Archive for the 'Finance' Category

 

Efficient Markets and Ethanol Spreads: Pacific Ethanol

Mar 27, 2014 in Finance

update: $20MM in debt paid down disclosed in the CC should read $10MM. I am expecting them to use warrant proceeds to help pay down debt based on guidance provided for debt management.

I find this post to be quite ironic considering my last post was on efficient markets.

Pacific Ethanol is my second ethanol investment, after investing with GPRE, but by far my largest position on the market. I picked up PEIX late in December and added more in January. I have been trading around this position at opportune times. PEIX is an ethanol company located in the west coast, which is a minority among ethanol producers who typically locate themselves close to the corn fields of the midwest.

They have four plants:

Item Madera Facility Columbia Facility Magic Valley Facility Stockton Facility
Location Madera, Ca Boardman, Or Burley, ID Stockton, Ca
Opening Q4 2006 Q3 2007 Q2 2008 Q3 2008
Status Idle – Q2 2014 Operating Operating Operating
Capacity 40 40 60 60
Primary Energy Natural Gas Natural Gas Natural Gas Natural Gas
Estimated WDG Capacity 293 293 418 418

Their total capacity comes in at around 160MM gallons per year with the idled plant but following Q4 2013 , they announced it will reopen for Q2 2014 bringing their active capacity to 200MM gallons.

The ethanol industry is highly volatile and since the bumper corn crop of last summer ethanol margins have exploded. PEIX earned $0.55 EPS in Q4, on the backs of historically low feedstock costs, higher co-product revenue and a higher premium than normal for west coast ethanol. Traditionally the ethanol industry has had to rely on the RFS, and last year when the EPA lowered the mandate amount the industry’s stock price fell into a free fall. However, the market currently is trading independently of government subsidies and is enjoying some of the best margins in their history. PEIX recent history is quite dark, they have gone bankrupt and are currently in the process of buying their plants back from their bondholders. In December they increased ownership to 91% and I suspect on the back of their current FCF they will buy the remaining portion out this quarter. Due to this, they literally cannot afford to hedge production. GPRE and REX both had relatively disappointing earnings for Q4 from their hedging activities and all indications point to further hedging losses in Q1.

Pacific Ethanol being on the West Coast traditionally means they have to pay a larger amount for corn shipping. They have averaged about $1.15-1.30 per bushel in shipping costs, and as of Q3 have started to pay a basis. At last check the basis for Q1 was $0.37. This is somewhat offset by higher west coast ethanol pricing of 20 cents, but as of Q4 this premium has ballooned to about $1 per gallon providing huge windfall profits. This is increasing their margins significantly and is due primarily to congestion in the train infrastructure caused by weather and Bakken oil production. Midwest suppliers are wary of shipping ethanol to the coasts because there is risk they may not get those rail cars back, allowing the west coast basis to persist. New capacity in light of the transportation infrastructure and memories of the overcapacity of the 2008/2009 boom will not be likely any time soon, with no producers making any announcements.

 

PEIX is however in a fairly unique position. Due to its bankruptcy, 9% of its capacity is still owned by its bondholders and can be purchased back for $0.32/gallon, representing a huge discount to actual new capacity which would cost somewhere around $2.00/gallon. They also have the idled Madera plant which will go from a $1.5MM expense to adding $10MM EBITDA. This is assuming $0.30 gallon margin, which you will see shortly is not very representative of the current environment.

I have put together a model comparing past earnings to projections based on PEIX’s reporting and current pricing from the USDA/CBOT. The model is not very well organized but captures all of the data I have gathered and shows projections going out for the next two reporting periods. I assumed 0.1mcf of natural gas per gallon that I got from CARD. I understand that PEIX uses much less gas due to the production of WDG, however this number seemed to be a fairly good number to be representative with past earnings periods. The first thing you will notice is that the revenue and COGS are much lower for estimate periods. This is because I stripped out their third-party distribution business and focused only on internal production. The assumption here is that it is cash flow positive, and historically they make over $4MM on this business so that is conservative.

March 28 PEIX Earnings Model

March 28 PEIX Earnings Model

You will see that current earnings are certainly astronomical. I made certain assumptions due to warrant exercising, as at current prices they will all be in the money. As long as PEIX hasn’t hedged production, based on current corn and natural gas prices they are making record profits that for the current foreseeable future are sustainable. There are risks such as the situation in Ukraine affecting corn pricing, Brazil changing blending limits and the domestic rail network, but even if current margins get cut in half this will be a record year for PEIX. If current YTD margins stay in stable, PEIX is looking at $8 EPS which would price the stock at a severe discount of 1.5X PE. Taking a more realistic stance and assuming that margins retrace back to late 2013 pricing, $4EPS is certainly in play.

I look forward to comments, as I have a hard time understanding the current trading of PEIX equity given the publicly available information, and what management disclosed in the Q4 call ($20MM debt payed down YTD as of the third week of February). Management should be buying back shares at the current time, and managing dilution versus paying down debt. With their current earnings power, they should be able to negotiate much lower interest terms. Trading PEIX stock has been very good to me, and I nailed Q1 earnings, but recent trading action has been very difficult to understand given the reaction on Q4 earnings. I believe that on confirmation of Q1 earnings, PEIX should deserve a higher multiple and should start seeing sell-side analyst coverage. Will the market notice before then?

 

Disclosure: I am a CFA institute member, and a professional engineer in the energy field. I am long PEIX stock, options and/or ethanol futures. I was not paid to write this article and it was purely an exercise in training. This does not constitute investment advice and should not be taken as such.

 

 

 

 

 

 

 

 

 

Efficient Market Hypothesis … people will always have to learn the hard way

Oct 07, 2013 in Electronics, Finance

In 2006/07 I started my journey into the financial markets that led me into learning about options, futures and foreign exchange; eventually into taking the CFA program. That journey started with AMD and a study that we had to do for school. That was a time when AMD was running on all cylinders. They were taking server market share, leading on the 64-bit transition and had a general cost advantage over Intel. Major PC makers were moving from Intel only shops to support both companies.

What is did not understand was that the market prices in all of these news topics, and unless I had information that the market had I was just buying a fairly valued stock. If I had predicted their new processors would dominate the market and steal market share, that would be different and I would be able to profit. Once the news is out and the trend is out, people can easily figure out at consensus forecast that prices in the most likely outcome.

Two things happened that were not priced in:

1) AMD bought ATI, a company worth equal to its own market capitalization at the time. They bought it for strategic reasons that were long term, and correct but they could not predict that shortly after the financial markets would be in turmoil just after. They had high debt, no profits, and a terrible environment to raise new capital. They sold off most of their fabrication capacity at very discounted prices.

2) Intel offered their customers financial incentives to discontinue the use of AMD processors. This was illegal and AMD later won the court case, but the damage was done. AMD lost market share literally over night, was forced to heavily discount their products, and this caused a serious financial problem for the company with the point above.

 

The reason I am bringing this up, is that over the weekend someone was pitching AMD and citing currently public information as reason to invest. This is a plan to lose money. Real investors take a position either short if they believe consensus to too high, or long if they believe that the underlying market trends are stronger than they currently forecast. This happens often, but the regular person who picks up investing does not have the skills to do the valuation models or is not informed enough on the underlying macro economic conditions. Their are other ways to do this such as long-short investments, but this is not what is normally talked about. Most of the “retail” herd simply invests in low dollar denominated stocks, and “trades” short term market oscillations.

As a ending to this article, I will play devil’s advocate and list the bear opinion on AMD.

1) AMD sold off their fabrication capacity, they have a long term disadvantage in that they no longer control the platform. Their are successful fab-less companies but they are in high margin markets developing niche products.

2) Europe (one of AMDs largest markets) is in tatters.

3)Interest rates are going up. Intel has no debt, and as such AMD is at a competitive disadvantage.

4)Windows 8 upgrade cycle is in progress and is priced in. New consoles are not significant profit drivers.

Don’t Understand the Media these Days…

Oct 07, 2013 in Finance

It was always my understanding that the media is supposed to present unbiased information and REPORT on the news. What consistently passes for news though, are opinion pieces tied to the beliefs of the underlying organization. Fox news being right wing and pretty much all other news outlets being mainly left wing. These reports focus on discrediting the other side and pushing their agenda, which is a shame that a developed country cannot make informed decisions without being pushed one way or the other. The BBC and RTT, IMO are a much better news sources than virtually anything out of North America.

The Republicans have said they will fully fund all of the current obligations in exchange to discuss FUTURE deficit spending. Oh, the unreasonableness of it all! People need to pull their political bias heads out of their butts and try focusing on the real problem that EVERYONE should be addressing – Deficit spending.

I do not understand how it has been 5 years since emergency spending has been put in, the economy is growing, yet we are projecting trillion dollar deficits several years out. I would just like to point out that Bush Jr, was chastised as an overspending war monger yet his deficit averaged a quarter of what we are seeing today and were more in-line with economic growth at the time. The deficit spending today is multiples of what recent democratic and republican presidents have run, yet there is a mainstream refusal to acknowledge the problem. The problem is that interest rates cannot be raised once a certain level of debt is increased without crushing public services… and low interest rates are robbing the retirees who cannot safely invest in higher yielding investments without jeopardizing their nest egg. IMO this is not about Obamacare (whose individual mandate violates individual liberties) but more about the greater debt problem. More spending is not the answer.

Cash on Hand – True Story…

Aug 11, 2010 in Finance

Lately, I have been reading on almost a daily basis of how cash on hand at corporations is going to start a string of M&A, rising wages, and get the economy going again.

A little history first. Back in 2008, the credit markets were freezing up, M&A collapsed and companies started feeling the pinch for liquidity as many of the corporate paper markets fell apart. Any company that could issue bonds or get loans did (Major deals come to mind are Goldman Sachs and Buffet), but those were companies with high credit ratings and they paid crazy rates for that capital.

Long Story short, the FED greased the wheels and the credit markets opened up and MOST companies went out and got some cash by issuing bonds and taking credit lines out of fear that when they needed the money they wouldn’t be able to get it.

Now fast forward to 2010.

Cash on hand at $1.72T and people are thinking that it’s going to be a spending spree. Kind of sounds like people feeling richer than they are with their home equity.  Truth is, if you borrow money because you feel that you need cash to protect yourself in case of a downturn…are you really going to just spend it and increase your balance sheet leverage? In the same report that states that cash on hand is $1.72T, it also shows that non-financial corporate sector debt has increased by $480 billion and now stands at $7.2T….Even more depressing is that Corporate debt net of cash has actually increased by about $200 billion since late 2008.

To simplify there has been no deleveraging in the corporate sector. Corporate debt net of cash stands at 37.6% of GDP, versus 36.7% in late 2008. It is also important to note that tangible assets have declined by 20% over the same period, furthering the dilemna.

So unless you though that corporate spending was going to prevent the economy from falling in 2008/2009…. your argument is even worse today. The FED’s attempts at spurring demand is also faltering. Every dollar is being used by consumers to deleverage, and rebuilt savings. The net effect is inflation/deflation combination in varying asset classes… notably food / housing.

Is it bad when the US cuts food stamps to fund public salaries? So let me get this straight… don’t cut taxes because people will just save it and the deficit is too high… but we can cut the food for the most desperate people so that states can balance their pensions for teachers unions? Prediction…private sector is going to riot at ridiculous public spending/salaries/pensions… which are much higher than what they get.