Government restrictions on movement, aimed at protecting public health during the coronavirus pandemic, have significantly affected demand for transportation fuels. Global consumption of crude oil has fallen by roughly 30% from pre-pandemic levels. Combine that with an oil price war started by Saudi Arabia and dwindling storage options, and it's not too surprising global crude oil benchmarks have dipped below $20 per barrel. 

What might be more surprising is the relative resilience demonstrated by shares of Renewable Energy Group (NASDAQ:REGI). The biomass-based diesel producer has lost only 13% of its market value since the beginning of March, while some oil supermajors have lost over 25%. Investors might be relieved by a lack of volatility for the small-cap stock, but the company's first-quarter 2020 earnings report is a good reminder that the stock's resilience is fragile.

A pile of note cards with question marks on them.

Image source: Getty Images.

Can government incentives offset a historic downturn?

Renewable Energy Group is one of the country's largest manufacturers of biomass-based diesel fuels, which include biodiesel and renewable diesel. In December, Congress retroactively reinstated an expired tax credit to the first day of 2018 and extended it through the last day of 2022. That decision created a windfall of $500 million for the business from production in the previous two years (received in March and April of this year), with additional revenue penciled in for the three-year period spanning the extension. 

That helps to explain why shares of the renewable fuels leader have been relatively resilient. The balance sheet will be historically strong thanks to the windfall from retroactive reinstatement, while every gallon of biomass-based diesel sold through the end of 2022 will earn a $1 per gallon tax credit. That will certainly help to cushion the blow from tumbling diesel prices, which serve as the basis for biomass-based diesel selling prices.

But that's only part of the equation for investors. Renewable Energy Group will receive a financial benefit from tax incentives for the renewable fuel it produces, but that will be partially offset by volatility in feedstock markets. Many of the inputs needed to manufacture biomass-based diesel fuels -- cooking greases, vegetable oils, and animal fats -- have been significantly affected by the closing of restaurants, dislocations in the food supply, and disruptions in meatpacking plants. Shortages of those products would result in higher prices, which would pressure the company's margin from two directions: higher-cost inputs and lower selling prices for fuel.

The nuance isn't immediately visible when viewing top-line first-quarter 2020 results: 

Metric

Q1 2020

Q1 2019

Change (YoY)

Revenue

$474.6 million

$478.2 million

(1%)

Gross profit

$107.2 million

($12.8 million)

N/A

Operating income

$79.8 million

($38.1 million)

N/A

Net income

$76.8 million

($43.4 million)

N/A

Data source: SEC filing. 

Investors can only see the nuance when taking a closer look at operations. For one thing, feedstock pricing volatility wasn't a significant factor in first-quarter 2020 operations because stay-at-home orders were only in effect for the final two weeks of the financial period. In fact, the end-of-the-quarter volatility may have worked in the company's favor. Renewable Energy Group reported a $76 million swing in risk management revenue in the year-over-year comparison period thanks to price hedges. But investors can expect the volatility to sap operations at some point in 2020 as the positive impact of hedging wears off.  

For another, Renewable Energy Group enjoyed a significantly higher average selling price (ASP) of biomass-based diesel in the most recent period, which nearly canceled out a double-digit reduction in sales volume. The business also limited sales of petroleum-based diesel fuels, which are under severe margin pressure. Add it all up and factor in government incentives that weren't in place in 2019, and investors see how revenue held relatively steady. 

Metric

Q1 2020

Q1 2019

Change (YoY)

ASP per gallon of biomass-based diesel

$3.10

$2.65

17%

Gallons sold

139.8 million

162.5 million

(14%)

Revenue from biomass-based diesel

$387.7 million

$395.4 million

(2%)

Tax incentives

$68.1 million

$0.5 million

N/A

Petroleum diesel sales

$44.3 million

$83.9 million

(47%)

Intersegment revenue

($45.1 million)

($21.1 million)

N/A

Total revenue

$474.6 million

$478.2 million

(1%)

Data source: SEC filing. 

Yet it's not all bad news. Renewable Energy Group touted a record amount of gallons sold to fleet customers, which is impressive considering biomass-based diesel markets are seasonal and encounter their stiffest headwinds in the first three months of the year. That's encouraging because it's the end market least likely to be affected by the energy market slowdown, as long-haul trucking is providing tremendous value to the United States during the health crisis. Weekly demand for diesel fuel has declined "only" 20% during the coronavirus pandemic, whereas gasoline and jet fuel have experienced 40% and 62% declines, respectively. 

However, sales to fleet customers represented less than 5% of total gallons sold, which means it won't be nearly enough to offset market weakness. Therefore, it's more important for investors to consider the broader impacts on the business. Renewable Energy Group lowered full-year 2020 sales guidance to at least 575 million gallons, a reduction of 11% from the low-end of previous guidance. It aims to produce roughly the same volume of biomass-based diesel as initially expected, although that could change as the year drags on. 

Is this renewable energy stock a buy?

Renewable fuel stocks are no strangers to uncertainty and volatility, but the effects of the coronavirus pandemic create new concerns for investors. Renewable Energy Group will not be immune from the broader market impacts. The reinstatement of tax credits will help to insulate the business from tumbling selling prices, but a shortage of feedstocks could more than offset the advantage. Long story short, now is not a great time to open a new position or add to an existing position in this biodiesel stock.