Is Green Plains a Buy?

Volatility is a common feature of biofuels stocks. Investors evaluating renewable fuels companies as potential additions to their portfolios must weigh government mandates, the lack of enforcement of government mandates, commodity prices, trade restrictions, and a host of other factors. The coronavirus pandemic and government efforts to contain it represent just the latest sources of uncertainty for this energy sector niche.

The challenging operating environment has been especially tough on Green Plains (GPRE +4.50%). It's one of the largest ethanol producers in North America, but the ethanol market has been mired in a historic rut. The company's ethanol segment hasn't generated operating income since 2016. 

As demand for transportation fuels cratered in mid-March, shares of this small-cap stock declined to lows last seen in 2012. It has more than doubled from its 2020 trough, but shares are still down by about 37% over the last 12 months, and off by 43% year to date. Given all of the moving parts and the company's near-term strategy to boost its margins, investors might be wondering if the stock at current levels represents good value or a value trap. Is Green Plains a buy?

Image source: Getty Images.

The argument in favor of Green Plains

Green Plains operates 13 ethanol facilities with a combined annual production capacity of 1.1 billion gallons. The business generates revenue from selling that ethanol to transportation fuels markets at home and abroad, as well as selling corn byproducts to agriculture and livestock markets, and cattle from its feedlot operations. The company is also the parent of a logistics partnership called Green Plains Partners. 

Weak ethanol prices have forced Green Plains to make difficult decisions in recent years. The company sold a high-margin subsidiary that made vinegar (which is fermented from food-grade ethanol) and divested a handful of ethanol facilities, then used the proceeds of nearly $780 million to pay down term loans, and formed several partnerships that serve as the foundation of its Total Transformation Plan. The success of this optimization plan will determine the stock's long-term trajectory -- and investors will soon learn if the first projects are on the right track. 

The overarching goal of the Total Transformation Plan is to significantly improve Green Plains' operating margins. The first step is to reduce operating expenditures in its routine ethanol production processes. To do so, the company formed a partnership with engineering firm ICM to install upgrades across its fleet. It expects to be among the 20% of ethanol producers with the lowest per-gallon production costs when the dust settles. Those upgrades should be complete at a number of facilities by the fourth quarter, and considering that the last three months of the year are typically the highest-margin quarter for ethanol producers, its results then should be telling.

The second step is a long-term play on a lucrative but elusive market: protein. All ethanol producers generate some revenue by selling distillers dried grains and solubles (DDGS) to livestock markets, where the byproduct is used as a protein source for animal feed. But with only 30% to 40% protein content, DDGS isn't the most valuable or nutritious product. 

Green Plains has invested in a handful of technologies and partnerships with the goal of increasing the protein content -- and the value -- of its DDGS. The first variant to be commercialized, a process optimized by Fluid Quip Technologies, is producing feed that averages 51% protein at Green Plains' Shenandoah ethanol facility. At an average selling price of $400 per ton, the product could add at least $0.15 per gallon of ethanol to the facility's overall margin structure. 

The idea is to continue walking up the value chain and pushing into higher-value markets with better technology. If Green Plains succeeds, then it could significantly de-risk its ethanol production by selling high-protein byproducts into the animal feed, pet food, and aquaculture markets. 

Data source: Green Plains.

Green Plains doesn't intend to upgrade all of its DDGS production or produce only high-value fishmeal, but every little operating improvement can be a big help in this beleaguered industry. 

Image source: Getty Images.

The argument against

The ethanol industry simply hasn't been a great choice for individual investors. Average annual selling prices have declined in six of the last eight years. Selling prices in 2018 and 2019 were the lowest they've been since 2005, when the federal government began requiring ethanol to be blended into America's gasoline. If selling prices through the first four months of this year are any guide, then 2020 could be the worst year of the 21st century for ethanol producers. 

The strange thing is ethanol prices have slid despite record export volumes and an increasing willingness on the part of the auto fuel industry to sell gasoline blends with 15% ethanol, up from the standard 10% blend commonly sold nationwide. Regulatory uncertainty and the willingness of the current administration to grant small petroleum refineries exemptions from blending mandates have created headwinds too fierce for the industry to overcome. 

Put another way, Green Plains' optimization strategy is both ambitious and long overdue, but investors have no way of knowing if success in its efforts will be enough to offset the weakness in the ethanol market. Besides, the animal feed and protein markets are susceptible to commodity fluctuations, too. 

Perhaps more important, investors can't be sure Green Plains will succeed or that the engineering upgrades will deliver the target per-gallon margin improvements. Many biorefineries have tried and failed to upgrade their protein products or to convert byproducts into valuable revenue streams over the last two decades. The assertion that high-protein products can be sold for several times more per ton than standard DDGS is more of a hypothesis at this point, so investors and analysts shouldn't be too quick to believe everything printed in company presentations. Until (and unless) the business shows that it can deliver sustainable results for a full seasonal cycle (read: one whole year), this will remain a very risky stock. 

Don't rush into this stock

Green Plains is a leading ethanol producer, although that's been more of a liability in recent years. Ethanol selling prices have been trending lower for much of the last decade and face considerable headwinds in mid-2020. While the business has embarked on an ambitious optimization plan that looks great on paper, investors must acknowledge that efforts by other industry players to maximize the economic potential of their biorefineries have mostly failed to live up to the hype. 

Simply put, the size and efficiency of the American agricultural base and bioeconomy suggest there's a massive market opportunity on the horizon, but investors should wait to see if Green Plains can deliver on its goals before rushing to buy its stock. If it succeeds, there will be plenty of time to move into a position and see how the company leverages its new economic advantage over the long haul.