Pacific Ethanol's Asset Sale Illustrates Its Challenges
Summary
- Pacific Ethanol recently announced that it is selling a sizable fraction of its total ethanol production capacity for just under $53 million.
- The company has been exploring "strategic initiatives" in response to a persistent low-margin production environment, and its share price jumped by more than 50% on the news.
- The rally quickly dissipated, though, as investors realized that the sale price valued the assets for much less than the company had paid for the same capacity in 2015.
- The asset sale buys Pacific Ethanol some much-needed time, but its underlying problems have not been mitigated.
The share price of U.S. ethanol producer Pacific Ethanol (PEIX) popped by more than 50% on March 3, although it quickly gave back all of its gains (see figure). The cause of the brief rally was the company's announcement that it has agreed to sell its 74% ownership stake in Pacific Aurora LLC to Aurora Cooperative Elevator for $52.8 million. The sale involves two Nebraska-based dry mill facilities, Pacific Ethanol - Aurora East and Pacific Ethanol Aurora West, that have a combined capacity of 145 million gallons, as well as associated logistical assets.
Data by YChartsThe immediate rally can be explained by the fact that the sale will provide Pacific Ethanol with a much-needed cash infusion. The company embarked upon an ill-timed expansion in 2015 that saw it greatly increase its ethanol production capacity, including the addition of the Aurora facilities, just as collapsing global fuel prices heralded the beginning of a long-term period of low ethanol production margins. The costs of that expansion came to a head in 2019 as Pacific Ethanol found itself with over $220 million in current liabilities and enough cash to cover only three quarters of interest expenses (see figure). The $53 million mixed cash-debt deal buys the company additional time.
Data by YChartsThe speed with which the rally dissipated, on the other hand, reflects the poor terms that Pacific Ethanol received on the sale. The company parted with an effective capacity of 107 million gallons (its 74% stake in the combined 145 million gallon capacity), resulting in a sales price of $0.49/gallon. To put this in perspective, its peer Green Plains, Inc. (GPRE) sold three facilities to Valero Energy (VLO) for an average of $1.08/gallon of nameplate capacity in Q4 2018. The Aurora facilities had previously been owned by Aventine Renewable Energy Holdings, which Pacific Ethanol bought out in 2015 for 17.7 million shares of stock and the transfer of $145 million of term debt, resulting in an average sale price of $1.02/gallon of nameplate capacity. The larger of the two Aurora facilities is a relatively new Delta-T plant of the type that is especially valued by the ethanol sector. While hindsight is 20/20, the recently-announced asset sale demonstrates just how much Pacific Ethanol has been damaged by the operating conditions that have prevailed since the Aventine acquisition was completed.
Investors who have been following my articles on Pacific Ethanol since late 2018 will not be surprised by the low sale price for the assets. Pacific Ethanol has long been one of the sector's lower-margin producers which, combined with its decision to wait to complete the sale until it found itself in the worst operating environment of the last decade, ensured that it was never likely to recoup its acquisition price. Viewed from that perspective, then, it could be argued that the recent asset sale justified the rally since it showed that Pacific Ethanol's assets have a combined value that exceeds its current market capitalization. Specifically, the current market cap of $30 million suggests that the company's 605 million gallons of pre-sale capacity is worth only $0.05/gallon. Even accounting for the premium that the market is willing to pay for the Aurora capacity, this would in turn indicate that Pacific Ethanol is grossly undervalued.
My response to this argument is the same as it was in late 2018: Pacific Ethanol's remaining assets are unprofitable in a low-margin environment such as the one that has persisted over the last six quarters. Worse, the company's loss on its Aurora sale means that it now has fewer assets from which to pay down its large debt load. It received some breathing space on that debt with a share-diluting maturity extension that was announced last December, but that extension only postponed a crisis. Even if Pacific Ethanol is able to value itself based on its pre-sale asset value of $0.49/gal - and it would not, given that much of its capacity has a lower value than the Aurora capacity - then it would have a market cap of $252 million relative to total liabilities of $380 million, of which $229 million of the latter are current. Add in the warrants for the purchase of 5.5 million shares at $1 that Pacific Ethanol issued as part of its maturity extension, and the current market cap looks more reasonable.
Data by YChartsThis is not to say that the asset sale is entirely negative for Pacific Ethanol's investors. It provides the company's management with additional time to wait for ethanol production margins to rebound, at which point the company will either be profitable enough to cover its interest costs or valuable enough to reduce its debt load to a sustainable level via additional asset sales. This additional leeway has become especially important as the growing COVID-19 outbreak has caused even U.S. crude prices to decline rapidly (see figure).
Data by YChartsAll the same, though, the asset sale illustrates to investors just how much damage the Aventine acquisition has done to Pacific Ethanol's market value. It also confirms the bearish view on the company that I first presented in Q4 2018. At the time, I argued that Pacific Ethanol's poor margins would negatively impact the value of its production assets, and its share price has fallen by over 80% since then (see figure). At this point in time, the primary hope for the company's investors is that ethanol production margins undergo a long-term rebound. The turmoil that has characterized the global energy markets in 2020 to date illustrates how improbable such a rebound is. The recent asset sale has demonstrated that, barring a rebound, Pacific Ethanol's future will continue to involve trading the production capacity that it staked its future on in 2015 in exchange for time.
Data by YChartsThis article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.
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Comments (15)
I don't know which one is the correct calculation.
In a slightly better environment (Summertime, Covid under control...) could we say that the assets could be valued at least around 0.7$ x gallon?
In the best case of the remaining 498m gallons that would value the assets at around 350 million $.
