Despite the consumption-sapping effects of the coronavirus pandemic, especially potent in transportation fuel markets, shares of Renewable Energy Group (REGI) have proven surprisingly resilient. The biodiesel and renewable diesel manufacturer is by no means immune to market forces, but the business can collect healthy tax credits from each gallon of fuel sold.
That provides at least some level of protection for shareholders. How much? Well, that's the most important question facing analysts and investors ahead of the company's second-quarter 2020 earnings conference call, scheduled to take place after market close on Aug. 4. Here are the factors that will dictate the answer to that pressing question and the trajectory of the small-cap stock.
Production, consumption, and feedstock prices
Renewable Energy Group has already stumbled in setting expectations for the second quarter of 2020. Initially, the company expected to deliver $20 million to $35 million in adjusted EBITDA for the three-month period -- not too bad given current events.
But the projection had to be walked back due to both souring market conditions and the discovery of calculation errors in initial guidance. The company's latest guidance expects adjusted EBITDA of negative $12 million to negative $2 million -- more in line with what investors might expect for a manufacturer of transportation fuels in the current market environment.
Revised guidance aside, investors should be watching three metrics in the upcoming quarterly update.
Production and utilization: One of Renewable Energy Group's core strengths in recent years has been the ability to steadily increase production volumes through improved operating efficiency. Boosting the output of existing facilities drives margins higher without the large, upfront investment required to build new facilities.
However, lower market demand might force the company to reduce production volumes to avoid an unsustainable buildup of inventories, which could weigh on margins from an operations standpoint. Manufacturing facilities have lower per-unit economics at lower utilization rates, so Renewable Energy Group could be contending with poorer margins before selling prices are taken into account.
After initially expecting to produce at least 500 million gallons of renewable fuels in 2020, the business now expects to manufacture at least 450 million gallons. Given the uncertainty of the coronavirus epidemic's effects on consumption and economic activity in the United States, investors might not be surprised if minimum production guidance remains volatile throughout the year.
Consumption and demand gaps: Production is closely related to market demand, but there isn't perfect overlap. Renewable Energy Group could exploit international and regional consumption gaps, although it might be difficult to do on short notice.
For example, the company might be able to offset lower domestic consumption by increasing exports. Compared with the United States, Europe has done a better job containing its coronavirus epidemics, might see consumption rebound more quickly, and has higher selling prices of transportation fuels. Renewable Energy Group already exports a growing share of renewable diesel production to Norway, which might become a more important market in 2020 than originally expected.
Domestic consumption gaps could appear, too, albeit on a regional basis. Renewable Energy Group might be able to increase sales in the Northeast, where it owns a smattering of product terminals. Meanwhile, strong incentives for renewable fuels in states along the West Coast could create unique opportunities for the business despite rising numbers of detected coronavirus cases for the region. And there are always opportunities to ink direct distribution deals to lock in demand, as evidenced by the supply agreement with Hunt & Sons announced in late July.
Feedstock prices: This is likely to be the single biggest headwind for Renewable Energy Group in 2020. While demand for and selling prices of transportation fuels have fallen significantly, the prices of biodiesel and renewable diesel feedstocks have remained elevated. Used cooking oils, distilled corn oil, and animal fats are each in short supply due to closed restaurants, idled ethanol manufacturing facilities, and disrupted meatpacking plants, respectively.
Given the combination of higher input costs to manufacture biomass-based diesel fuels and lower selling prices, investors might need to prepare for some pretty ugly gross margins for the remainder of 2020. That's especially true for the second quarter, which was the peak (so far) of the economic effects of the nation's epidemic.
Is a disappointing earnings report on the horizon?
This figures to be a difficult year for Renewable Energy Group. Management might like to steer investors to non-GAAP metrics such as adjusted EBITDA, but generally accepted accounting principles numbers such as operating income and cash flow from operations will ultimately determine the trajectory of the small-cap stock.
The coronavirus pandemic might not be a temporary risk, either. Depending on the severity and duration of the economic slowdown caused by the pandemic, Renewable Energy Group could face obstacles to investing in its future -- namely, efforts to expand renewable diesel production capacity. Given the rise of heavy-duty electric vehicles and increasing opposition to liquid carbon-based fuels, which create competitive pressures on the business, lingering economic risks from the health crisis aren't something investors can easily dismiss.