Ethanol producer Green Plains, Inc. (NASDAQ:GPRE) reported Q1 earnings this week that were quite poor despite modestly beating on revenue and handily outpacing the analyst earnings consensus. Investor sentiment in response was largely one of relief that conditions had not been as bad as feared, and the company's share price has climbed by as much as 27% following the report's release. The share price has staged an impressive rebound from its early-April lows, although it remains well below its pre-pandemic levels (see figure).
Green Plains reported revenue of $633 million that modestly missed the consensus but represented a YoY increase of 44%. The revenue growth was primarily attributable to an ethanol production volume increase of 86 million gallons over the same period as the company responded to strong export demand and a modest bump in ethanol production margins in early Q1.
The good news for the quarter ended with the revenue result, however. All three of the company's major segments (Ethanol, Agribusiness, and its stake in Green Plains Partners (GPP)) fared worse on a YoY basis in terms of operating income. The decline was led by the Ethanol segment, which recorded an operating loss of -$61 million compared to -$44 million in the prior-year period. The consolidated operating loss increased by 41% YoY to -$54 million as the other two segments' results only partially offset the Ethanol segment's poor performance. Contributing to the Ethanol segment's poor performance was a $24 million non-cash goodwill impairment charge that was incurred when the company's market capitalization collapsed in March.
The U.S. ethanol sector has been dominated by news of the impact of the COVID-19 pandemic on U.S. transportation fuel consumption, but the effects of this only showed up late in Q1. Ethanol production margins were already quite low going into the pandemic (see figure), and the sharp reduction in ethanol demand that occurred in March only worsened an operating environment that was already quite poor. This could be seen in the Green Plains Ethanol segment's operating margin of -$0.25/gallon of ethanol produced. Even after accounting for the impairment charge, the segment's operating margin was still quite poor.
Production margins at a hypothetical Iowa dry mill corn ethanol facility. Sources: CARD, EIA (2020).
GAAP diluted EPS came in at -$0.47, beating the consensus by $0.47. This result was achieved despite the widening operating loss due to the effects of the federal CARES Act that Congress passed in response to the COVID-19 pandemic. This legislation enabled Green Plains to record an income tax benefit of $44 million in the latest quarter, up from $13 million YoY. The EPS result was further supported by a 14% reduction to the number of weighted shares outstanding through the company's ongoing buyback program.
The market's reaction to the earnings beat by Green Plains, Inc. has been something of a relief rally as investors have realized that a company that was being priced for bankruptcy in March is in no immediate danger of insolvency. The company did report Q1 cash burn of $64 million, but with $206 million in cash at the end of that quarter it is equipped to handle an extended ethanol demand disruption, particularly if additional aid from the federal government becomes available.
That said, the market is potentially getting ahead of itself. The blending of ethanol with gasoline, which is the primary source of ethanol demand in the U.S., is recovering only slowly from March's collapse (see figure). Moreover, U.S. ethanol inventories remain near record highs (see next figure), and the reduction that has occurred in recent weeks has been due as much to lower production volumes as it has to rebounding demand. Green Plains reported an average utilization rate of 86% in Q1 that was only just short of its 90% target, meaning that the mass idling of capacity that has occurred in the U.S. ethanol sector in response to the pandemic was not reflected in the Q1 earnings report. (An April utilization rate for Green Plains was not provided in the Q1 earnings call.) A much larger demand rebound will be necessary before this production capacity is likely to be brought back online. In the meantime, ethanol producers' earnings will miss out on what are normally some of the year's higher-margin months.
Source: EIA (2020).
In fact, it is likely that the impacts of the COVID-19 pandemic will not be reflected in the company's earnings until the Q2 report is released three months from now. In other words, Green Plains recorded the positive aspects of the pandemic (e.g., the CARES Act) in Q1 but will not record the much more substantial negative aspects until Q2. This can be seen in the consensus analyst estimate of the company's 2020 EBITDA, which has fallen from more than $80 million at the beginning of the year to below -$20 million now (see figure). Green Plains is now not expected to return to EBITDA profitability until 2021 at the earliest.
Bulls might point to the fact that Green Plains is trading at a mere 0.28x price-to-book ratio as evidence that the company remains deeply undervalued despite the recent rally by its share price. This ratio is not a good way to value heavily-indebted companies such as Green Plains, though. Enterprise value, which also accounts for a company's balance sheet, is a superior measure. Green Plains currently has an EV of $752 million due to its substantial debt load. A 2020 EV/EBITDA ratio cannot be calculated, of course, given the negative consensus estimate, but the 2021 EBITDA consensus estimate is $85 million. This yields a EV/EBITDA ratio of 9x compared to a 10-year average ratio of 7x. The company's shares are not providing a margin of safety to investors as a result, and such a margin of safety is something that investors should require given the company's current operating environment.
