In the last quarter I saw that they increased fourfold the position in Green Plains Renewable Energy (GPRE), an alternative energy play that I think is undervalued and could be an opportunity for investors looking to have some renewable energy exposure in their portfolios.
Green Plains Renewable Energy (GPRE) is a vertically integrated ethanol producer in the U.S. The company has grown quickly over the past four years. Total ethanol production capacity has increased from 50 million gallons per year (MMGY) in 2007 with one plant to 740 MMGY in capacity with nine plants. GPRE operates in four segments: Ethanol Production, Corn Oil Production, Agribusiness, and Marketing and Distribution. Ethanol Production is the largest segment, generating approximately $79.5 million in operating income. Corn Oil Production has recently been disclosed as an operating segment as plants have been retrofitted with corn oil extraction equipment over the last two quarters. This is a high-margin co-product that enables Green Plains to increase their overall margin. In other words, instead of recovering value only from primary operations, the company is now able to extract non-edible corn oil immediately prior to production of distillers grains.
Corn oil is used as an additive to animal feed and for the production of biodiesel. The agribusiness segment is involved with storage of grains and selling grains and commodities to local farmers. It represents approximately 17% of TTM revenues with growth of 10% in 2009 and 7% in 2010 . The marketing and distribution segment markets Green Plains’ ethanol to distributors, markets ethanol produced by other companies, and owns an interest in a fuel blending and distribution network.
Green Plains is the fourth largest ethanol producer in the U.S. with nine operating ethanol production plants located throughout the Midwest. The company has acquired facilities over the past four years, with the most recent acquisition in Minnesota in early 2011.
I like that the company has demonstrated profitability in difficult times and offers new non-ethanol earnings growth. I believe management can execute on a growth strategy and the market will reward the shift into less volatile non-ethanol businesses and will begin to appreciate the algae trials for higher value animal feed.
I see four main positives in Green Plains (GPRE)
(1) Green Plains is well positioned to benefit from continued rational growth in the ethanol fuel industry. Ethanol is a low carbon footprint, economically attractive, high octane fuel. The industry benefits from government mandates, known as Renewable Fuel Standards (RFS2), which provides growth and revenue visibility through 2022. Additionally, even at elevated corn prices, the export market remains very robust.
While there is ample supply in the U.S., I believe the supply/demand balance will likely tighten slightly over the next two years due to: (1) increasing RFS2 mandates increasing to 13.2 and 15 billion gallons in 2012 and 2015, and (2) strong export market due to a rising prices for sugar in Brazil, and (3) continued need for octane and oxygenates in gasoline.The ethanol industry is in a phase marked by consolidation for improved risk mitigation, increased value extraction from plant operations (such as corn oil co-products), and continued vertical integration of the industry as ethanol operators expand upstream agribusinesses and add downstream distribution channels. Green Plains can deliver 10%+ EPS growth from improving margins and vertical integration.
2) Green Plains is among the low-cost ethanol producers in a commodity market:
Green Plains is a low-cost producer in a commodity processing business, making them well positioned for difficult periods in the industry. The dynamics in the ethanol industry can be challenging, as input costs (mainly corn) are not directly related to the prices producers receive for ethanol. As the industry matures, I expect the volatility to be reduced, over time, in the ethanol business. Green Plains has demonstrated their strength in risk management and has delivered strong operational results in difficult times.
3) Green Plains is diversifying into other non-ethanol businesses, which should reduce the overall risk profile: If the entire “field to pump” operation is consolidated in one organization, and the full value of corn is extracted, total revenue opportunities can increase and the overall risk profile can be reduced. Green Plains is on track to diversify their business, growing the upstream and downstream assets and extracting value in ethanol co-products.
4) Green Plains is starting next-generation algae bioprocessing technology. Green Plains is part of a joint venture called BioProcess Algae to commercialize algae for animal feed and other higher-value markets. This technology can use the CO2 that would otherwise be emitted during ethanol production to produce valuable products, increasing the economics of ethanol production while reducing the greenhouse gas emissions.
I believe the risks come from continued negative headlines and regulatory changes that may limit near-term stock appreciation, but should subside over time. There are two potentially negative developments that may limit share price appreciation. First, the U.S. Congress will likely modify the existing tax incentives for the ethanol industry as part of a measure to reduce government spending. Second, the government will likely eliminate or reduce the import duty on ethanol, which was put in place to ensure foreign ethanol did not benefit from the blenders' credit. Removing this import duty will shift the relative cost competitiveness of foreign ethanol (mainly produced in Brazil). I think those are the main risks to GPRE stock but I assume that government will not hurt an industry that it made so many efforts to develop.
The best way to analyze Green Plains is to create a simple sum of the parts (SOTP) valuation approach given the different characteristics of each business segment. I arrive at $555 million-$1 billion in enterprise value from the ethanol production business assuming a 55% to 18% discount to replacement cost for ethanol production capacity, $209-$335 million for the non-ethanol businesses, assuming 5x to 8x EBITDA multiples, and $0 to $229 million in optionality value from Green Plains’ interest in the algae technology using a discounted cash flow model. I came to a $13 fair price that represents 6.1x 2012 EBITDA and 7.8x 2012 earnings. Green Plains currently trades at 5.3x 2012 EBITDA and 5.6x 2012 earnings, a multiple that implies very negative news to the ethanol industry and does not fully reflect GPRE leading position in a growing but volatile industry.
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