Green Plains, Inc. Is Becoming One Of My Favorite Growth Stories
Source: By Tristan R. Brown, Seeking Alpha • Posted: Thursday, September 1, 2016
While lower-than-expected gasoline prices kept operating margins from being as high as had originally been hoped for, robust demand ensured strong sales volumes on high utilization rates.
The company’s management has had a busy summer, buying additional capacity while improving its export access and possibly expanding into the food ingredients market.
While I normally hesitate to maintain a position after this type of share price rally, Green Plains’ growth prospects are too good to pass up based on current valuations.
Green Plains, Inc. (NASDAQ:GPRE) reported Q2 earnings earlier this month that beat the consensus handily on both lines, capping a strong summer that was marked by a number of interesting acquisitions and investments with the potential to transform the company. Last May, I wrote that the company’s shares were attractively valued at the time at the price of $14.75 despite a recent rally. That rally has only continued to increase in strength since then as its share price has gained another 64% in the subsequent three months (see figure). This article re-evaluates Green Plains as a potential long investment opportunity in light of its recent share price gains and acquisitions.
Q2 earnings report
Green Plains reported Q2 revenue of $888 million, an increase of 19.2% YoY that beat the consensus analyst estimate by $84.1 million. The company has made a number of acquisitions in recent years and these are continuing to show up in its earnings reports in the form of production volume increases. It achieved record production in Q2 of 274.3 million gallons, an increase of 15% YoY. Co-product volumes also increased on the additional capacity: DDGS sales increased by 16.5% and corn oil sales increased by 3.5%, both compared to Q2 2015. The company’s earlier spin-off of its logistics assets in the form of the MLP, Green Plains Partners (NASDAQ:GPP), also contributed to capacity in the form of 274.3 million gallons of quarterly ethanol storage.
The company’s gross margin rose by a similar amount, improving by 15% YoY to $78.2 million despite an increase to cost of revenue from $676.6 million to $809.5 million over the same period. The ethanol segment’s gross margin fell sharply by 39% YoY as its consolidated crush spread fell from $0.20/gallon in the prior-year period to $0.17/gallon in the most recent quarter. This decline was more than offset by improvements to the other segments, however, especially from Green Plains Partners.
Operating income increased from $24.4 million in Q2 2015 to $27.4 million in the most recent quarter. This in turn drove a slight increase to net income over the same period, which rose from $7.8 million to $8.2 million, despite the lower consolidated crush spread. EPS improved from $0.20 to $0.21 YoY, beating the consensus analyst estimate by an impressive $0.31. The latter result was in part attributable to a 4% YoY reduction to the number of weighted shares outstanding as Green Plains continued to repurchase shares as a means of returning cash to shareholders.
EBITDA also improved over the same period, however, rising to $47.7 million from $39.3 million. Operating cash flow increased from $69 million to $84.7 million as well, showing that the improved earnings were due as much to its previous acquisitions as they were to the buyback program. The company ended Q2 with $386.9 million in total cash, up slightly from $383.4 million QoQ, despite a 1.1% decrease to its long-term debt over the same period.
Outlook
The broad production environment for ethanol producers was something of a mixed bag in Q2 as strong demand coincided with lower-than-expected prices. Management reported during the Q2 earnings call that national ethanol demand in 2016 through July had been 3% higher than during the same period of 2015. As I discussed in my previous article on the company, this development after years of stagnating and even shrinking demand is the result of persistent low energy prices since the second half of 2014, which has prompted drivers to spend more miles on the road in less fuel-efficient vehicles. The 10 vol% blend wall that threatened U.S. ethanol producers with a slow but steady volume decline for the foreseeable future as recently as 2013 has remained in place, but record gasoline consumption has made higher ethanol consumption possible despite this restriction.
Source: EIA (2016)
Rising demand at home has coincided with stronger demand abroad as well. The combination of the Paris Climate Accord last December and growing concerns in major metro areas about extreme air pollution has prompted developing countries to implement their own ethanol blending mandates. (While fuel ethanol is controversial as a means of reducing greenhouse gas emissions, there is little debate about its ability to reduce gasoline’s local pollutants such as emissions of carbon monoxide and particulate matter.) Brazil, which has historically had a cost advantage over U.S. producers as an ethanol supplier, is continuing to suffer from the effects of a multi-year drought that has hurt cane yields and pushed up sugar prices. Green Plains’ management reported that ethanol exports were up 6% in 2016 through July as well, and that they made up 13%, 16%, and 72% of its Q2 sales of ethanol, DDGS, and corn oil, respectively. Export volumes were down sequentially in the most recent quarter, although this was to be expected given that it coincided with higher domestic demand resulting from the onset of an especially busy summer driving season.
Management further expects that this strong demand in both the U.S. and international markets will lead to utilization rates at its facilities in the 90-95% range in the second half of 2016. Its Q3 volumes are largely hedged following the summer rebound to the price of ethanol, although its Q4 volumes are still heavily dependent on the spot market. At first glance, this is bad news for the company’s outlook given the recent decline to gasoline prices from July’s highs due to the persistent gasoline inventory overhang. Two factors help Green Plains here, though. The first is that ethanol continues to trade at a high premium to gasoline on an energy-equivalent basis compared to its historical average, a disconnect that benefits ethanol production margins. The second factor is that expectations of an especially strong corn harvest this autumn have caused corn prices to move sharply lower since June (see figure), providing further support for the ethanol crush spread. While a return to 2014’s high margins is unlikely, margins should continue to support positive earnings reports in Q3 and Q4.
US Gulf Coast Conventional Gasoline Regular Spot Price data by YCharts
Operating conditions have not changed all that much since May despite significant volatility. What has changed Green Plains’ outlook, however, are its acquisitions over the same period. Two are expected to occur and a third is possible, and all three together will both expand and provide much-needed diversification to the company’s asset base. The first acquisition is actually an investment in the form of a 50/50 joint venture with privately-held refined products terminal owner Jefferson Gulf Coast Energy Partners. Jefferson is a downstream logistics company that provides services for a number of Gulf Coast refineries, including storage and multi-modal terminals. Phase 1 of the JV will see it invest $55 million in import/export capacity at one of Jefferson’s existing petroleum and refined products terminals in coastal Texas. The resulting capacity, which will be able to handle multiple grades of ethanol, will be offered to Green Plains Partners as a potential dropdown.
The export capacity alone is enticing given the company’s increased access to international markets for ethanol sales. What intrigues me the most, however, is the access that this relationship could provide Green Plains to a refined products terminal. These terminals have become especially valuable in 2016 as Renewable Identification Numbers [RIN] prices have traded at record high averages (see figure). As I describe in an article published last week, terminals with access to refined products and ethanol that also possess blending capabilities produce separated RINs as part of their product stream. These RINs are, if owned by non-refiners, sold to refiners to create a valuable revenue stream. This is especially true now that every gallon of ethanol that is blended produces nearly $1 worth of RINs.
Source: EcoEngineers (2016).
While RINs are not mentioned as source of revenue in the Green Plains press releaseannouncing the JV, Jefferson Gulf Coast’s website mentions that its coastal terminal has the ability to blend cargoes to customer specifications. I would not be at all surprised if the JV announces ethanol blending and production of separated RINs as part of a future expansion phase as a result. There is no guarantee that ethanol blending activities will be as valuable in the future as they are now, of course, although the Environmental Protection Agency’s (EPA) May proposal to increase the corn ethanol blending mandate volume by another 2% YoY in 2017 has provided RIN price support over the last several months and will continue to do so if the increase is finalized later this year.
Green Plains also recently announced the acquisition of 236 million gallons of ethanol capacity in the form of three facilities from Abengoa SA (NASDAQ:ABGB) for $237 million, or roughly $1 per gallon of installed capacity. This is a relatively steep price, especially in relation to the company’s own previous acquisitions of capacity from other producers. The Abengoa facilities offer a number of competitive advantages that increase their value to Green Plains, however. First, the sale is driven by the seller’s unprofitable European operations rather than poor returns at the facilities, and Green Plains’ management expects a seamless transition when the deal closes with no production disruptions. Second, two of the facilities being purchased are located on the Mississippi River and will have barge connections to the JV’s terminal in Texas, further expanding the company’s access to the international markets. Finally, the third facility supplies the industrial ethanol market, providing product diversification as well. The transaction will make Green Plains one of America’s largest ethanol producers with 1.5 billion gallons of capacity, and the company has sight on becoming the largest given the potential for further consolidation in the industry.
The third transaction is the most unique of the three. On August 9, Green Plains announced that it had signed a non-binding letter of intent to buy an unnamed food ingredients company for roughly $250 million in Q3. The market’s initial reaction was very negative, with the company’s share price plunging at one point by 10%, although it has since regained all of the lost territory and then some (see figure). It is difficult to say much about the income potential of the proposed acquisition given a lack of details to date: the company has only said that the acquisition would give it access to the food and feed market while complementing its ethanol operations.
A lack of details aside, it is worth noting that management’s past track record with acquisitions has been solid, with the company achieving attractive purchase prices while only pursuing assets that fit within its broader operations. I consider the most likely candidate to be a corn processing company that would expand Green Plains’ product base – sweeteners, perhaps? – without requiring it to participate in a new feedstock market. Any type of corn product diversification is a positive at this time, especially given current corn prices.
Valuation
The consensus analyst estimates for Green Plains’ earnings in FY 2016 and FY 2017 have rebounded strongly over the last 90 days as the crush spread has remained in positive territory and ethanol demand has continued to improve. The FY 2016 EPS estimate has increased from -$0.31 to $0.01 while the FY 2017 estimate has increased from $1.31 to $1.40. Similarly, the FY 2016 and FY 2017 EBITDA estimates of $145.8 million and $229.5 million have also improved over the same period. This has coincided with the strong rally in the company’s shares and their valuation has also increased at the same time (see figure). That said, while the company’s shares are not nearly as attractive on a forward basis as they were in Q1, they are not especially overvalued either.
GPRE PE Ratio (Forward 1y) data by YCharts
Conclusion
Green Plains, Inc. has treated its investors to outsized returns since May as robust domestic and international ethanol demand allowed it to generate unexpectedly high earnings in Q2 despite the continued presence of low gasoline prices. Management has not been idle in the meantime, announcing three important acquisitions and investments since June that have the potential to quickly be accretive to earnings while also diversifying the company’s portfolio of products. Of the three, I find the JV with Jefferson Gulf Coast Energy Partners to be the most intriguing given its export access and potential blending operations. Analysts now expect the company to generate its highest EBITDA since 2014 next year as a result even though ethanol prices will almost certainly be below their previous highs. Green Plains continues to be an attractive growth story, and it is rapidly becoming one of my favorite growth opportunities in the renewable energy sector. I encourage existing investors to maintain their holdings despite the recent share price rally given the potential for continued earnings growth in the coming quarters.