Renewable Energy Group Couldn't Outrun Weak Margins in Q1 2019

The first quarter of the year is generally a slow one for North American biodiesel markets, especially since blend rates are affected by temperatures. But seasonality wasn't the only headwind attempting to blow Renewable Energy Group (REGI) off course in the first quarter of 2019. The business also dealt with unusual weather events that affected production, abnormal movements in feedstock price spreads, and significantly lower selling prices.

That confluence of negative factors weighed on operations in the most recent quarter, although the biodiesel leader announced progress on important strategic initiatives that will help to insulate the business from market volatility in the future. Wall Street didn't seem to care much for that, but individual investors have the advantage of remaining patient and thinking with a long-term mindset. Here are the major takeaways from Q1 2019 operating results.

Image source: Getty Images.

By the numbers

Renewable Energy Group tried to outrun weak margins by increasing sales volumes. That didn't work, but it wasn't the whole story, either.

Data source: Press release.

The table above ends with reported revenue because it's important to point out the large year-over-year decrease. Renewable Energy Group received a $209 million windfall in the first quarter of 2018 from the retroactive reinstatement of the blenders tax credit (BTC) for 2017. The company received all of the benefit at once, which juiced operating results.

Therefore, it's helpful to view adjusted operating results -- numbers provided without influence from the BTC -- to see an apples-to-apples comparison, especially considering the federal subsidy was inactive for all of 2018 and the opening quarter of 2019.

Data source: Press release.

As the two tables demonstrate, Renewable Energy Group faced multiple headwinds during the most recent quarter. Selling prices for its products were significantly lower than in the year-ago period. Meanwhile, some of the feedstock pricing advantages enjoyed in 2018 began to fade this year, although the increase in cost of goods sold was affected by higher production volumes and a $21 million year-over-year increase in risk management loss from price hedges. Some of that will be recovered in the second quarter as the gallons produced last quarter are sold.

Challenges aside, the company delivered on several long-term initiatives. Renewable Energy Group reported record production volumes at five of its facilities. The biodiesel leader also added five terminals to its nationwide network and 15 end-use customers, adding to the 46 points of distribution and 33 direct customers reported at the end of 2018. It's an easy detail to overlook, but expanding the network drives incremental sales growth and results in higher margins.

CEO Cynthia J. Warner also provided some of the most detailed comments to date regarding the planned joint venture with Phillips 66. Investors know the two companies are exploring a "large-scale" renewable diesel facility adjacent to the Phillips 66 Ferndale Washington refineries. Now investors know how large: An annual nameplate capacity of 250 million gallons. That's massive.

For perspective, Renewable Energy Group's lone renewable diesel facility in Geismar, Louisiana had an effective annual capacity of 90 million gallons at the end of 2018. It generated half of the company's adjusted EBITDA last year. That's because renewable diesel is chemically identical to petroleum-based diesel, and sells for a large premium to biodiesel. Expanding production of the fuel will likely be the single-most important priority of the business in the next few years. Good news on that front: Geismar ended March with an effective annual nameplate capacity of 112 million gallons.

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Looking ahead

Management expects the weak margin environment to persist during the second quarter of 2019. Guidance calls for adjusted EBITDA in the range of negative $25 million to negative $10 million. However, the business would have churned out breakeven operations if not for one item in particular.

The state of California made small changes to its Low Carbon Fuel Standard (LCFS), which, similar to federal programs available nationwide, provides incentives and credits for renewable fuel sales in the state. California is attempting to reduce the carbon intensity of transportation fuels 20% from 2010 levels by 2030. Biodiesel is currently the lowest-carbon verified fuel in the program -- even lower than electric vehicles.

While the California Air Resources Board validates credits on a quarterly basis, it recently changed the deferral period from three months to four months to allow fuel blenders more time to reach compliance. The change means at least some LCFS credits earned by Renewable Energy Group in Q1 will not be sold until Q3. The one-time delay will push $25 million to $30 million in revenue and adjusted EBITDA from Q2 to Q3. The business isn't losing that value, it's just a matter of timing with respect to financial reporting.

The one-time delay stings a little, but the program remains a big driver for the business. First-quarter 2019 revenue from the LCFS increased $27 million from the year-ago period, while the program is a tailwind for the proposed renewable diesel joint venture with Phillips 66.

Image source: Getty Images.

Volatility is back, but REG remains on solid ground

The first half of 2019 is going to be a rough one for Renewable Energy Group. The pain should be temporary, however. The business continues to earn healthy returns on invested capital, the financial importance of the LCFS continues to grow, and the planned expansion in renewable diesel could significantly reduce risks from feedstock prices and the political state of the BTC.

Of course, the retroactive reinstatement of the BTC for 2018 would result in a windfall of $237 million for the business, which would be enough to pay near-term debt maturities and fund a large portion of proposed renewable diesel projects. So even though investors are rooting for the business to outgrow the program if necessary, one more year of cooperation by Congress would certainly go a long way on the road to financial freedom.