|Shares Out. (in M):||33||P/E||0||0|
|Market Cap (in $M):||459||P/FCF||0||0|
|Net Debt (in $M):||3||EBIT||0||0|
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Green Plains Partners (“GPP”) is a little known, recently-launched ethanol MLP with stable, multi-year contracts with minimum guarantees for more than 80% of current distributable cash flow (“DCF”) and solid growth prospects from two acquisitions announced in the last two months. Despite these strong fundamentals, the Company’s misunderstood ties to oil and unrecognized near-term growth have resulted in a $14 price, or a 12% yield. Comparable MLPs trade in the 6-8% yield range even after the recent sector selloff. GPP is the baby that has been thrown out with the bathwater – low oil prices should be a tailwind for this Company and 2016 growth is locked in, with 2017+ growth likely. Execution on several fronts should draw more attention to the name in the near-term. We believe the stock is worth at least $23/share, with significant additional upside potential.
GPP is an ethanol storage and transportation MLP. It was launched in June 2015 from Green Plains Renewable Energy (“GPRE”), who retained roughly two-thirds ownership. GPP owns 27 storage tanks located at GPRE production facilities, and it collects a $0.05 fee on each gallon of ethanol produced by GPRE. All of GPRE’s production flows through GPP’s tanks before getting loaded onto railcars or tanker trucks for transportation to the buyers. The buyers are primarily fuel blenders. This storage business is three-quarters of GPP’s DCF. GPP’s remaining DCF comes from ethanol transportation using terminals, railcars and trucks.
GPP has contracts in-place with GPRE and other third-parties that guarantee a minimum EBITDA of more than $42M annually, which is >80% of current DCF. GPP has virtually no exposure to GPRE’s more volatile margins – GPP just collects this $0.05 toll for each GPRE gallon. GPP has committed to paying out at least $51M of DCF ($0.40/share) until June 30, 2018. As GPP acquires additional assets, minimum guaranteed volume levels will be revised upwards in-line with the additional capacity.
Why it is Mispriced
There are three reasons that we believe GPP is mispriced:
Misunderstood Ties to Oil
We believe low oil prices are generally a tailwind for GPP. This point is contentious and in our opinion misunderstood – even by some otherwise well-informed ethanol market participants with whom we have spoken. At a high-level, the sequence below represents our view of the link between low oil prices and distributable cash flow at GPP.
LOWER OIL PRICES à LOWER GAS PRICES à GREATER GAS DEMAND à GREATER ETHANOL DEMAND à GREATER ETHANOL PRODUCTION AT GPRE à GREATER STORAGE AND TRANSPORTATION AT GPP à GREATER DCF AT GPP
Lower oil prices mean cheaper gas, which leads to greater gas demand by US drivers. Octane requirements for engines call for 10% ethanol in our gas today – in general, 90% 84-octane RBOB is mixed with 10% 113-octane ethanol to get to our 87-octane gas at the pump (i.e., 90% * 84 + 10% * 113 = 87). In addition, the EPA’s Renewable Fuel Standard (“RFS”) mandate for ethanol blending also fixes ethanol demand at roughly 10% of US gasoline demand. Please see the appendix for further detail here. Thus, increases in gas demand imply increases in ethanol demand. In fact, both US gas demand and US ethanol demand are up 3% this year. The recently announced RFS mandates for 2016 suggest that US ethanol demand will be up again next year.
Industry wide increases in ethanol demand are good for GPRE – GPP’s primary customer. The more ethanol that is produced by GPRE, the more that is stored and transported at GPP, which drives up distributable cash flow.
The above discussion focuses entirely on the US oil/gas/ethanol ecosystem, which accounts for roughly 90% of the story. However, approximately 10% of US ethanol production is exported and low oil prices could negatively impact a small portion of this international demand. For example, some countries use substitute products to enhance octane, which are petroleum based and thus may be lower priced vs. ethanol. That said, ethanol exports are currently up 9% this year due to increased price competitiveness of US ethanol vs. substitutes as well increasing worldwide ethanol demand. Today, 80% of US exports go to countries with ethanol mandates in place – 40% to Canada alone. Long-term, global demand for ethanol is expected to grow 2-3% annually.
Unrecognized Near-term Growth Prospects
The June GPP IPO was originally slated to price between $18-$22, a 7-9% yield, but actually priced at $15/share, or an 11% yield. Management attributed this to both general MLP jitters as well as concerns around growth execution. Many MLP sponsors have a backlog of income-generating assets that can be dropped down from the sponsor to the MLP to provide growth. At the time of the IPO, GPRE outlined 200M gallons of debottlenecking/production capacity expansions to be realized over time (representing 20% growth in GPP volumes, at no cost to GPP), but had no other asset drop-downs to highlight.
We thought these growth concerns were short-sighted by the market. GPP held no debt on its books, and had revolver availability of up to $150M at an attractive L+175-275 bps rate to acquire drop down assets from GPRE. GPRE management stated explicit plans to acquire additional production capacity; its successful six-year track record of ten plant acquisitions totaling 790M gallons of capacity for $0.70/gallon lent credibility to this plan.
In fact, since the GPP IPO, GPRE has acquired two plants; in October 2015 and November 2015 they acquired the Hopewell (60M gallons) and Hereford (100M gallons) plants. This, combined with their debottlenecking actions, represents an incremental 360M gallons (35%) of production capacity. The guidelines for when these plants and the extra production capacity will be dropped down to GPP imply $0.47/share of distributions by Q416, which is 18% distribution growth from today’s $0.40/share.
There are numerous additional acquisition opportunities for GPRE/GPP to pursue. The market today consists of 213 ethanol plants, of which 146 are owned by companies outside of the top five players. The industry is extremely fragmented and there are strong scale advantages, so we anticipate a wave of consolidation over the next five years. It is worth noting that Valero, ADM, Pacific Ethanol and other players in the industry have also publicly commented that they believe there is a pending wave of consolidation.
It is our view that GPP is priced like an MLP that has no growth prospects despite recent acquisitions and a favorable growth environment going-forward. Today many MLPs are 4-5x levered, are forced to issue equity at unattractive prices to grow further and have already triggered their full IDRs. GPP currently has no debt, operates in a highly fragmented industry with strong scale advantages, and is partnered with a sponsor with an established track record of making smart, cheap plant acquisitions.
Lastly, GPP is cheap because it is largely unknown. It is a recent IPO, is small ($450M market cap with a $150M float), has low liquidity (around $1.5M traded a day), screened with a 0% dividend up until the end of November, and the management team has not actively marketed the Company. The IPO was primarily marketed to existing GPRE investors.
More on the Business Segments
GPP has four segments; ethanol storage (their most important segment), and three segments related to ethanol transportation: terminals, rail, and trucking. Base case summary financials from 2014-2016E are laid-out below:
Ethanol (53% of revenue and 74% of EBITDA)
GPP owns 27 ethanol storage tanks attached to GPRE’s ethanol production plants. GPRE pays GPP $0.05/gallon for each gallon that passes through the storage tanks and we estimate that EBITDA margins are about 85% in this segment.
GPRE has annual minimum volume commitments of 850M gallons per year, which represents $36M of EBITDA annually. Growth is primarily tied to additional capacity going on-line at GPRE, either through expansion at existing facilities or through acquisitions of new plant storage tanks. GPRE will produce 1.1B and 1.4B gallons of ethanol in 2015 and 2016 to be passed through the GPP storage tanks. The additional volume is tied to the GPRE debottlenecking capacity expansions (200M gallons, some of which is already turned on), the October 2015 Hopewell acquisition (60M gallons), and the November 2015 Hereford acquisition (100M) already discussed. These GPRE volume numbers imply GPP ethanol storage EBITDA of $40M in 2015 and $51M in 2016.
Terminals (13% of revenue and 18% of EBITDA)
GPP owns eight terminal facilities located near major rail lines. Ethanol travels by rail from storage tanks to these terminals. Ethanol is usually blended into gasoline at the terminal and then it is loaded onto tanker trucks for the journey to local retail gas stations or other end-use locations. Growth is tied to additional ethanol volumes transported by rail. GPRE and other third-parties pay GPP $0.0355/gallon for each gallon that passes through their terminal tanks and we estimate that EBITDA margins are about 85% for this segment as well.
At the Birmingham terminal, GPP has an annual minimum volume commitment of 33M gallons per year from GPRE, and minimum gallon commitments of 166M gallons per year from other third parties. These minimum volume commitments imply $6M a year in EBITDA from Birmingham. These contracts extend for another 2-2.5 years, with auto-renewals annually after that time.
At their other seven terminals, contracts have a variety of terms ranging from month-to-month to six months. Typically, about 110M gallons flow through these terminals annually at rates similar to the Birmingham terminal. In addition, GPP just announced an investment in a new terminal facility in Arkansas, which will cost $6M of capex in 2016 and is anticipated to generate $1M of EBITDA, beginning in 2017. Note that while these are small investments, the economics of these greenfield terminals are terrific – GPRE invested $16M in capex in 2012 for the new build of the Birmingham terminal and the terminal today generates roughly $6M in EBITDA annually. The consolidated terminal numbers imply GPP terminal EBITDA of $10M in 2015/2016.
Rail (33% of revenue and 5% of EBITDA)
GPP leases a fleet of 2,200 railcars, which are used to ship ethanol from the GPRE plant to the ethanol buyer (usually, a fuel blender) under take or pay contracts. These leases have an average term of 3.5 years remaining today, but GPRE anticipates re-signing the leases and re-upping their minimum volume commitments as the cars come up for renewal. GPRE pays GPP $0.0374/gallon for each gallon transported by rail. The 2015 minimum commitment and anticipated actual commitment is 66M gallons, which is about $3M of EBITDA. EBITDA margin is much lower in the rail segment because the lease expense is about 80% of the total revenue collected. Although rail demand should grow with GPRE’s ethanol volumes, we have modelled rail as flat from the 3Q15 run-rate.
Trucking (2% of revenue and 3% of EBITDA)
The last piece of revenue at GPP is trucking. This segment is around $2M of EBITDA in 2015 and $3M of annual EBITDA in 2016. As with rail, trucking demand at GPP should grow with GPRE’s ethanol volumes, but we have modelled trucking as flat from the 3Q15 run-rate.
On a relative basis, here are some of the comps that we believe are most similar to GPP. They are all transportation and logistics MLPs in the oil and gas space. There are no other ethanol MLPs, so these are the only relative data points that we have. Note that GPP has a favorable growth rate, capex spend, debt/EBITDA ratio and IDR position relative to the comps, despite a much higher yield.
Our base case scenario, only reflects growth from their debottlenecking efforts and 2 acquisitions already announced – nothing beyond that. Using a 9% yield implies a $23 price target by year-end 2016. Note that we have calculated the share price target using a 9% yield on the run-rate distributions, then added the cumulative cash collected per share over our investment horizon, assuming we invest in GPP and begin receiving distributions in 4Q15.
If GPP levers up to 4.0x at the end of 2016 to buy assets at 8.5x EBITDA (approximate IPO price), an additional $17M in DCF per year is created, using acquired EBITDA less incremental financing costs. At a normalized 7% yield, this leverage scenario implies a price target of roughly $36/share by year-end 2017.
· Downturn in the ethanol industry (for any number of reasons) threatens GPRE’s ability to pay GPP’s fees. However, GPRE/GPP contracts are non-cancellable outside of bankruptcy and GPRE debt is held at the sponsor level, meaning there is no ability for GPRE to put select plants into bankruptcy to void the associated GPP contracts. Additionally, ethanol margins aside, GPRE also produces corn oil and DDG alongside its ethanol production. Corn oil is roughly $0.04/gallon of EBITDA and DDG is roughly $0.03/gallon of EBITDA, which together cover GPP’s fee per gallon even if the ethanol industry is running at negative margins per gallon. Note also that GPRE has run at negative margins for only two out of twenty-eight quarters across $7 corn, $4 corn, $100 oil, $40 oil, etc. Across these twenty-eight quarters, GPRE has averaged $0.14-0.19 of EBITDA/gallon, depending on the date ranges, so $0.05/gallon (or $0.02/gallon net of GPP’s 66% distributions back up to GPRE) is generally comfortably paid to GPP.
· Extended downturn may impact utilization, which could reduce GPP’s distribution coverage. This is a real risk, but in the last quarter, we saw utilization very near the actual minimum guarantees and GPP still covered its dividend at 0.99x. This GPRE utilization was also the lowest since 2009 because GPRE was concerned about running at negative margins during the quarter.
· GPRE drops down acquisitions at high prices to GPP. The MLP tax advantage is so significant at GPP that GPRE can actually buy at $2/gallon (a level never seen at GPRE), push acquisitions down to GPP at 10x EBITDA and still have the acquisition break-even for GPRE and be slightly positive for GPP. We have found GPRE’s management team to be solid, so we are cautiously optimistic that these drop-downs will occur at reasonable prices to GPP. We note also that there has been a significant amount of GPP insider buying across several different insiders both in the IPO and after the IPO. GPRE is also, of course, the largest shareholder of GPRE.
· GPRE does not actually complete the second 100M gallons of new capacity. We believe that this will happen based on recent commentary and conversations with management. However, if it does not happen, it takes our distribution to $0.44/share in 2016, which is still a $22 price target and 10% growth from 2015.
We believe that the primary reason ethanol is used in our gas supply is due to octane requirements and not RFS mandates. Octane is necessary to ensure a controlled burn of gasoline in automobile engines – insufficient octane levels cause gasoline to combust too quickly, which voids automobile warranties and causes significant damage to the engine. Ethanol is the cheapest additive available to combine with 84 octane RBOB to get to the required 87 octane level in our gasoline supply. Ethanol also acts as an oxygenate, making for cleaner emissions levels which are required by the EPA. Note that EPA requirements for oxygenate require less ethanol than what is required to meet the 87 octane requirement, so the octane requirement is the primary driver of ethanol volumes in our fuel supply.
Many believe that the RFS mandate drives ethanol demand. We think the mandate is helpful, but not that important today. Historically, the mandate was crucial – the ethanol industry build-out would not have happened without the mandate and other government incentives. However, ethanol is now built-out and does not need government support to exist. High ethanol production volumes have reduced ethanol production costs to the point where it is consistently the cheapest additive available to blend with 84 octane RBOB to produce acceptable (87) octane gasoline. The RFS mandate levels, not coincidentally, have been set at roughly 10% of gasoline gallons consumed for the last four years.
There is a scenario where the mandate becomes important to keeping ethanol in our fuel supply, but it is only relevant if there are extreme movements in the ethanol-RBOB spread. Historically, ethanol was priced lower than RBOB, so blenders had a very clear economic incentive to blend ethanol up to the 10% level. As oil prices have come down, ethanol has traded at a slight premium to RBOB (around $0.15/gallon). This spread is expected to reverse over the next six months, according to the futures curve. Even with this premium, ethanol is still the cheapest additive available. For a refiner to “re-crack the barrel” to change 84 octane RBOB output to a higher octane (and thus eliminate or reduce dependence on ethanol), it would cost $0.30-$0.50/gallon. As a result, ethanol is the cheapest source of octane available up until it trades at a $0.30-$0.50/gallon premium to RBOB. Right now, ethanol-RBOB is substantially below this level.
However, if the spread widens to something greater than this $0.30-$0.50/gallon level, the RFS mandate starts to matter. The RFS enforces its mandate through a program whereby blenders using less than the mandated level need to incur additional costs to maintain compliance (through the purchase and submission of a RIN). The RINs program details are beyond the scope of this write-up but the key point is that the cost of this RIN is roughly $0.50/gallon on average, and fluctuates. This then adds an additional $0.50/gallon in cost to switch away from ethanol, which means the spread between ethanol and RBOB can actually widen to $0.80-$1.00/gallon before market participants would seriously consider changing out ethanol from the fuel supply. In this scenario, the mandate becomes the backstop for ethanol use instead of octane requirements. We reiterate that we are far from this scenario today, but we will continue to monitor the ethanol-RBOB spread closely.
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