Did This Refining Giant Just Give Investors a Hidden Message?

There has been a lot of naysayers on ethanol but rising margins and new feedstocks are hard to ignore which may bode very well for this industry player.

Feb 2, 2014 at 11:44AM

In case you missed it, Valero Energy's (NYSE:VLO) recent Q413 Interim Update gave a strong hint that the ethanol industry will see operating income that will be "significantly higher" in Q413 vs Q412 thanks to higher gross margins and production volumes. The positive view of its ethanol business didn't seem to hit many investors' radars, who were focused on Davos and watching a general sell-off in the market. Now that Valero released its Q413 earnings and showed a whopping 214% rise in earned operating income ($269 million) for the quarter, this may open a window for those interested in buying shares of Pacific Ethanol (NASDAQ:PEIX), a name that fell over 20% in recent trading thanks to a rally in natural gas, a chief component in producing ethanol. 

The pullback in shares of Pacific Ethanol now have my interest from a valuation perspective, especially since the company's plants don't consume as much ethanol as competitors because of proximity of plants to customers and the fact that ethanol the company does produce is a lower-carbon transportation fuel (something important to keep in mind after Obama's State of the Union address). Additionally, the company has trimmed debt by retiring $14 million in convertible notes and management has stated that they are seeing more global demand for ethanol globally.

I think at a time when people tend to question where the feedstock comes from to produce ethanol, Pacific doesn't get enough recognition by the investing community for its ability to convert diverse feedstocks such as sugar, corn, sorghum, and even sugars to produce from cellulosic material. So, sounds like a buy at these levels huh? Maybe, but not so fast. According to the company's latest 10Q, "if the Company fails to make ongoing quarterly cash dividend payments, it will be in default under the terms of its agreements with the holders of its Series B Preferred Stock and the holders' current forbearance through March 31, 2015 will be ineffective. The Company could experience a material adverse effect on its liquidity if it is required to pay in cash the entire current balance of accrued and unpaid dividends."

Concerns related to patent violations don't seem valid at this time considering the company's technological process for corn oil separation does seem different than accusations suggest.

Therefore, for a company that was very optimistic about its future just two months ago, the recent haircut in shares of Pacific Ethanol may be a nice entry for patient longs regardless of concerns that ethanol derived from corn is driving up food prices and could damage rubber, plastic, and even some engines. Why? The company's dividend seems secure (at least for now) and the future of ethanol may have nothing to do with food. In fact, the education Pacific Ethanol is getting by using beet sugar as a feedstock may actually open the company up to a whole new opportunity to tap second generation biofuel feedstocks like switchgrass, stems, leaves, pulp and woodchips. 

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John Licata has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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