VeraSun Energy (VSE) President and CFO Danny Herron presented at the William Blair 28th Annual Growth Stock Conference 2 weeks ago. I listened to the replay, checked out the slide show and took some notes. The presentation was very upbeat, as they usually are. This is a company that has gone from a couple of plants to the nation's leading ethanol producer in the space of about 3 years. I was most interested in the comments concerning the ethanol market in general and the specific growth and profitability prospects for VSE.
First, some notes on ethanol production overall:
- Every gallon currently being produced (9.4 billion gallons annual capacity) is being used to blend with gasoline. There is no excess capacity or inventory of ethanol.
- Gasoline blenders are reformulating their gas to require ethanol blending. This reduces the overall cost of the gas and increases the blender’s profits.
- In 2007, for the first time since 1977, oil imports from the Middle East decreased. This is due to the use of 6.5 billion gallons of ethanol, replacing 228 million barrels of [not] imported oil.
- Ethanol plants currently being built or planned will top out at 12 billion gallons per year production. No new plants have been proposed for the last 2 years, so additional capacity is a minimum of 2 years out.
- Note: Brazil could export to the U.S. at most 500 million gallons per year of sugar ethanol, they too would need a couple of years to get new plants built.
Positive notes on VeraSun specifically:
- Overhead cost is down to 5¢ per gallon. All of its plants are identical (and still under warranty) reducing training costs and allowing personal to be easily transferred.
- Next profit stream: Corn oil extraction from distillers grains (NYSEARCA:DDG). The company will be able to extract 175 lb. of oil from each ton of DDG. Oil extraction will add $20 million EBITA per plant. The resulting, dryer, DDG is of higher quality than soybean meal, which currently costs twice as much as DDG. First plant with oil extraction coming fall 2008.
- The merger with U.S. BioEnergy (USBE) will yield synergistic savings of $80 to $160 million per year by the end of 2009.
My belief is that ethanol blended into gasoline of at least 10% will be the standard for U.S. gasoline ,and in fact, is about 2/3 of the way there. VeraSun, as the largest, best managed of the ethanol companies, will stay profitable and grow its revenues and profits. I also think the market has no clue on the future profitability of VSE. The analyst estimates for 2008 earnings (courtesy of Yahoo Finance) range from -26¢ to +61¢ per share and we are half way through the year. VeraSun does not buy corn at the CBOT market rate and it does not sell ethanol at the spot rates. Most ethanol is sold to blenders at a contract price that is related to the cost of gasoline, and we know what gas prices have been doing.
Many of the factors that will help VeraSun’s profitability will not kick in until late 2008 and into 2009, so there may be no rush to buy the stock even if you think the company will do better in the next 2-3 years. However, a positive earnings release in the next couple of weeks could make hindsight of $4 VSE stock seem very attractive.
Note: I have a long position in VSE.