After spending all of 2018 reshuffling its portfolio and paying off all of its term debt, Green Plains (GPRE -4.58%) is finally on the other side of a long-awaited inflection point. Management can now focus on investments that boost operating efficiency and increase the production of high-value protein byproducts. If only economics would cooperate.
While the ethanol producer is eager to turn the corner after finishing its worst year of operations in recent memory, ethanol selling prices remain stuck in the gutter. In fact, there was barely any improvement in prices during the first quarter of 2019 compared to the year-ago period. That's noteworthy considering 2018 was the worst year for ethanol prices since 2002 -- years before renewable fuel mandates became federal law and provided a floor for the industry.
There's a lot at stake for Green Plains in the year ahead. Here's what to watch when the business reports Q1 2019 earnings.
1. What was the impact from recent Midwest flooding?
Numerous factors affect the stubborn economics of domestic ethanol markets. This year investors will be forced to contend with one more: flooding in the heart of the American Corn Belt.
Flooding along the Missouri River knocked an estimated 13% of the nation's ethanol production capacity offline earlier this year. Green Plains hasn't officially commented on the impact to its operations, but as many as seven facilities representing 49% of its total annual production capacity are located in the affected states of Nebraska and Iowa.
Investors will be eager to learn the extent of the disruption. Short-term obstacles such as transporting finished product when railroads were submerged are one thing, but disruptions to regional corn planting this year could result in lingering headwinds for the business. As an analysis from Justin Fox of Bloomberg suggests -- in which he discusses the centurylong wrestling match between humans and the Missouri River -- the latter's recent winning streak might make sacrificing farmland and even some rural towns to nature the best long-term option. It's a relatively distant concern, but one for investors to think about nonetheless.
2. Is the new strategy going to take shape in 2019?
This year may mark the first few steps on the other side of the inflection point reached in 2018, but progress could be slower than investors anticipate. At the end of 2018, Green Plains sold off the world's largest vinegar company and three ethanol production facilities to pay off a $500 million secured term loan and significantly lower interest expenses. The plan now is to focus on low-cost ethanol production and high-value protein sales, but they might not materialize in 2019.
Consider that the business achieved a $19 million annual run rate reduction in controllable expenses by the end of 2018. While that's a significant sum in the low-margin ethanol industry, Green Plains reported an operating loss of nearly $112 million in its ethanol segment last year. It hasn't produced a profitable gallon of ethanol since August 2018. Simply put, operating improvements alone won't be enough to combat weak market fundamentals.
That helps to explain management's long-term vision to upgrade the quality of protein byproducts created from its ethanol manufacturing fleet. Instead of the traditional dried distillers grains with solubles (DDGS), which is sold as animal feed, Green Plains wants to add new processing equipment capable of turning leftover corn into higher-quality protein products. It's even created a 50-50 joint venture with Optimal Fish Food to sell into high-margin, high-demand aquaculture markets.
But the technology is largely unproven at commercial scale. Green Plains is still installing the first project at a single ethanol facility, which suggests there's a long way to go before high-value protein products become a significant driver for the business.
3. Insight into policy updates
More so than any other first-generation renewable fuel, American ethanol is helplessly tied to the whims of unpredictable federal policy. Overproduction certainly hasn't helped in recent years, but there's no concerted effort in Washington to ensure American ethanol exports continue to feed the global market, or to provide more domestic demand by increasing (even slightly) blend rates in gasoline.
Investors will be listening for any insight management can provide into expected policy decisions. For instance, the U.S. Environmental Protection Agency was supposed to allow 15% ethanol blend rates across the nation year-round, up from a 10% ceiling today, sometime this year. The move could provide an extra 1.3 billion gallons of domestic demand annually, equivalent to a 10% increase, in just five years and significantly reduce swollen national inventories. The industry is still waiting for the official policy to be handed down.
Investors will need to remain patient
Ethanol has not been a great investment over the years. Early indications suggest 2019 will not be the year that changes for investors, although Green Plains can still make progress toward laying a sustainable foundation for long-term operations. While operating losses will continue to pile up without sharply higher ethanol selling prices, lowering production costs and prioritizing high-value protein production projects could help to expedite the turnaround once the market stabilizes. Until then, investors will need to remain patient with the business.