|Shares Out. (in M):||42||P/E||0||0|
|Market Cap (in $M):||800||P/FCF||0||0|
|Net Debt (in $M):||431||EBIT||0||0|
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Green Plains (GPRE)’s stock price has declined YTD into the teens; at this level, GPRE trades at 1.1x tangible book value. At its market cap of $815 mm, GPRE is valued significantly below the private market value of GPRE’s assets and trades at a 24% free cash flow yield to equity on normalized crush margins. In addition, through strategic vertical acquisitions, GPRE is expected to generate $150 mm of stable non-ethanol related EBITDA (45% of total EBITDA), lowering the volatility of GPRE’s earnings profile. We’ve been in and out of this stock over the last several years and didn’t think the price would get into the teens again. The current share price provides an excellent entry point with multiple catalysts on the horizon that we believe will result in a significant re-rating.
The cause for GPRE’s depressed stock price has been the weak ethanol crush margins. The reasons for the weak crush margin are explained in GPRE’s recent Q2’2017 call (link: http://tinyurl.com/yap5ug8h) and summarized as follows:
1. Creeping uptick in ethanol supply led to overproduction
2. Weather related weak gasoline demand in H1 2017 lessened the need to draw down on ethanol inventory, leading to an unexpected increase in ethanol inventory
For a description of GPRE and its different business units, please refer to the attached presentation (link: http://tinyurl.com/y9bnhajm)
There are multiple catalysts for GPRE to re-rate to $30-40 per share in the near term, with multi-bagger potential through the implementation of a new DDG technology over the next 3 years.
1. Ethanol margins, while volatile, have averaged $0.20 per gallon over the past 5 years. This through-the-cycle margin makes economical sense in the backdrop of ethanol assets transacting for at least $1 per gallon of capacity, implying a return on capital of ~15-20%.
2. Recent industry discipline has increased optimism that we will see a return of ethanol margins to their historical levels.
3. Continued increase in domestic ethanol demand as the number of E15 c-store sites grows. Since E-15 started in 2013, the number of E-15 sites has grown from 38 to 920 as of Q2’17 and is projected to increase to 2,000 over the next 12 months.
4. Continued growth in exports, driven in part by the recent regulations in Mexico to increase its ethanol blend target to 10% for the majority of the nation.
5. The financial contributions from GPRE’s vertical acquisitions in its Food & Ingredients (F&I) segment will be fully realized in 2018
6. GPRE’s agribusiness and energy services segment will receive a much greater contribution from its trading segment in H2’17
In addition to the above catalysts, we believe the following factors, while difficult to predict the timing, serve as further upside that’s not accounted for in our valuation.
A. China returns to US ethanol export market. In 2016, China imported 267 mm gallons of ethanol from the US, representing 24% of US ethanol exports and in 2017 through June, China has not imported any US ethanol. Known to be an opportunistic buyer of ethanol, China also recently announced its intention to create a E10 standard fuel.
B. RVP waiver that would make E15 to a year-round fuel; it could not only be the impetus to raise the avg. ethanol blend in the US from 10% to 11%, leading to an increase of 1.4 bn gallons of incremental ethanol demand, but also increase the supply of available RINs, which would help reduce RIN prices.
C. Further value creation from strategic M&A that utilizes Green Plain Partner’s lower cost of capital. For instance, GPRE lowered the cost of acquiring Abengoa’s ethanol assets from $1/gallon to $0.64/gallon because of GPRE’s ability to drop-down related logistic assets to GPP.
D. Implementation of a new technology that would convert 20% of the DDG by-product into a high-protein variant comparable to soy protein. Such an investment would increase GPRE’s EBITDA by ~$180 mm as soy protein sells at a $200/ton premium to DDG and would cost $400-500 mm to install in all of GPRE’s plants over a 3-year time period, implying an 40% ROIC. This technology is currently being installed by Flint Hill at its Fairmont plant.
E. GPRE’s leadership in algae technology. GPRE’s mgmt. is optimistic about its BioProcess Algae venture; GPRE has spent ~8 years advancing research on this technology, increasing its ownership from 50% to 90% in the process. Furthermore, as part of the Abengoa plants acquisition, GPRE obtained state of the art algae research facilities that will spur further development. Over the next couple of quarters, mgmt. expects to present the size and scope of this opportunity.
F. Value of GPRE’s GP units in GPP. Based on projected GP incentive distributions of $1.4 mm after the Jefferson & Little Rock projects and a market multiple of 20x for GP cash flows, we believe the GP units are currently worth $30 mm. Additionally, based on GPP’s stated annual target of “high single digits, low double-digit kind of long-term distributions growth”, the GP units would reach the top tier of its IDR structure by late 2020; at that point of time, GPRE’s GP units could potentially be worth $150 mm.
G. Tax reform. As GPRE is a full rate U.S. tax payer, any meaningful reduction in the corporate tax rate would benefit GPRE.
Valuation: We value GPRE in a sum of the parts valuation using the assumptions laid out below and arrive at ~$40/share in our base case scenario.
Ethanol production: Assume 95% plant utilization and through-the-cycle average net crush margin of $0.20/gallon, less transportation fees of $0.05/gallon and marketing fees of $0.02/gallon, valued at 7x
Food & Ingredient: 2018E pre-tax cash flow of $38 mm from Cattle Feedlot valued at 6x and 2018E EBITDA $32 mm (high-end of guidance) from Fleischmann’s valued at 10x (multiple paid by GPRE)
Agribusiness and energy services: EBITDA (high-end of guidance) of $35 mm less $7 mm of interest expense associated with its working capital line, valued at 6x
Green Plains Partners (“GPP”): 2018E dividend per share of $1.85, incorporating the contributions from Jefferson and Little Rock terminal projects, capitalized at 8.5% dividend yield
Corporate: $40 mm of corporate expenses capitalized at 8x
Excludes $350 mm of working capital debt as the operating expense of utilizing the working capital lines is allocated to the cattle feedlot (currently $150 mm, growing to $300 mm due to the Cargill feedlot acquisition) and agribusiness segments ($200 mm)
Assume $170 mm of the ’22 convertible notes and $64 mm of the ’18 convertible notes are converted into equity ($28 and $21 conversion price, respectively)
Share count: Shares outstanding increases by 8 mm shares as part of the conversion of convertible notes
In our downside valuation, we value GPRE’s segments based on the following assumptions and arrive at $30/share.
Ethanol production: Liquidation value based on $0.8 per gallon of capacity, the 5-year average transaction multiple. However, it is important to note that this multiple is lower than the current market clearing price. GPRE’s CEO recently mentioned that that are no willing sellers at $1 per gallon of installed capacity. Especially considering that GPRE assets are much better situated with scale and utilize state of the art technology superior to the average ethanol plant and that average newbuild costs are $1.7-$2.0 per gallon, we believe the liquidation value to be extremely conservative.
Food & Ingredient: Cattle Feedlot based on its invested capital of $65 mm. Fleischmann’s generates $28 mm of EBITDA (low-end of guidance), valued at 8x multiple
Agribusiness and energy services: $30 mm (low-end of guidance) less $7 mm of interest expense associated with its working capital line, valued at 6x
Green Plains Partners: Based on GPP’s market value
Industry structure and discipline
Currently, the top 5 companies hold a 44% market share vs 37% 5 years ago. This is in part driven by GPRE’s consolidation efforts. The firm has more than doubled its ethanol production capacity from 740 mm gallons to 1.5 bn gallons through opportunistic acquisitions of assets at cheap prices, ranking as the 2nd largest ethanol player on a consolidated level. GPRE expects to continue to consolidate the market and increase its asset base to over 2 bn gallons in the next 3-5 years.
In 2016, GPRE added 150 mm gallons of capacity through its publicly announced de-bottling projects. The rest of the industry copied GPRE and engaged in similar low-cost de bottlenecking projects. Thus, the industry unexpectedly grew 4-6% of capacity and coupled with the impact of bad weather in the first half of 2017 that lowered gasoline demand, caused crush margins to decline into negative territory in the 2nd quarter.
As a result, GPRE in May’17 made decisive capacity cuts in response to the over supply; it idled 50 mm gallons of capacity for a month. Thus, as ethanol inventories tightened from 966 mm gallons back to its historical range of 900 mm gallons, crush margins subsequently increased by $0.15/gallon. GPRE’s leadership demonstrated that actions from the large ethanol players can significantly impact the ethanol market and that the demand-supply balance can quickly be brought back in-line.
In a sign of further industry discipline, ADM and GPRE announced their intention to re-purpose an aggregate of 150 mm gallons of capacity away from ethanol to beverage/industrial alcohol (Peoria plant for ADM and York plant for GPRE). These two plants represent a permanent reduction of 1% of industry capacity
Domestic ethanol demand
Domestic ethanol demand in H1 2017 was lower than demand in 2016 because severe weather limited gasoline demand (82.7 bn gallons of gasoline ’17 YTD through July vs 83.1 bn gallons over the same time period a year ago). While weather is a volatile factor that impacts domestic ethanol demand, we believe that the growing adoption of the E15 fuel provides a secular driver to increase domestic ethanol demand.
Industry participants expect E15 adoption to increase from 900 retail sites today to 2,000 sites over the next twelve months. Auto makers have explicitly approved the use of E15 in more than 70% of 2016-2017 models sold in the US and c-stores with lower cost E15 fuel are attracting more customers. Hence, this incentivizes competing corner stores to install E15 as a competitive response. For example, QuikTrip in Q1’17 announced its decision to sell E15 fuel across all its Dallas stores in response to Murphy USA. The ~1,100 increase in E-15 sites is expected to add an additional 100 mm gallons of ethanol demand.
Hypothetically, if we assume that the ethanol blend increases from 10% today to 11% as a result of growing E15 adoption, the increase would result in annual ethanol demand of 15.8-16 bn gallons up from 14.1 bn gallons in 2017 (depending on gasoline growth assumptions). Even if one accounts for ~1% annual production increases, the demand from a 11% blend level would match annual domestic ethanol production. With ethanol export demand of 1.3 bn gallons, this would leave the industry short.
Finally, US gasoline demand growth is expected to remain strong. EIA’s Short-Term Energy Outlook estimates gasoline demand in 2018 to be 143.6 bn gallons, up 0.4% YoY from estimated 2017 levels. This growth is supported by continued strong new-car sales data in the US (2017 SAAR revised up to ~18.47 mm) and the fact that gasoline-hungry truck/SUV represented 61% and 64% of vehicles sold in 2016 and YTD 2017 through July, respectively.
Domestic ethanol supply
The ethanol industry underestimated the amount of capacity creep that resulted from de-bottlenecking efforts. Run-rate production in 2017 increased to 15.8 bn gallons, up ~4-6% vs. 2016 levels. But, going forward, there will be headwinds that limit future supply growth. First, ADM’s and GPRE’s permanent capacity removal mentioned above reduced capacity by 150 mm gallons. Second, the de-bottlenecking projects that were available now cost a lot more compared to those from 1-2 years ago. GPRE CEO mentioned that “there was a lot of low-hanging fruit in the debottlenecking in the $0.1, $0.15, $0.2 [per gallon range]; today, some of the projects are $0.6-$0.7 per gallon and we’re not going to invest capital at these higher costs to increase capacity.” Hence, GPRE estimates that the industry capacity growth creep will be at a manageable 1-2%, rather than the 4-6% the industry recently experienced.
Domestic regulatory developments
The drive to shift the point of obligations downstream has lost steam as well as the hope by some participant that the EPA may consider counting ethanol exports toward the annual ethanol volume mandates. GPRE stated that these considerations did not gain momentum because 1) it would be a logistical nightmare to keep track of RINs associated with exported ethanol; 2) foreign countries would view the RINs associated with exports as subsidies, and 3) tracking thousands of retail locations versus a few refineries would be prohibitively complex.
A more positive regulatory development would be a waiver to the RVP. Currently, the EPA RVP regulation limits E15 sales during summer months. While a legislative passage of a RVP waiver appears to be stalled due to gridlock in Washington, there is the potential that the administration could issue a RVP waiver through executive order. GPRE mgmt. has strongly pushed EPA to consider this action, advocating that E15 provides greater octane and that E15 adoption would generate a greater supply of new RINs, which would help reduce the prices of RINs.
Exports of US ethanol have remained strong in 2017 through July, up 31% YoY, as both global gasoline demand and demand for cleaner octane enhancement continues to grow. The pollution benefits of using ethanol is twofold. Besides serving as an additive to motor fuel to produce cleaner burn, ethanol can also replace aromatic and olefin molecules or MTBE as blendstock to increase octane rating (which prevents auto ignition / “knocking”). Aromatics are carcinogens while MTBE (made from methanol) pollutes groundwater. In comparison, ethanol leaves little trace in groundwater because it can be easily broken down by bacteria in water.
The industry expects 2017 exports to come in at 1.3 bn gallons, a 15% YoY increase over 2016 levels of 1.1 bn gallons. Industry participants believe that 1.3 bn gallons of ethanol exports represents a stable base-line and that there is further upside from this level for several reasons.
First, in Mexico, the Energy Regulatory Commission approved the use of 10% ethanol blends, up from 5.8%, in all but three cities (Monterrey, Guadalajara, Mexico City). MTBE is presently used as the primary source of octane and Mexico wants to phase out MTBE because of water pollution concerns. GPRE believes that the Mexico export market can grow to 250-300 mm gallons over the next 3 years. Because Mexico is a direct neighbor south of the United States and existing rail infrastructure can support exports to Mexico, it is expected that this export opportunity would quickly ramp up.
Second, China has not imported any US ethanol in 2017 vs 180 mm gallons in 2016. China has recently announced its intention to create a E10 standard fuel; this policy will generate an additional ~3 bn gallons of ethanol demand. Currently, China’s gasoline demand is ~36 bn gallons, requiring ~3.6 bn gallons of ethanol to meet the mandate, and the nation can currently only produce ~800 mm gallons of ethanol. Hence, GPRE thinks it’s quite likely that China will return to the ethanol import market, albeit in an opportunistic way.
Below is a summary of the different nation’s current target blend, the realized ethanol blend, and the future target blends.
The most recent WASDE USDA 2018 price forecast for corn was $2.8-3.6 per bushel compared to $3.5 currently. Furthermore, while farmers planted more soybean than corn this year, GPRE expects that next year, the acreage dedicated to corn will increase because of the customary crop rotation from soybean to corn. Hence, the price of corn is expected to be stable.
FOOD AND INGREDIENTS
GPRE’s Food and Ingredients segment is comprised of 1) Fleischmann’s and 2) cattle feedlots. GPRE entered into these businesses through strategic vertical acquisitions, as vinegar production and cattle feedlots are businesses that are users of the production from its core ethanol business.
GPRE acquired Fleischmann’s Vinegar in Oct’2016 for $250 mm, obtaining a non-cyclical, high margin, and stable 3% growth business with high customer switching costs that can serve as a platform for future acquisitions. The primary raw material in vinegar production is food grade ethanol from an ethanol plant. Over a 40-hour period, Fleischmann’s is able to turn food grade ethanol into vinegar in its plants. Fleischmann’s sells a range of food-grade industrial vinegar to a variety of loyal blue-chip customers. Fleischmann’s is expected to generate $28-32 mm of EBITDA in 2018, which would bring the acquisition multiple down to ~8x. Additionally, GPRE expects to spend $12 mm to pursue the high-growth apple cider vinegar and antimicrobials categories.
The cattle feeding business vertically integrates with the ethanol business as cattle feeding utilizes the dried distiller grains (DDG) and corn oil that are byproducts of the ethanol production process. On its Q1’17 call, GPRE mgmt. stated that the feedlot would utilize 0.3 -0.4 mm tons of DDG out of the 4 mm tons produced from its ethanol production process.
With capacity of 255K heads, it ranks as the 4th largest cattle feeder in the US. GPRE has invested $65 mm of capital into this business; most recently, it acquired 155K head of capacity from Cargill for $37 mm. Based on $250 per head of capacity, GPRE’s cattle feeding operation is worth at least $65 mm on an asset replacement value.
On an operating basis, this business is worth $120 mm - 220 mm, based on a 6x multiple on $20-36 mm of annual pre-tax cash flow. For each head, GPRE generates a margin of $60-90; in 2016, GPRE generated a margin of $80-90 per head. Because the cattle turns over twice a year, GPRE can market ~500K of cattle annually. As part of the operation, GPRE has in place a $300 mm working capital line that costs L+270 to absorb the working capital swings. This segment’s EBITDA will grow from $20 mm in 2017 to $30-50 mm in 2018 as it transitions from feeding Cargill’s cattle in the feedlots that GPRE acquired to purchasing company-owned cattle.
While cattle feedlots can be a volatile business, GPRE believes it can manage the feedlots in a more disciplined manner than the industry can through its comprehensive hedging program, ability to pass on cattle when feeding margins swing negative, and its strategic and stable relationship with Cargill (7 year off-take agreement to supply Cargill Meat Solutions with cattle). GPRE mgmt. “calculates the cattle crush margins and make decisions according to returns and profitability” before it buys feeder cattle. Furthermore, this segment represents a cheap way to bet on our macro thesis that the world is short on beef protein because of China’s increasing desire to consume beef.
AGRIBUSINESS & ENERGY SERVICES
GPRE’s Agribusiness and Energy Services segment originates and trades the raw materials that GPRE utilizes or produces. These include grain procurement, grain storage, and the marketing and distribution of ethanol & DDG. By purchasing its corn directly from farmers (60% currently vs 15% several years ago) rather than through intermediaries, GPRE reduces its costs. In addition, by increasing its grain storage capacity to 45+ days, up from 10 days 7 years ago, GPRE’s agribusiness can opportunistically buy corn at cheap prices.
On an annualized basis, this segment is expected to produce $30-35 mm of EBITDA and $23-28 mm of pre-tax cash flow after incorporating the $7 mm interest costs associated with the segment’s $200 mm working capital line. In 2017 YTD, this segment only generated $11 mm of EBITDA because of the required accounting valuation re: fully-hedged merchant inventories. GPRE anticipates that the profits of these inventories will be fully realized in Q4’17, lifting the agribusiness segment to a full-year EBITDA of $30-35 mm. The CEO noted that GPRE had historically seen similar quarter to quarter moves in which profits were fully recoverable in subsequent quarters; hence, he expects the same for this year. This business is expected to reliably produce this level of cash flow managing GPRE’s internal needs with minimal value-at-risk.
GREEN PLAIN PARTNERS
Green Plains Partners is a MLP formed by GPRE to be GPRE’s primary downstream logistics provider of storage and transportation services. GPP completed the IPO of GPP in July 2015; currently, GPRE owns 64.5% of GPP. GPP’s assets include 39 ethanol storage facilities, 8 fuel terminals, and 3,100 leased rail cars that are used to transport ethanol from GPRE’s plants to refineries and export terminals.
We believe that GPP provides GPRE with a competitive advantage in acquiring ethanol plants because GPP allows GPRE to capture the economic value of the logistics assets that are associated with the ethanol plants. For instance, in GPRE’s $237 mm acquisition of Abengoa plants (capacity of 236 mm gallons), GPRE dropped down the plants’ associated storage and logistics assets and received proceeds of $90 mm; this dropped GPRE’s effective purchase price from $1/gallon to $0.62/gallon.
Finally, GPRE’s IDR is projected to produce $1.5 mm of cash flow, assuming the contribution of the growth projects below. Based on market multiple of 20x for GP stakes, GPRE’s GP stake is worth $30 mm. In addition, we expect the GP units to reach the top tier of its IDR structure by late 2020 based on GPP’s stated target of 10% annual distribution growth; at that point of time, GPRE’s GP units could potentially be worth $150 mm.
Growth projects: The completion of the Jefferson and Little Rock projects will increase GPP’s EBITDA by $7 mm and increase its DPS from $1.74 per share to $1.85 per share in 2018.
Jefferson Terminal: GPRE is partnering with Fortress Transportation & Infrastructure (FTAI) in a 50/50 JV to build an ethanol logistics terminal in Beaumont, Texas. Because of the size of the project, GPRE is funding $27.5 mm for its share of the project and will drop the completed project down to GPP for $45 mm once the contracts are secured. Jefferson Terminal is expected to be completed in October 2017 and is expected to generate $5-7 mm of EBITDA for GPRE’s share.
Little Rock Terminal: GPP is partnering with Delek in 50/50 JV to construct new terminal in Little Rock, Arkansas for $3.5 mm (GPP’s share). The Little Rock terminal will have access to 2 Class 1 railroads and enter into 5-year agreements with customers. Little Rock terminal project is expected to generate $1 mm of EBITDA for GPP.
HIGH CASH FLOW GENERATOR
Assuming normalized crush margins and 100% consolidation of GPP, GPRE should generate EBITDA of $333 mm and free cash flow of $222 mm. $152 mm of EBITDA and $104 mm of FCF is projected to come from non-ethanol businesses. Market has not given GPRE credit for diversifying its cash flow to more stable segments.
Second, we believe GPRE’s normalized cash flow is higher than its normalized accounting profits because of the delta between maintenance capex and D&A in the ethanol segment. While maintenance capex for GPRE’s ethanol plants cost ~$15 mm per year, based on GPRE’s estimate of ~$0.01/gallon, reported D&A for the ethanol segment is ~$80 mm annually. The difference is because of previous growth investments, acquisitions, amortization of intangibles, and a quicker depreciation schedule.
Third, GPRE’s headline leverage is not representative of its true indebtedness because of its working capital lines. Of GPRE’s $1 bn debt (excl. GPP), ~$350 mm is in the form of working capital - $200 mm in the Agribusiness & Energy segment and $150 mm in the cattle feedlot business (the cattle feedlot working capital line would expand to $300 mm as part of the Cargill acquisition). In our analysis, we incorporated the interest expense on the working capital lines as an operating expense; thus, we value the agribusiness and cattle feedlot units based on a pre-tax cash flow figure. Currently, secured debt on the ethanol plants is ~$0.2/gallon. If the convertible notes are included, GPRE’s ethanol plants have debt per installed capacity of $0.35/gallon, lower than debt per installed capacity of $0.54/gallon 5 years ago. Although GPRE seems leveraged on headline numbers due to the working capital lines, its actual leverage is well below its historical metrics.
NEW DDG TECHNOLOGY
The potential of applying a new DDG technology to GPRE’s ethanol plants could be significant. GPRE would generate $180 mm of incremental EBITDA; capex would cost $400-500 mm and be implemented over a 3-year period through internally generated cash flows. In addition to the earnings increase, we believe this EBITDA contribution would be more stable and be valued higher than the core business. Assuming an 8x multiple, this would imply ~$1.4 bn of additional value for equity-holders or ~$28/share).
The market is discounting this possibility now and our valuation does not incorporate this benefit, but Flint Hill is currently implementing the technology at its Fairmont, Nebraska plant. Below is a summary description of the technology and a link for further information: http://tinyurl.com/ybdowxxv
The technology, called Maximized Stillage Co-Products (MSC), was developed by Fluid Quip Process Technologies specifically for the dry-mill ethanol industry. MSC is an innovative, bolt-on technology that separates and upgrades a portion of distillers grains into a cost-competitive, high protein feed ingredient. The high protein feed produced using MSC is a combination of corn gluten (protein) and spent yeast. The MSC-produced feed will have at least 48% protein making it an excellent ingredient for the aquaculture, pet food and poultry industries among others and will be marketed under the name NexPro. The Fairmont plant will be the fourth ethanol plant in the world to deploy the proven technology.
Regulatory developments that negatively affect ethanol
Development of new technology that increases ethanol production yields
Poor corn harvest
Delayed contract signings at Jefferson Terminal
Global gasoline demand
Undisciplined supply growth
We had long exposure to GPRE at the time of submission 10/13/17. We have no obligation to update the information contained herein and may make investment decisions that are inconsistent with the views expressed in this presentation. We make no representation or warranties as to the accuracy, completeness or timeliness of the information, text, graphics or other items contained in this presentation. We expressly disclaim all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained in this presentation.
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