As North America's largest producer of advanced biofuels, Renewable Energy Group (REGI) has long offered an intriguing investment opportunity. Unfortunately, that intrigue was outweighed by a sobering reality: The business was historically reliant on federal subsidies. But that all changed last year.
A combination of scaling its biodiesel and renewable-diesel production fleet, investing in operating efficiency, and dabbling in petroleum-based diesel fuels allowed the company to achieve profitable operations throughout 2018 -- a year in which federal subsidies weren't even available. That new reality firmly reinstates Renewable Energy Group as a stock worth paying closer attention to, as its fourth-quarter and full-year 2018 earnings results demonstrate.
1. The business is profitable, growing, and managing costs well
The most difficult thing for investors to keep track of when it comes to Renewable Energy Group is the effect of the blenders tax credit (BTC). This federal subsidy has lapsed for entire years only to be retroactively reinstated later, which causes lumpy financial results that can be difficult to compare. Thankfully, the biodiesel leader does a great job explaining both GAAP and adjusted non-GAAP financial metrics.
Without including the federal subsidy, Renewable Energy Group reported adjusted EBITDA of $138.9 million in 2018, up from just $25.3 million in the previous year. That was driven by an 11% year-over-year increase in gallons sold and a $107 million decrease in the cost of goods sold in that span. The latter demonstrates that the company is deftly managing raw materials costs and that past investments in operating efficiency are paying off handsomely.
Here's where things get a little tricky. The BTC for 2017 was retroactively reinstated in early 2018, which resulted in a lump sum windfall of $205 million in the first quarter of 2018. If that's instead allocated to financial results for 2017, then the biodiesel leader would have reported adjusted EBITDA of $230 million that year.
To make for an apples-to-apples comparison, Renewable Energy Group has estimated the value of the BTC for 2018 at $237 million. That's the amount that would be received in a lump sum windfall should the federal subsidy for biodiesel produced in the 2018 calendar year be retroactively reinstated in the future -- and it would result in full-year 2018 adjusted EBITDA of $376 million.
Check out the latest earnings call transcript for Renewable Energy Group.
2. There are multiple catalysts on the horizon
First and foremost, Renewable Energy Group has the potential to receive a fat check from Uncle Sam if the BTC for 2018 is retroactively reinstated in the future. The estimated $237 million payment -- all profit -- would be equivalent to 26% of its current market cap and would value shares at about 3.8 times future earnings. That's absurd, but it's not the only catalyst on the horizon.
The Environmental Protection Agency's (EPA's) renewable fuels mandate calls for 2.43 billion gallons of biomass-based diesel fuel to be blended into the nation's fuel supply in 2020. That marks an increase of 330 million gallons, or 16%, from the 2.1 billion gallons required in 2019 and represents one of the largest year-over-year volume increases in the program's history. To put that into perspective, the total mandated volume increase from 2015 to 2019 was 370 million gallons.
The EPA increase comes at exactly the same time global diesel markets will face a potential spike in demand. A new global fuel standard goes into effect on the first day of 2020 requiring all shipping vessels to sharply reduce sulfur emissions. Some fleet operators will install scrubbers and attempt to use cheaper, dirtier bunker fuel, but many will simply switch to an inherently low-sulfur fuel: diesel. Analysts think the rule could increase planetary diesel fuel demand by 12 billion to 30 billion gallons per year, which would surely increase diesel prices and boost the operations of Renewable Energy Group.
3. It's looking to exit industrial biotech
Renewable Energy Group announced that its board of directors has decided to sell a research-based business unit called REG Life Sciences. The biodiesel leader entered the industrial biotech space through the up to $61.5 million acquisition of synthetic biology start-up LS9 in 2014. The technology platform had the potential to produce fatty acid methyl ester (FAME) chemicals, including biodiesel, with genetically engineered microbes. Better yet, the key input to the original process was glycerin, which is a high-volume waste by-product from traditional biodiesel production.
But it didn't work out. For one thing, researchers discovered glycerin wasn't going to enable an economical commercial-scale process. For another, most biology-based chemicals won't be able to compete with ultra-cheap and scalable petroleum-based chemicals for the foreseeable future.
The sale of REG Life Sciences will not have a significant financial impact on the business, but it will likely remove Renewable Energy Group from an industrial biotech collaboration with ExxonMobil and specialty chemicals company Clariant that is pursuing next-generation renewable fuels. It last announced a research and development (R&D) milestone in late January 2019 -- swapping out glycerin in favor of sugars derived from agricultural wastes -- but is still many years away from a commercially viable process.
While it's possible that ExxonMobil will acquire the business unit to consolidate the project, the sale won't fetch a needle-moving sum of money for Renewable Energy Group and will likely fall well short of its original acquisition price. That said, exiting industrial biotech R&D will allow the company to focus on more-immediate growth opportunities such as expanding its production footprint in renewable diesel (chemically identical to petroleum-based diesel and not the same thing as biodiesel). It's doing just that with Phillips 66, building an industrial-scale facility (Renewable Energy Group's second) in Washington state that could be operational by 2021.
This renewable energy stock is still attractively valued
Shares of Renewable Energy Group more than doubled in 2018, but they're still relatively cheap. The stock trades at just 12 times future earnings -- and that's without including any windfall from the potential reinstatement of the BTC for 2018. The business is growing production and sales volumes, increasing operating efficiency, and investing in its future with new renewable-diesel production facilities. Considering the strong year of performance in 2018 and the fact the company sports a market cap of just $900 million, investors should consider this renewable energy stock a buy.