to the public. Aventine Renewable Resources (AVR) offered shares on July 5th at $43, and today those shares are selling for less than $20. The company is solidly profitable and has $3.75 per share in cash and almost no debt, so the question is whether the shares have become a bargain.

The tough part with evaluating ethanol stocks is the lack of operating history. The industry just recently exploded in size, reflecting the banning of MTBE, an ingredient in gasoline which ethanol has replaced, and the rise in alternative fuels due to soaring oil prices. But as oil prices have tumbled lately, so have ethanol prices.

AVR's book value per share is around $6.40 presently, and they seem to be earning around $2. That would imply a 31% return on equity, which is very high but likely not sustainable. It also looks like they are earning around a 100% return on capital employed, a level of profitability enjoyed by Coke (NYSE:KO) and Microsoft (NASDAQ:MSFT) but not typically by manufacturers in competitive industries.

Ethanol futures are trading at a forward discount, meaning prices are expected to drop in the future. Given the supernormal profits being earned in the industry, more plants and competitors are likely to enter the space, ultimately pushing prices and profits down. So profitability is likely to come down, but volume is all but certain to rise in coming years.

At a price of $19.97 (yesterday's close), Aventine looks cheap at just under 10 times estimated 2006 earnings. But with the lack of operating history and low level of equity, we're going to pass.

AVR 1-yr chart:

AVR 1-yr chart

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