Ethanol Producers May be in Trouble Again
February 08, 2011
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Ignoring the absurdity of converting an inefficient source like corn to create fuel, I have decided to look at the current economics of the ethanol production business to see if these companies might be a solid investment idea. There was a great article on the subject over at Seeking Alpha the other day, Looking for a Pure Play in Ethanol.
One company that was mentioned in the piece is Green Plains Renewable Energy (GPRE). Here's what the author had to say about the company:
GPRE: A "change driver", this company is likely to be one of those that drives the consolidation process in this market. They're buying the small guys out one at a time as the opportunity arises. Only about half of their revenues are in ethanol production, the rest are byproducts and other related materials, plus use of their market distribution capabilities for the smaller producers. They are leveraged, Debt-to-equity is about 113%, but at the current size they are, their interest expense is only adding about 3 cents per gallon on their production cost, which is manageable if - and it's a big if - the margins stay high. They lost a lot of money in 2007 and 2008 learning this business.
This company is far from a pure play on the ethanol sector, as only half of its revenue comes from ethanol production. Most of the pure production companies have come and gone because they ran into serious financial trouble, so this is probably a pure a play as we are going to get.
As the author noted, the company should not have any trouble covering its interest expense if ethanol margins "stay high." That begs the question, what are ethanol margins like right now. Here's a great chart on the subject from the CME Group.
As you can see, margins for ethanol producers are falling and falling fast as the rising price of corn outpaces the gains in the cost of their end product. The ethanol-corn crush margin has actually been negative for the past two weeks. Over the past seven months, the price of corn has nearly doubled, up 90%, while the price of ethanol has only increased 55%. Producers are now losing one cent on every gallon of ethanol they produce versus making a $0.20 per gallon profit as recently as July. This negative margin can be improved some by sellnig the byproduct of ethanol production, distiller dried grains (DDGs), Still overall profit margins are low and according to the CME Group "most [ethanol producers] are barely profitable at present and some are already losing money. The profit risks remain high for ethanol producers if corn continues to rally."
Needless to say, at this point I would stay far away from investing in any company that produces ethanol in CAPS and especially in real life.
Deej
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