Renewable Energy Group's Headache Continued in Q2

It appeared that the nation's largest biodiesel producer had finally turned a corner in 2018. Yet sustained pricing headwinds -- and stubborn members of Congress -- are proving difficult to overcome for Renewable Energy Group (REGI). Judging from second-quarter 2019 operating results, investors might need all the patience they can muster.

The biodiesel producer saw average selling price (ASP) per gallon drop 13% from the year-ago period. An important tax credit remains unavailable due to government inaction. While the company attempted to offset that top-line weakness by selling gallons from inventory, higher feedstock prices eroded margins.

Still, despite the headwinds, Renewable Energy Group is in a good place relative to its peer group. It also made a handful of moves to position itself more effectively for the long haul, although that may not make waiting out the storm any more comforting. Here's what investors need to know about the latest operating results.

Image source: Getty Images.

By the numbers

A quick glance at Q2 operating results shows that not much has changed in the American biodiesel industry since the first quarter of 2019. To support its top line, Renewable Energy Group sold more gallons than it produced while attempting to manage operating losses. It didn't really help. In fact, the company was forced to close a manufacturing facility in late July. It was smaller and less efficient than its remaining facilities, and unlikely to contribute to margins in the current environment. 

Data source: Renewable Energy Group press release.

What's going on? Selling prices are weak, feedstock prices are traversing through their normal seasonal patterns, and the most important federal subsidy -- the Biodiesel Mixture Excise Tax Credit, also known as the blenders tax credit (BTC) -- hasn't been active since the end of 2017. The latter is the most important drag on the industry.

The BTC has lapsed many times before, only to be retroactively reinstated by Congress each time, and has come to be regarded as a point of certainty in an otherwise unpredictable environment. But the industry has now operated for over 20 months without the tax credit, and it wasn't included in the latest two-year budget deal.

That matters because the absence of the tax credit has started to drag on biodiesel selling prices and affect customer relationships. Making matters worse, a record number of refineries have been exempted from having to blend renewable fuels, which has caused the prices of separately traded compliance credits, called renewable identification numbers (RIN), to tank. The impact is clearly evident from biodiesel-to-feedstock price spreads trending well below the historical average. 

Put another way, Renewable Energy Group is caught in regulatory limbo. There's bipartisan support for extending the BTC, but no action has been taken. There are rules on the books for refiners and renewable fuels, but regulators aren't enforcing them. There's only one thing the business can do: plow ahead and focus on the factors it can control.

Image source: Getty Images.

Looking ahead

While shuttering manufacturing capacity isn't a great sign, Renewable Energy Group is relatively well positioned among peers, many of whom have been forced to shut down multiple facilities and operate the remainder at reduced run rates. The operational strength is a testament to the company's focus on efficiency over the years, which has added close to 100 million gallons of annual production capacity since 2015 without building a new facility. It's also leveraging its nationwide distribution network.

Management's long-term mindset hasn't wavered in the weak margin environment. Other highlights from recent months include: 

• Renewable Energy Group opened a diesel fueling station outside its 60-million-gallon-per-year Seneca manufacturing facility. The first company-branded station provides biodiesel blends of 11% (called "B11") and above, which is notably higher than the 5% blends (called "B5") most distributors use. The direct sales channel should drive higher-margin revenue from the 17,000 trucks that pass through the facility each year, and could be implemented at other manufacturing facilities.
• In another move to increase sales density and margins with higher-percentage blends, the biodiesel producer began transitioning customers of its distribution hub in Iowa from B5 blends to B11 and B20 blends.
• Renewable Energy Group retired 2019 debt notes with cash on hand, rather than refinance them and take on new debt. The transaction left the renewable fuel leader with $61.6 million in cash at the end of June and reduced its debt-to-capital ratio to 15.2%, from 20.6% at the end of Q1.

Furthermore, Renewable Energy Group estimates that it would receive a windfall of $370 million if the BTC is retroactively restored and applied to production from the last six quarters. That works out to $9.50 per share. It might seem unlikely, but a similar transaction in early 2018 handed the business a $205 million windfall for production from the previous year.

Management remains confident that the tax credit will be retroactively reinstated in the coming quarters. If that occurs, then the business would have to remain prudent in how it deploys the cash injection. The most obvious choice: investing in renewable diesel (different from biodiesel) capacity. That would allow Renewable Energy Group to increase sales of its highest-margin product and capture a growing share of California's low-carbon fuel standard credits.

That said, the business will continue to struggle without more certainty. Investors will want to follow the company's lead and buckle up until the storm passes, assuming it passes at all.