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Since our last update (An Update On Renewable Energy Group), a number of important events have transpired. As such, we believe it is time to provide our updated thoughts on Renewable Energy Group.
Update on Geismar Renewable Diesel Plant Valuation
On November 6, 2019, Darling Ingredients ("DAR") reported in its 10-Q strong renewable diesel ("RD") margin in Q3. More importantly, it provided strong guidance on RD margin for Q4 2019 and 2020. As a result, DAR's stock has gone from ~$19 before its partner Valero Energy Corporation ("VLO") reported Q3 RD margin, to over $24 per share early last week - before excitement on the potential for the reinstatement of the biodiesel tax credit ("BTC") started to creep into the share price. We believe this level of RD profitability increase should apply to REGI as well, which we discuss below.
For fourth quarter and next year, we anticipate running at full capacity and current margins are approximately $1.40 per gallon."
- Randall Stuewe, DAR CEO on 2019 Q3 earnings call
So, is $1.40 the goal or what you're seeing right now because if I look at current diesel pricing in RINs, and even assuming not a full capture on the LCFS, I get to margins well in excess of $1.40. So, I was wondering if you could help me understand that better?"
- Heather Jones, analyst on 2019 Q3 DAR earnings call
Yes, your math is pretty good Heather. The $1.40, I'm throwing out there is simply a benchmark that for this moment. Right now, the margins that we're seeing anywhere in Q4 to Q1 range from anywhere from $1.50 to $2.10 a gallon. So, you always want to set yourself enough. I don't want to have to go out here, we've not and haven't practice guidance in the past. So, we're just throwing $1.40 out and that's just kind of where we think the year could average. But I suspect right now if you said me, for me to recast it, looks like it'd be a whole lot better for next year."
- Randall Stuewe, DAR CEO on 2019 Q3 earnings call
We have updated the implied RD valuation in Neste and DAR using the same methodology we used in our original article (Renewable Energy: 100%+ Upside For This Misunderstood Renewable Energy Producer). Please refer to that article for a discussion of the approach and rationale.
Figure 1 - Implied RD Valuation of Neste's RD Business
Figure 2 - Implied RD Valuation of DAR's RD Business
We estimate that Neste's RD valuation is 16.7x and that Darling's RD business is 12.4x. Using an EBITDA/gallon range of $1.25 to $1.55 and EBITDA multiple of 12x-16.5x, we estimate REGI's existing RD business is worth ~$25-$44 per share, inclusive of the company's net debt.
Figure 3 - REGI's Existing RD Business Valuation
Given the increase in valuation of REGI's peers, we have updated the potential value creation from these two projects. Note that we are using the same range of EBITDA margin assumption that we did in our first article. This is obviously conservative relative to where DAR sees it today ($1.50-$2.10).
Figure 4 - PSX JV Plant Value Creation
Figure 5 - Geismar Plant Expansion Value Creation
Based on the appropriation bills that have been passed in the House and are expected to be passed in the Senate and signed by President Trump before the end of this week, BTC will be reinstated. In our opinion, the proposed version under consideration is materially better than expected. Prior proposals called for a retroactive reinstatement for the year 2018 and 2019, and an extension through 2020. The current version provides the 2018 and 2019 reinstatement but extends BTC for three years through 2022.
In a few weeks, REGI should receive ~$515mm in cash or ~$11 per share of cash from the U.S. government. Based on our estimate, there is an additional $5 per share in BTC per year in each of the years from 2020-2022, bringing total BTC value to $26 undiscounted.
While the extension to 2022 could be worth ~$15 per share in total if one just sums up the 3 years' worth of BTC payments, the reality is that it is a bit more complicated than that. Despite we have concrete visibility on this income stream for only 3 years, BTC has also been reinstated each time it has expired in the past. As such, there is a decent probability that BTC will be renewed again at the end of 2022. On the other hand, BTC could impact RIN and feedstocks prices which drive BD and RD margins. As such, we valued the BTC go forward income stream assuming a range of outcomes in incremental EBITDA contribution using EBITDA multiples that are at a meaningful discount to how we value the respective businesses (5.5x EBITDA for BD and 12-16.5x EBITDA for RD).
Figure 6 - BTC Go Forward Value
The estimated $500mm of cash fortifies REGI's balance sheet and provides tremendous flexibility for REGI to pursue its RD business expansion plan more aggressively. In our opinion, there is no longer the need to explore ways to fund the new RD projects as this $500mm of cash alone is sufficient to fund the equity portions of both the PSX JV plant and the Geismar expansion, which we believe are very high incremental return on capital investments. As REGI management said on its Q3 2019 earnings call, the company is evaluating additional sites for RD expansion. We believe the improved balance sheet and the forward visibility will allow the company to pursue projects beyond the PSX JV and Geismar expansion, something we have not attributed any value to.
So again, lots of good questions embedded in all that. And I did signal in my comments, that we continue to look at additional sites"
- CJ Warner, REGI CEO on Q3 2019 earnings call
Despite the strong move in REGI's stock price since our initial publication, in our opinion, a number of events have happened that increase the value of REGI dramatically. As such, we continue to see tremendous upside in REGI.
Figure 7 - Overall REGI Valuation
At ~$25 per share, we believe there is very strong downside support. If we back out ~$11 per share in cash from the BTC reinstatement, as well as the net debt of the company, it implies a value of approximately $16 per share. In turn, this suggests that the RD business is trading at ~6-7x EBITDA, with no value attributed to its BD business, RD expansions, or BTC go forward. Thus, we believe an investment in REGI at the current level provides a highly attractive upside potential with strong downside protection.
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Disclosure: I am/we are long REGI. 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.