After a rough 2017 investors might have been hoping that things couldn't get worse for ethanol producers. Then 2018 happened. Last year, ethanol prices averaged their lowest selling prices since 2002 -- years before the United States started blending the renewable fuel into its gasoline supply.
That spoiled the operations of Green Plains (NASDAQ: GPRE) . While it began 2018 as the nation's third-largest ethanol manufacturer, it exited the year a peg or two lower. Management sold noncore assets and 20% of the company's ethanol production fleet, then used the proceeds to retire $495 million in long-term debt. The move should save enough in interest expense to tip the business into profitability, but there are still some questions that won't be answered until year-end results are announced.
Will this upcoming event show that this stock is a buy? Let's dig into the details.
By the numbers
Green Plains generates revenue and income from multiple products and services supporting ethanol production. The business also creates animal feed products (primarily byproducts of the overall ethanol production process), sells meat from its cattle feedlot business (one of the largest in the United States with 355,000 head of cattle), and generates income from an ownership stake in Green Plains Partners (a storage and transportation partnership supporting the parent).
Vertical integration has become a necessity for improving the margin structure of ethanol production. That was especially true last year. In the first nine months of 2018 the company's ethanol segmen t report ed an operating loss of $60.7 million, compared to an operating loss of $26 million the year before. High-margin products and services in the animal feed, food ingredients, and partnership segments allowed Green Plains to post an overall operating profit -- barely .
First Nine Months 2018
First Nine Months 2017
Operating cash flow less inventory change
Data source: SEC filing.
Of course, the slimmed-down business will look a bit different in 2019. Late last year, Green Plains sold off its high-margin vinegar business, which, alongside the cattle feedlot business, helped to generate $34 million in operating income for the food ingredients segment through the first nine months of 2018. Losing that high-margin income will hurt, but the company will save more in interest expense from paying off its term loans. Shedding 20% of its ethanol production will also help to shrink losses in the core segment.
The biggest improvements might arrive on the balance sheet. Here's how management last communicated the changes, with the pro forma results indicating the impact from recent transactions:
Sept. 30, 2018 (Pro Forma)
Sept. 30, 2018 (Actual)
Total long-term debt
Book value per share
Net debt to EBITDA
*NOTE: Comprising convertible debt and a revolving credit facility. Data source: Investor presentation.
Overall investors have to like the improvements in the table above, but investors will want to make sure these asset sales don't result in sharply lower EBITDA -- therefore hiking up leverage ratios -- going forward.
How does Green Plains compare to peers?
Despite the overnight improvements on the balance sheet, Wall Street hasn't changed its pessimistic outlook for the business. Perhaps analysts are waiting for clearer signals from management on what to expect in the near term, but they haven't updated their earnings expectations for the next 12 months. That much is obvious from a side-by-side comparison between Green Plains and its closest publicly traded ethanol-producing peers Archer Daniels Midland (NYSE: ADM) and Valero (NYSE: VLO) , notably in the price-to-earnings (P/E) ratios.
Archer Daniels Midland
Stock performance in 2018
Trailing P/E ratio
Forward P/E ratio
Price to book
0.65 (0.55 on a pro forma basis)
Enterprise value (EV) to EBITDA
Data source: Yahoo! Finance.
The comparison doesn't look pretty, but there are some very important caveats to note. First, Green Plains is likely to deliver improved earnings in 2019, which should result in a lower forward-looking PE ratio than what's in the table above. Investors should check back once analysts update their estimates.
Second, the EV-to-EBITDA ratio is calculated based on income statement and balance sheet metrics from the most recent quarter. That would be the third quarter of 2018 for all three companies, but Green Plains didn't pay off its term debt until the fourth quarter of 2018. In other words, that metric will sharply improve (lower is better) going forward as well, with a decent shot at leapfrogging its peers when the dust settles.
Third, comparing the stock valuations of the nation's top ethanol producers is never apples to apples. Green Plains is much more dependent on ethanol for its overall operating performance, whereas Archer Daniels Midland generates most of its business from agricultural materials and Valero is better known for its oil refining prowess. In other words, the comparison is really looking at businesses in three different industries -- and ethanol manufacturing might be the riskiest of them all.
This stock belongs on your watchlist for now
Transactions completed in the final weeks of 2018 will significantly increase the financial flexibility of Green Plains going forward. Management hopes that extra breathing room, coupled with a new focus on novel protein products , will help create a more sustainable business no matter the health of the ethanol market. While everything could transpire as planned, right now investors sure wish they had more detailed information on what to expect from operations in 2019 and beyond. That's why it would be best to wait until management provides full-year 2019 guidance when operating results from 2018 are reported later this winter. That could provide enough certainty for investors to make a move, or signal that more patience will be required.
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