Energy stocks have largely been reeling for the past several years. This little-known renewable energy stock was no different. Until it started producing something else, that is.
Shares of Pacific Ethanol (ALTO 2.65%) have shot up 857% so far in 2020. The loss-making ethanol producer catapulted to profits by shifting production to specialty alcohols, used in making hand sanitizers, disinfectants, and cleaning products (among other things). But are the company's profits sustainable, and is the stock a buy? Let's take a deeper dive into the company's operations to find out.
Liquidity crunch
Until 2019, Pacific Ethanol mainly produced ethanol from starch-based feedstock, primarily corn. Ethanol is a renewable fuel that can be blended with gasoline to meet requirements under the Environmental Protection Agency's Renewable Fuel Standard or RFS. Record-low ethanol prices in the last five years severely impacted ethanol manufacturers' profits. Excess production as well as high inventory levels pressured ethanol prices.
Image source: Getty Images.
Low ethanol prices hurt Pacific Ethanol's performance, too. At the end of 2019, the company projected that it didn't have enough liquidity to meet its debt service and other obligations in 2020. Then, a sudden demand for specialty alcohols came to the company's rescue.
COVID-19 drove the demand for specialty alcohols
In addition to renewable fuels, Pacific Ethanol manufactures specialty alcohols and ethanol co-products used as high-protein feeds for livestock. The demand for specialty alcohols, used to make sanitizers and disinfectants, hit the roof with the spread of the coronavirus. Pacific Ethanol quickly responded by increasing its specialty alcohols production. The company's production mix shifted from 15% specialty alcohols and 85% ethanol in 2019 to 50% each in Q3 2020. Pacific Ethanol generated 45% of its revenue from specialty alcohols in the first nine months of 2020, up from 15% in 2019. Specialty alcohols commanded premium pricing, boosting the company's bottom line.
Pacific Ethanol quarterly net income and revenue, data by YCharts.
Strong margins from specialty alcohols swung Pacific Ethanol to profits for the past two quarters after three straight years of losses. The company has idled a sizable chunk of its renewable fuels production facilities, resulting in a drop in its revenue, as the graph above shows.
Change in focus, and name
In October, Pacific Ethanol announced plans to permanently shift its focus to specialty alcohols and essential ingredients and away from renewable fuels. It also intends to change its name to reflect the changed focus. In addition to sanitizers, specialty alcohols have a variety of uses, including in alcoholic beverages, mouthwash, cosmetics, and pharmaceuticals. As part of its strategy, the company has idled several of its ethanol distilleries, which it plans to sell.
Additionally, the company raised $75 million through an equity offering in October. Pacific Ethanol intends to use the money from its asset sales and equity offering to repay its debt and invest in growing its specialty alcohols business. The business requires investments in quality-related certifications, as the end products are directly consumed or used on the human body.
Is Pacific Ethanol a buy?
With positive developments on the vaccine front, the coronavirus pandemic may soon come to an end. But until that time, and even beyond that, the demand for sanitizers and disinfectants may remain strong due to a lasting change in people's habits. Similarly, the market for alcoholic beverages is expected to grow steadily. Pacific Ethanol has done a good job so far in quickly grabbing the opportunity in the specialty alcohols market. Nevertheless, the stock is trading at a forward P/E of less than 5.
On the flip side, while the market looks good, that won't automatically translate into growth for Pacific Ethanol. The company is entering into largely uncharted territory and has yet to prove itself in the specialty alcohols segment. Though the forward P/E looks attractive, the company hasn't been profitable for years. At this point, it has generated profits for only two quarters, from a demand source that may not last long.
That said, the company's recent performance shows that it has the potential to generate growing profits. However, given that the company is betting its future on an unproven business -- as well as the stock's volatile past performance -- it is suitable only for investors with a high level of risk appetite.
