How We Played Green Plains

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About: Green Plains Partners (GPP), GPRE
by: Quad 7 Capital
Summary

U.S. ethanol producer Green Plains, Inc. stock fell hard following earnings.

We saw this as a significant opportunity to make a trade.

We discuss operational changes and pending catalysts as a reason why the Street quickly changed course, and is likely to continue to rally.

U.S. ethanol producer Green Plains, Inc. (GPRE) is a stock that fell hard. In this column we want to share with you the play we made at BAD BEAT Investing, and why we see some continued upside.

The stock has seen better days. When the stock hit the mid-$12 range we saw some opportunity here after the company has made some moves to shore up its balance sheet and cut the fat from its operations. The newly sized company here in 2019 has some possible catalysts to improve margins, and we think BAD BEAT Investors could find some upside in this name.

Source: Green Plains Website

What the company does

Green Plains is an ethanol producer based out of Omaha, Nebraska. The company currently has an ethanol production capacity of approximately 1.1 billion gallons per year with 13 plants strategically located across the U.S. Green Plains also operates an independent third party ethanol marketing business, called Green Plains Trade. Within the ethanol production segment you've got production of ethanol, distillers grains, and corn oil recovery all going on at the aforementioned 13 ethanol plants in Illinois, Indiana, Iowa, Minnesota, Nebraska, Tennessee, and Texas. At full capacity, Green Plains processes approximately 390 million bushels of corn per year to produce the aforementioned 1.1 billion gallons of ethanol. It also produces many tons of distillers grains and millions of pounds of industrial grade corn oil. On a more comparative scale, all this activity makes Green Plains is the second largest owner of ethanol plants in North America (behind Poet).

While ethanol is the bread-and-butter of the company distillers grains are a key co-product of Green Plains’ ethanol production. At capacity its plants will produce approximately 3.1 million tons of distillers grains annually that will be used as a high-protein, high-energy animal fodder and feed supplement. Corn oil is a processing residue from ethanol production that is recovered at all plants. Corn oil is sold to biodiesel manufacturers and to feed lot and poultry markets.

Green Plains also provides grain storage through its subsidiary, called Green Plains Grain. Green Plains Grain has grain storage capacity of approximately 46 million bushels. This business segment is becoming more relevant as it increases efficiencies and reduces commodity price and supply risks.

The company also dabbles in commercial algae. Looking to next generation technology, Green Plains is part of a joint venture called BioProcess Algae to commercialize algae production technology. In addition to Green Plains, the other partners in the venture are CLARCOR Inc. and BioProcess H2O. Its a small project working off a $4.1 million grant but it is one that we believe is part of an ultimate greener economy. It may be years away but it is coming eventually, in our opinion..

Take a look below to learn more about the actual operations we invite you to review this informational video:

Source: Vimeo

Now that you have a basic understanding of what the company does, lets talk about the stock and the company's operations and finances. We were drawn to the stock after seeing it drop following a strong earnings report. Take a look at the chart in the last year, its been beaten down:

Source: BAD BEAT Investing

The chart looks pretty ugly, and it is because ethanol and energy related items has been a miserable sector to be in the last 6 months. Much of the declines coincide with the market tanking to end 2018. Shares began to rebound in 2019, but the 5%+ decline created opportunity for entry:

The play

Target entry: $12.45-$12.65

Stop loss: $12.00

Target exit: $14.00+

Performance and recent moves

Let's talk performance. The company just put out results for the fourth quarter of 2018. In Q4, net income attributable to the company was $53.5 million, or $1.13 per diluted share, compared to net income of $46.6 million, or $0.99 per diluted share last year. This is 15% growth over 2017. Revenues were down though we have to say this was expected as several business lines were offloaded. The revenue number for the quarter came in at $827.5 million compared with $921.0 million for Q4 2017.

Source: Green Plains Investor Presentation for Q4

Revenues attributable to the company were $3.9 billion for the year ended 2018 and were up nicely despite Q4. The company saw revenue of $3.6 billion for the same period in 2017. Net income attributable for 2018,was $15.9 million, or $0.39 per diluted share, compared with net income of $61.1 million, or $1.47 per diluted share last year, but had to do with significant expenses earlier in the year.

We believe better days are head for the company following its its portfolio optimization plan that began in mid-2018 in which Green Plains said it would divest assets that do not support the company’s strategic focus on the production of high-protein feed ingredients and ethanol exports to significantly reduce or eliminate the company’s term debt and invest in high-protein process technology at certain ethanol facilities. The plan’s five strategic pillars were:

1. "Prove value of Green Plains’ assets for shareholders through strategic divestments."

2. "Significantly reduce or eliminate term debt by the end of 2018 with sale proceeds."

3. "Invest in high-protein process technology at the Shenandoah, Iowa ethanol facility with other locations to follow."

4. "Repurchase shares with remaining proceeds and free cash flow when market conditions are optimal."

5. "Reduce controllable expenses $10 to $15 million on an annual run rate basis, starting in the third quarter of 2018."

The company has made significant moves

The company also summarized nicely the moves it made in its year-end report:

"On July 31, 2018, the company acquired two cattle-feeding operations from Bartlett Cattle Company, L.P. for $16.2 million, plus working capital of approximately $106.6 million. The transaction included the feed yards located in Sublette, Kan. and Tulia, Texas, which added combined feedlot capacity of 97,000 head of cattle to the company’s operations, now totaling 355,000 head.

During the third quarter of 2018, the company extended the maturity date for one year to October 1, 2019 with certain beneficial owners of $56.8 million of the company’s outstanding 3.25% convertible senior notes due 2018. On October 1, 2018, the remaining aggregate principal of $6.9 million not extended was paid in cash.

On November 15, 2018, the company announced the completion of the sale of three ethanol plants to Valero Renewable Fuels Company, LLC for $319.8 million in cash, including preliminary net working capital and other adjustments. The transaction included ethanol plants located in Bluffton, Ind., Lakota, Iowa, and Riga, Mich. which represented approximately 20% of the company’s reported ethanol production capacity. Also, the company announced the permanent closure of the Hopewell, VA ethanol facility.

On November, 28, 2018, the company announced the completion of the sale of the Fleischmann’s Vinegar Company, Inc. for $353.9 million in cash and restricted cash including preliminary net working capital and other adjustments.

On November 28, 2018, the company announced that it repaid its entire obligation for the $500 million senior secured term loan due 2023. As a result, all of the company’s assets and subsidiaries, not including Green Plains Partners LP (NASDAQ:GPP), are unencumbered from term debt.

On December 12, 2018, the company announced the formation of Optimal Aquafeed, a 50/50 joint venture to produce high-quality aquaculture feeds utilizing proprietary techniques and high-protein feed ingredients. The joint venture brings together Green Plains’ production capabilities, commodity expertise, and infrastructure and combines that with Optimal Fish Food’s intellectual property, industry expertise and customer relationships."

While we will not discuss in depth each of these moves, we will state that the company did what was necessary to better focus its operations, clean up its balance sheet, and to focus on the business segments that should help boost margins in the future. We also like that part of the plan was to repurchase shares.

Repurchases

Another reason we like the name is the revamp of share repurchasing at these lower valuations. During the fourth quarter of 2018, Green Plains repurchased 209,682 common shares at an average price of $14.18. Approximately $80.3 million remains available from the $100 million stock repurchase program. We fully expect repurchases to continue. Couple this with a regular dividend, and we like shares yielding nearly 3.6%. One issue we expect to improve is margins, which have hit the stock.

Margin pressure

Part of the reason the stock has taken a beating is higher inventory and narrowing margins

Source: Green Plains Investor Presentation for Q4

With the decline in margins and the increasing inventory, the company has worked for over a year to improve its margins. Offloading lower margin business lines was a key step. Secondly, the company is saving on expenses as it has recently announced some job cuts. Perhaps most significant was closing a high cost Virginia production plant last month and the output cuts at several other facilities as it tries to navigate a supply glut that has pummeled biofuel profits. Are there any pending catalysts?

Pending catalysts?

We do think there are some catalysts in the medium-term. It is very likely that E15 will be implemented by the Trump Administration for the upcoming summer driving season and exports could get a boost from the U.S. and China resolving the trade issue between the two countries.

There is no doubt that the ethanol industry needs demand growth, and both of these initiatives could reduce inventories allowing for a return to a better margin structure for the industry over the next several months. There has also been a recently reported reduction of industry run rates and inventory levels not much above last year. Lower overall retail gasoline prices have helped keep demand for products high, and we see this as continuing. Where the opportunity exists will be the addition of high-protein feed co-products. The margins are high here and should improve profitability in our opinion.

The trade paid off

Shares have been battered following the oil industry and the general markets. Shares were trading at $12.51 at the time of this alert and our traders sold between $14.00 and $14.50, but we see them rallying further once the Street recognizes these pending catalysts. The company has strategically shifted and we believe by-products will continue to keep margins intact while the ethanol supply and demand curve normalizes.

Disclosure: I am/we are long GPRE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.