Are Ethanol Stocks Good Bargain Buys?

Ethanol Stocks Are Poised to Refuel - Barrons.com

The article linked above from Barrons give some reason why ethanol stocks should rebound in price. There are a couple of points I find interesting:

• The stocks of the ethanol companies, VeraSun Energy (VSE) and Aventine Renewable (AVR) are trading at up to 30% less than the replacement cost of their ethanol plants.
• Congress renewed the Farm Bill, giving a 45¢ (reduced from 51¢) per gallon blenders credit and keeping in place a 54¢ tariff on imported ethanol. These credits/tariffs are good through 2010.
• Over 1/2 of the gas in the country is now 10% blended with ethanol and ethanol accounts for 7% of all of the “gasoline” sold.
• Blending with ethanol is an economic plus, reducing the cost of gasoline by about 10-15¢ per gallon at current prices.
• Ethanol companies remain profitable at $6.00 per bushel corn prices.

These are all positives for the ethanol companies, but the big worry now is the corn harvest and resulting prices. Ethanol production currently uses about 25% of the U.S. corn harvest and the recent weather events and harvest predictions are driving up corn prices, maybe to the point where ethanol production is no longer profitable. A short harvest in 2008 would come at the worst possible time for these companies.

A note here: One option for farmers who have washed out crops is to leave the land fallow and take government crop insurance payments. Note a positive for fertilizer companies.

My analysis of ethanol producers is this: Ethanol prices and corn prices are now linked. The ethanol producers are the major consumers of corn and will reduce production if they cannot stay profitable, causing corn prices to fall. The markets sense this, so you will not see the ethanol crush spread move into negative territory for an extended period. Either corn or ethanol prices will correct, or both, to allow ethanol producers some level of profit.

The challenge for the ethanol companies and stock owners is what level of profits can these companies obtain. Improved efficiencies, finding new markets and/or products and eventual conversion to cellulosic production will determine to future value of these companies.

At this time the stocks appear to be oversold, just on the value of their plants and could move up 20-30% on some good news. The next few quarterly earnings reports will show if they are reacting well to the current market conditions.

Note: I have a long position in VSE.

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Comment by Biofuelsimon

2008-06-11 04:46:26

The stocks may be trading at less than the replacement value of the assets in the ground, but may be that’s because the value (profit) that can be extracted from those assets is now considerably less than it was when the assets were installed.
I wonder if it would be a better recommendation to buy stock in the grain handling intermediaries between consumers and farmers?

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Comment by Tim Plaehn

2008-06-11 08:04:20

From what I am hearing and reading from the farm belt anyone connected with the crop is going to be hit this year. New post on my blog later today.

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Comment by Beanieb

2008-06-11 20:49:38

Pacific Ethanol (peix) is on my watchlist now.

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