This Biodiesel Stock Is on Sale

Shares of biodiesel producer Renewable Energy Group (NASDAQ: REGI  ) have been sinking since the Environmental Protection Agency announced its intentions for renewable fuel mandates for 2014 (link opens PDF). What's the reason? Well, the amount of biomass-based diesel required to be blended into the nation's fuel supply has steadily risen by about 200 million gallons per year since the creation of the current Renewable Fuel Standard, or RFS2, in 2007. The EPA proposed freezing mandates at 2013 levels, or 1.28 billion gallons, through the end of 2015. While every other fuel category had its mandated volume reduced, investors didn't take kindly to the possible removal of a key growth catalyst for REG.

Freezing the biomass-based diesel mandate is bad news for all producers. However, shares of REG have dipped much lower than those of the next largest publicly traded peer, Darling International (NYSE: DAR  ) , which recently began producing fuel with Valero (NYSE: VLO  ) as part of the Diamond Green Diesel joint venture.

REGI Chart

REGI data by YCharts

Why the seemingly unequal treatment? Is it possible this dip is a buying opportunity? I think a solid case can be made for adding shares to your portfolio.

Take note
Why did REG pullback more than its peer? Darling is a viable business with or without Diamond Green Diesel. It simply made sense for the rendering (processing of cooking oils and animal fats) leader to partner with the world's largest independent refiner to produce fuel. REG is a little more beholden to EPA mandates because it solely produces fuels and heating oils, although the market is overlooking the fact that it, too, is viable in the current environment (more below). 

It's important to note the differences between biodiesel and biomass-based diesel. Although they are often collectively referred to as biodiesel, the EPA categorizes them separately. Both companies produce biomass-based diesel fuels that are grouped into the "advanced biofuel" category. To qualify for the EPA's "advanced biofuel" category, a fuel must reduce lifetime greenhouse gas emissions by 50% compared to petroleum-based fuel. This category is pegged at 2.2 billion gallons for 2014, although it includes the 1.28 billion gallons of biomass-based diesel.

By comparison, biodiesel that does not reduce emissions by 50% qualifies for the EPA's "renewable fuel" category along with corn ethanol, which are both first-generation biofuels. The category is pegged at 15.21 billion gallons for 2014, although corn ethanol will contribute a great majority of that total. The major difference stems from which feedstock is used during production. Additionally, advanced biofuels qualify for more valuable credits than first-generation fuels.

Darling and Valero's renewable diesel offers more value than an advanced biofuel, and actually satisfies the ASTM D975 standard -- making it interchangeable with petroleum-based diesel fuel. Nonetheless, the renewable diesel will be used as a blendstock for Valero's petroleum-based diesel. It's also worth noting that REG has done an incredible job improving the efficiency and flexibility of its biorefineries this year. However, the market is still worried about what the proposed policies mean for REG's growth plans for the next few years.

Growth frozen?
Freezing biomass-based diesel requirements through 2015 may force management to freeze plans to finish constructing four biorefineries -- representing an annual capacity of 150 million gallons (mmgy) -- that have had their construction halted at various times since 2008. Two factors contributed to the decisions to halt construction: market conditions and financing.

The company's growing cash pile seemed to be hinting that construction could once again resume for some of the biorefineries, but market conditions may have just trumped that for the short term. There's still the possibility that process improvements, which improve the economics of each biorefinery, will allow REG to complete construction in the current market. Unfortunately, shares are focusing on short term conditions. 

Take the long-term view
If the EPA refuses to revise biomass-based diesel volumes upward for next year, it still isn't the end of the world. REG has room to grow with or without increasing volume mandates, and will continue to exceed $1 billion in annual sales. Consider how the company grew in the third quarter of 2013 compared to the same period of 2012:

Financial Metric

3Q13

3Q12

% Change

Gallons produced

56.8 million

---

---

Gallons sold

77.6 million

61.7 million

25.8%

Average selling price (per gallon)

$4.95

$4.44

11.5%

Revenue

$458.4 million

$322.9 million

42%

Adjusted EBITDA

$48.9 million

$16.6 million

194%

Cash

$135.9 million

$88.3 million

53.9%

Source: REG

It would be great to add the 150 mmgy of capacity sooner rather than later, but let's not forget that REG's eight biorefineries in operation have an annual capacity of 257 mmgy, which make it the nation's largest biodiesel producer. Those same facilities were profitable this year, when biomass-based diesel was pegged to 1.28 billion gallons. Why should anything change when the market is pegged to the same volume in 2014? Am I crazy for thinking it's crazy to value a profitable company with more than $1 billion in annual sales at just over $400 million? Sometimes, I wish I had a megaphone to yell at Wall Street.

The biggest reason to be optimistic about a resurgence in REG's share price is the expectation that biomass-based diesel volumes will be revised upwards before 2014 mandates are finalized. There's no reason to reduce volumes for any type of diesel fuel blendstock when the biggest concern for the nation's fuel supply is the Blend Wall related to gasoline fuel blendstocks. Even if diesel consumption continues to fall, the country's overall blending ratio of 1.16% is nowhere near the theoretical limit of 7% for diesel-based fuels. REG President and CEO Daniel Oh voiced his frustrations with, and his intentions to respond to, the proposed mandates before they are finalized. Investors will have to wait until early next year before learning of his success.

Foolish bottom line 
There's no doubting that REG just got riskier, but I think it's highly likely that the EPA raises biomass-based mandates for 2014, and inevitable that required volumes are raised for 2015. Be aware that REG shares will continue to be volatile given the focus on short-term conditions, which has generally been the case since its IPO several years ago. However, the company remains on firm financial footing, and is profitable with current volume obligations. There's simply no reason to think the viability of current operations will change in 2014.

Biodiesel isn't a major threat to OPEC, but this company is
Imagine a company that rents a very specific and valuable piece of machinery for $41,000... per hour (that's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click HERE to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable LANDSLIDE of profits!


Read/Post Comments (1) | Recommend This Article (5)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 27, 2013, at 3:21 PM, BioFool wrote:

    Maxx,

    While I agree that REG will probably continue to grow their gallons produced, I am concerned about reduced pricing due the impact of the expiration of the $1.00 per gallon Blenders Tax Credit on December 31, 2013 and the probable reduction in RIN pricing in 2014 due the RVO mandates remaining at 1.28 Billion gallons.

    What is your forecast for 2014 average sales price for biodiesel in 2014 in this scenario?

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2740525, ~/Articles/ArticleHandler.aspx, 10/21/2014 9:36:09 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Apple's next smart device (warning, it may shock you

Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!


Advertisement