Historically speaking, renewable fuels haven't been a very good investment. Despite incredible overnight growth in the American ethanol and biodiesel industries in the last decade or so, hardly any pure-play renewable fuel stocks have managed to beat the S&P 500 in that span. The underlying businesses aren't entirely to blame (well, not always, at least) -- instead, there's simply too much uncertainty when it comes to federal tax credits. And since fuels are commodity-driven, low-margin products, most companies have become dependent on subsidies to deliver profitable results to shareholders.

That's exactly what makes the second-quarter 2018 earnings of Renewable Energy Group (NASDAQ:REGI) worth a closer look. The nation's largest biodiesel producer just turned in two consecutive quarters of profitable results, all without the help of federal tax credits, which lapsed at the end of 2017. While six months is not a very long time, the details strongly suggest that the company's recent performance is sustainable going forward. If that's the case, then this renewable energy stock might be one of the best bargains in today's expensive stock market.

A roll of $100 bills with a green bow.

Image source: Getty Images.

By the numbers

To be fair to Renewable Energy Group, the business has a great track record of delivering growth, even though the stock price hasn't always reflected that. Management has always maintained that it was possible for the company to grow large enough and efficient enough to ensure that federal tax credits wouldn't dictate profitability. Wall Street dismissed that argument, because, well, this is a biodiesel company we're talking about.

But operating results from the second quarter and first half of 2018 may have finally proved management correct after all these years.

Metric

Q2 2018

Q2 2017

Year-over-Year Change

Gallons sold

171.9 million

160.2 million

7.3%

Average selling price

$3.11 per gallon

$2.86 per gallon

8.7%

Revenue

$580.1 million

$535.1 million

8.4%

Gross profit

$57.6 million

$31.4 million

83.4%

Operating income

$30.6 million

$4.1 million

646%

Net income

$33.8 million

($34.8 million)

N/A

Adjusted EBITDA

$42.3 million

$19.7 million

115%

Source: SEC filing.

While increased biodiesel selling prices certainly helped to lift the business in the most recent quarter, other factors within the company's control played even more significant roles.

  • Petroleum diesel sales: The business has invested in growing its nationwide distribution terminal network and selling more petroleum-based diesel to diversify revenue. In the first half of 2018 it sold 58 million gallons of petroleum diesel, a 45% increase from the year-ago period. The company also signed agreements for two new terminals by the end of June, and expects to complete up to 10 for the entire calendar year.
  • Fleet agreements: The business has begun courting large fleet customers interested in lower-emission renewable diesel fuels. It's a wise and proactive move, especially considering the top three states (California, Texas, and Illinois) require almost 1.2 billion gallons of biodiesel per year, meaning customers are highly concentrated. And beyond those three, many other states have ambitious air pollution reduction targets for 2020 and beyond.
  • Production efficiency: Roughly $40 million has been invested in upgrades to existing biodiesel production facilities since 2015. The resulting efficiency gains have added 77 million gallons of annual production capacity without building new facilities, and added the equivalent of $0.52 per gallon to margins since taking full effect in 2017 and 2018. This is the most important driver for the business' recent performance, and the company says it could pull the trigger on another $222 million in capital investments to upgrade existing facilities.

Judging from the stock's 72% rise since the beginning of the year, Wall Street may finally be changing its view of Renewable Energy Group. Yet despite the incredible leap in share price, the renewable energy stock is still embarrassingly undervalued across multiple metrics.

Metric

Value

Market cap

$759 million

Trailing PE

3.8

Forward PE

11.9

PEG ratio

0.2

Price to sales

0.31

Price to book value

0.99

EV/EBITDA

2.9

Source: Yahoo! Finance.

It's important to note that the stock trades at 11.9 times forward earnings assuming the federal tax credit for biodiesel remains out of the picture. While there are no guarantees that the subsidy will be reinstated, the fact is that it lapsed in 2010, 2014, 2015, 2017, and now 2018 -- and has been retroactively reinstated each time.

Renewable Energy Group is accustomed to the perpetual uncertainty, and it has become accustomed to preparing adjusted operating results showing what would have been if the federal tax credit were active in a specific period. Here's the kicker: the potential windfall from reinstatement gets larger and larger each year, because the business has quietly executed on its growth and efficiency strategy. Take a look at the potential benefit to first-half 2018 results and those from prior years:

Period

Adjusted EBITDA, Without Subsidy

Adjusted EBITDA, With Subsidy

First-Half 2015

($26.9 million)

$11.7 million

First-Half 2016

N/A*

$10.2 million

First-Half 2017

$20.3 million

$116.4 million

First-Half 2018

$59.8 million

$168.5 million

*Subsidy was active for all of 2016. Source: Investor presentation.

Considering the business is profitable in 2018 for the first time even without the subsidy, reinstatement would result in a record windfall and a record level of profits.

A businessman refueling his car.

Image source: Getty Images.

This might be a top value stock now

Renewable Energy stock has long been chronically undervalued using traditional valuation metrics, but investors always knew that was because of the above-average uncertainty inherent in the biodiesel industry. But if the business can prove that it doesn't need federal tax credits to deliver sustainable and profitable growth, then that argument could dissolve -- and this renewable energy stock would be a clear bargain at current prices.

Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.