REG's Earnings Don't Worry Me

Biodiesel leader Renewable Energy Group (REGI) reported fourth-quarter and full-year 2012 financial results – its first as a public company – after the market closed on Monday. The company is poised for sizable growth in the years ahead as it continues to expand its distribution network and bring new, multi-feedstock capacity online. However, a dismal outlook for the year ahead has smacked shares out of the gate today. Do the rewards continue to outweigh the risks?

Financials
How did 2012 compare to 2011? REG surpassed $1 billion in revenue for the first time in its history as management executed a profitable year in light of falling government credits and selling prices.

Source: Renewable Energy Group

The company raised a net of $59.9 million from its IPO, increased its nameplate capacity from 212 million gallons per year (mmgy) to 227 mmgy across seven biorefineries, and is currently constructing another 150 mmgy at four new or retrofitted facilities. The cash balance was strengthened to $66.8 million and debt was reduced from $81.6 million in 2011 to $37 million in 2012.

Some investors may shy away from REG due to its association with biofuels and the stigma of government aid. It is always good to note that the biodiesel sales to government incentive revenue ratio to check the validity of those fears. In 2011 nearly 8% of revenue came from government incentives, while just 0.8% could be chalked up to the same line on the books last year.

Does REG make biofuels? Yes, but it manufactures biodiesel in a profitable and investor-friendly manner. In fact, the company represents nearly 17% of the domestic market, which makes it a prime candidate to tap into the industry's volume growth.

Outlook
We Fools don't believe in worrying over short-term noise, but Wall Street is a different animal. The company has guided for a weak start to the year with 90 million-100 million gallons sold and adjusted EBITDA between $20 million and $40 million. Even in a best-case scenario, EBITDA would be markedly below the $66.2 million watermark of the first half 2012.

What's the big deal? Well, from a macro standpoint, current B100 prices are about 13% lower than they were for the first six months of 2012. For example, the company enjoyed an average selling price of $4.60 per gallon in all of 2012, but current biodiesel prices are just near $4.30 per gallon. Contributing to and compounding the lower price environment is the fact that domestic B100 stocks stood at 32 million gallons at the end of last year – a 128% increase over December 2011.  

Nonetheless, the renewable volume obligation for the biodiesel industry increased from 1 billion gallons in 2012 to 1.28 billion gallons in 2013. Annual increases in recent years have been in the neighborhood of 250 million gallons, although the industry's production capacity is actually closer to 2.1 billion gallons. The company's focus on bringing new multi-feedstock capacity online and acquiring strategic assets at favorable prices bodes well for its long-term future.  

Competitive advantage
What exactly does it mean to have multi-feedstock capability? Biodiesel can be produced from numerous sources including soybean oil, corn oil, yellow grease (vegetable oil), and white grease (animal fat). Feedstock availability and pricing can vary in different regions of the country, so it pays to remain flexible across your stable of biorefineries. REG does just that.

Source: Renewable Energy Group

The company also maintains a vibrant and growing distribution network across the nation's most important transportation hubs with 19 major terminal locations. Whereas smaller producers with a handful of plants will be more susceptible to the volatility of renewable identification numbers and feedstock prices, REG's size and efficiency helps mitigate risk to market forces. It is by no means immune, but it is in a much better position than smaller competitors.

Solid leadership
One dynamic that doesn't show up on the balance sheet or income statement is the treatment of shareholders. I have always wondered why some companies choose to go public when they will flounder around in annual losses for several years. The public markets may represent a new stream of capital, but they do not diminish a company's fiscal responsibility to shareholders. For once, it seems that a management team at a newly public company understands that.

Management also stated on the conference call that despite acquiring new assets in Texas and Georgia it "walked away" from several acquisition targets last year because terms were not capital or shareholder friendly. Resisting the temptation to grow too quickly and impress short-term-minded shareholders will no doubt pay dividends down the road.

Foolish bottom line
REG had a great 2012 and should continue to treat long-term shareholders well. While the company has guided for weaker than expected EBITDA for the first half of 2013, keep in mind that increased sales volumes will strengthen relationships with customers and suppliers – often overlooked metrics in an investment. At the end of 2012 the company's book value stood at around $9.45 per share, or a 35% premium to $7.00 per share. Oddly enough it also represents a P/E of 35, which goes to show you the importance of not relying on simple valuation metrics.

This Fool is sold on the long-term viability of the company. Biodiesel mandates will continue to increase for the next several years (remember, industry capacity is 2.1 billion gallons) and few companies have the scale and efficiency of REG. I will be looking to open a position in the next few weeks. Will you be joining me? Let me know in the comments section below.