Looking for a Pure Play in Ethanol

by: James Shell

We came across Pacific Ethanol (NASDAQ:PEIX) the other day when we were researching Valero's (NYSE:VLO) presence in the ethanol business, and it raises the question: what if you wanted to invest in a pure play in ethanol?

According to various sources, the US produced about 10 billion gallons of fuel ethanol in 2009, and there are some prospects for this business going forward, as we all know (topic for future discussion: what are the merits of this? More on that subject later.).

Of the 10, three big companies produce about a third of it: Archer Daniels Midland (NYSE:ADM), Valero, and Chevron (NYSE:CVX) combine for 3.2 billion. This market still has not gone through its consolidation stage. There are probably 50 little companies, mainly out in the middle of the country that are trying to run ethanol plants - that totals about 5 billion - and that leaves about 1.8 billion gallons produced by a handful of mid-level type companies. That's the group we're interested in.

Here's a summary:

2010 Total
Company Stock Price Mkt Cap Mgal/Yr EtOH Rev$M Revenue $M
ANDE Andersons 40.22 740 300 449 3160
AVR Aventine 0.93 na 425 473 942
GPRE Green Plains 11.54 412 657 984 1810
BIOF Biofuel Energy 1.28 32.5 115 433 433
MGPI MGP Ingredients 9.84 175.2 79 118 208
PEIX Pacific Ethanol 0.89 79 250 281 281

ANDE: This company is only about 15% ethanol, their primary business is operating grain elevators and other activities in the supply chain between the farmers and the users of grains. They have a bit of an advantage because they're "experts" in all of the hedging and inventory type activities. They have competition in their main business, the profit margin on their overall business is only a couple of percent of revenues, but they are in an interesting place if you are one of the people that believe there are going to be food supply issues.

AVR: The stock was delisted in 2009; they were caught in the downdraft when the markets readjusted. According to their website they own or are in the process of constructing a handful of big ethanol plants in the middle of the country. They claim to have their financing lined up, and they also have a distribution channel, which allows them to be a third party seller. Lots of questions.

GPRE: A "change driver", this company is likely to be one of those that drives the consolidation process in this market. They're buying the small guys out one at a time as the opportunity arises. Only about half of their revenues are in ethanol production, the rest are byproducts and other related materials, plus use of their market distribution capabilities for the smaller producers. They are leveraged, Debt-to-equity is about 113%, but at the current size they are, their interest expense is only adding about 3 cents per gallon on their production cost, which is manageable if - and it's a big if - the margins stay high. They lost a lot of money in 2007 and 2008 learning this business.

BIOF: Not profitable at its current size, the analysts have dropped coverage. They are restructuring their debt and using the third party marketers to distribute the product.

MGPI: This was an interesting find. They are one of the three main producers of "food grade" ethanol, and I included it just for fun because their stock has gone from 7 to 10 due to the brilliance on the part of their management to essentially get out of fuel ethanol and concentrate on something they can make money on: drinkable ethanol and some starch related products, a lot of which go into "health conscious" type food products and some bioplastics. The stock value picked up in 2010 when their year-on-year profitability got better after they dumped the fuel ethanol business, and they have added some sales resources to try to penetrate some of these specialty markets. They have some big competitors, but are also in an interesting place.

PEIX: The subject of our earlier research, they declared Chapter 11 in 2009 and have not been profitable since. They recently announced a stock buyback and bond issue to raise a little cash, and keep the stock price over $1 so that they would not be delisted, plus to raise a little cash to restart one of their units. They have some advantages: their plants are out west, positioned to take advantage of higher margin markets, and they are good at distribution out west. Still, they have some headwinds because of their size, and need higher margins to stay in the game for more than about another year.

I should also mention that in the background of all of this, while we were looking at the oil price increase last quarter, the price of corn went back over $6.35, and with one exception, all of these companies need higher margins.

So, I see two of these that might be interesting, the fun MBPI - relatively impervious to low ethanol margins - and the change driver GPRE, if you are willing to tolerate a little more risk. The third choice is ANDE if you want to be more in the grain supply chain, which might be a place to be.

The world is chaotic. There are no guarantees on anything.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.