Ethanol Demand Stronger But Still Have to Take Wait And See Approach to the Stocks

May 30, 2008
Author: SCP Editor

May 30, 2008 – the Energy Information Administration posted end of March ethanol supplies held at production plants yesterday that totaled 11.391 million bbl, up 926,000 bbl, or 9 percent from the prior month. Production for the month increased by 2.362 million bbl with output from ethanol plants in the U.S. reaching 17.387 million bbl, or 561,000 bpd.

While the debate around first generation ethanol continues to swirl, we are seeing pretty impressive increases in implied demand. DTN Ethanol Daily reports that “Implied demand for ethanol jumped 1.486 million bbl or 47,935 bpd during March, with the data suggesting 17.038 million bbl or 549,613 bpd of ethanol supplied to market during the month. During the first quarter, implied demand for ethanol was 49.4 million bbl or 531,430 bpd. That compares with ethanol demand at 37.9 million bbl or 407,129 bpd during the first quarter 2007.”

Ethanol stocks have gotten a lift recently on Pacific Ethanol’s (Nasdaq:PEIX) better-than-expected Q1 earnings report which showed sales increasing 63 percent to $161.5 million on sales of 59.2 million gallons of ethanol, an increase of 57.9 percent from ethanol gallons sold Y/Y. The company beat the Street’s expectations, posting $0.06 per share earnings as opposed to the expected loss of $0.09 per share.

The problem that the industry is seeing though is that ethanol prices are actually declining while corn prices have increased. Our take is that if success of the ethanol industry is contingent upon keeping ethanol prices sufficiently high, it will continue to have a tough time competing at the pump against gasoline. On the other hand, if the industry can figure out how to bring ethanol prices lower and better control its production costs, it will win at the pump. This much is being proven in Brazil.

To be fair, Brazil’s feedstock, sugar cane, is much more cost effective than corn. We have persistently argued that if Congress is really serious about addressing higher gas prices and addressing what we think is a spurious criticism of the impact of corn ethanol on food prices, then it would give pause to consider eliminating the $0.54 tariff on Brazil’s ethanol. We doubt politics will get of the way though.

In the meanwhile, until the climate changes, we aren’t getting too aggressive with our accumulation of ethanol stocks, and we frankly see them lagging the alternative energy sector for the remainder of 2008. Names that we do like, and we are watching in this space include:

·         Aventine Renewable Energy Holdings (NYSE:AVR) recently reported a net loss for Q1, 2008 of $10.8 million, or $0.26 per share down from income of $3.3 million, or $0.08 per share in the Q4, 2007. Revenue increased 34.4 percent to $509.9 million on 211.2 million total gallons sold, compared to 176.2 million gallons sold in Q4 2007. The biggest problem for AVR is that corn costs increased to $4.50 per bushel, up from the $3.66 per bushel it paid in Q4, 2007.

·         The Andersons (Nasdaq:ANDE) recently reported Q1 earnings of $7.8 million, or $0.42 per share on revenues of $713 million, up on a Y/Y basis from income of $9.2 million, or $0.51 per share on $407 million in revenue. The grain and ethanol group’s income of $2.2 million was down from $10.2 million reported the earlier year , on revenues of $499 million, up Y/Y from $244 million.

It is pretty clear that despite rising demand and top line sales these businesses are just having a harder time making money. If margins are going to continue to get pinched, then maybe it will be more practical from an investment point of view to recalibrate trading multiples to much more modest levels, say 7-10x PE. But P/S in this sector is already astonishingly low at 0.10x P/S (ttm) to 0.18x P/S (ttm).