Description

Founded in 2004 as an ethanol producer, Green Plains, Inc. is in the 6th or perhaps 7th inning of a dramatic business transformation that will result in a company that much more closely resembles a high quality value-added feed company with stable operating margins, rather than a cyclical ethanol company at the mercy of the wild swings in ethanol crush margins, which is how the market views GPRE today.

Green Plains reported Q4 results last week and we now have a number of hard, near-term catalysts, each of which could propel the stock on their own, and which, taken together, could crystallize asset values that would lead to a stock price 30+% higher in a conservative scenario or 75+% in a more reasonable scenario.

Substantial additional upside comes in the form of several cost reduction / new business initiatives underway that require minimal capital investment and have a fast payback period, but to which I ascribe no value in my SOTP.  In sum, a newly strengthened balance sheet, downside protection from asset coverage, a strong management team with an excellent record of capital allocation, and multiple cheap or free call options from several growth / cost reduction initiatives are coming together to make 2019 a very exciting year for the company.

GPRE was written up by lpartners in 2017 with an excellent overview of the company’s assets, as well as good background on the US ethanol industry structure / pricing discipline, high level supply/demand dynamics and relevant regulatory developments.

Since the 2017 write-up, management has made substantial progress on its subsequently announced “portfolio optimization plan” by divesting non-core ethanol production assets, acquiring additional cattle feedlot assets, and divesting its vinegar production company, Fleischmann’s, all at favorable prices.  The purpose of this write-up is to provide in one place a full and thorough update on what’s transpired over the past 1.5 years, summarize the various moving pieces that remain, and to highlight the opportunity the shares present today given all the progress made, the presence of several hard, near-term catalysts, and the 25+% decline in the stock from its highs over the past year.

Company overview –

GPRE is one of the largest consolidated owners of ethanol plants in the US, owning and operating multiple assets throughout the ethanol value chain: ethanol production facilities, grain handling / storage facilities, marketing / distribution services, cattle feeding operations, food-grade corn oil production, and fuel storage / transportation services.

The company currently reports in four segments:

1. Ethanol Production: production of ethanol, distillers grains and corn oil at 13 plants with capacity of 1.123 billion gallons.

2. Agribusiness and Energy Services: Grain procurement, commodity marketing business.

3. Food and Ingredients: Cattle feeding operations with the capacity to support 355K head of cattle, food-grade corn oil operations.

4. Partnership: GPRE’s MLP that provides fuel storage and transportation services by owning, operating, developing and acquiring ethanol and fuel storage tanks, terminals, and transportation assets.

The stock has fallen ~45% over the past ~2 years.  The two primary drivers for the stock price decline have been:

1. Continued oversupply of ethanol.

2. Confusing capital structure that overstates actual leverage.

Addressing each in turn:

Ethanol oversupply –

Several quarters of a glut of ethanol – caused by industry overproduction and slower than expected inventory drawdowns – have sent consolidated crush margins well below historical averages.  The bulk of the value in Green Plains’s assets has been in the ethanol production facilities, and the below-average margins have dramatically impacted profitability, effectively halving the stock price over the past 2+ years.

This past December saw an all-time low in crush margins.  A mid-cycle crush margin of $0.15 – $0.18 results for GPRE when the industry gets down to ~20m barrels of inventory, but we are at 23m today so inventory still needs to be taken out of the system.  The good news is that we finally have clear indications from both the supply- and demand-side that this is starting to happen:

Supply-side indications –

a) Production levels year to date are 3% lower than in 2017 and continue to fall.

b) Last week’s EIA print of 967,000 barrels of production was the lowest since June of 2016.

c) Inventory is currently lower than last year’s levels when crush margins were 20 cents higher than they are today.

d) Several quarters of weak margins have weighed on balance sheets across the industry and the industry is entering its second year of a cash burn situation.

e) Other industry players are slashing production rates (Valero ran at 93% during Q4 and is now run-rating at 82% for Q1 off a substantially larger capacity base than GPRE’s).

Some relevant commentary from GPRE’s CEO on the Q4 call:

“So I think the next couple of weeks will tell the story on where this industry is going to go into the second quarter.  We will start to see demand outpace supply, hopefully exports pick up, and we get back into positive territory. I’m very surprised we’re not there now, where we are relative to last year and the spread, as we’re really not that different than last year at this time.  We’re running lower on production and margins are $0.10 to $0.20 a gallon lower. And so we’re finally starting to see that start to make a move and adjust for market conditions. We think it’s taking too long, but we’re optimistic that the turn is in based on current fundamentals.”

“I think the market this quarter expected us to grow stock aggressively and we really haven’t done that coming into driving season.  And if we could stay down at these production levels, the industry could right this ship pretty quick, especially with E-15 and higher exports.”

Demand-side indications –

a) E-15:

A waiver to sell E-15 gasoline year-round appears imminent.  The acting EPA Administrator told a group of suppliers last week at a California clean air conference to get the E-15 fuel supply ready for summer, and GPRE has “every confidence” that by June 1st, they should have approximately 2,000 retail stations in 30 states selling E-15 gasoline.  This should add an incremental 200-300 million gallons of demand (representing ~15% of GPRE’s capacity).  ~95% of the cars on the road in the US are approved for E-15 fuel, and wherever E-15 has been available at gas stations, it has been some of the best-selling fuel at the pump.

b) Return to normalized exports:

China is currently unable to fulfill its nationwide E10 mandate without importing ethanol from abroad, but the trade war has taken China out of the market.  As we appear to be ever closer to a resolution on this front, and as any deal with China would certainly include the resumption of ethanol exports, China’s return to the market would, according to GPRE, conservatively result in an incremental 300m gallons of demand for 2019 alone.

In sum, GPRE management currently expects 1.7 - 1.8 billion gallons of ethanol exports for 2019.  But the inclusion of incremental demand from an E15 waiver (which seems a near certainty) and a resumption of exports to China (which seems increasingly likely) would absorb an incremental 500-600m gallons of current supply and have a material and immediate impact on the overall supply/demand and crush margins.  GPRE management believes that the two above catalysts could actually bring supply/demand back in balance and a return to normalized crush margins as early as this summer.

The Market Misunderstands GPRE’s leverage –

GPRE’s headline leverage is high, but misleading, as over 50% of it represents working capital financing.  An additional 12% of headline “debt” comprises noncontrolling interest, reflecting GPRE’s majority stake in Green Plains Partnership (ticker: GPP), their MLP and primary downstream logistics provider of storage and transportation services.

Including the working capital lines and NCI results in headline leverage of 9.6x, but stripping out the NCI and working capital lines and treating the related interest expense as an operating expense better reflects the economic reality of the business and results in leverage of just 1.5x.  Doing so makes sense as the working capital lines can be easily serviced by the liquidation of A/R and GPRE’s readily marketable inventory.

Portfolio Optimization Plan –

With the release of Q1 2018 results, management announced a proactive “portfolio optimization plan” to correct the misleading optics of high leverage and to transform the nature of the company’s core operations and render it far less vulnerable to wild swings in ethanol/commodities prices.

Todd Becker (CEO) on the Q1 18 cc:

“Now, let’s talk about the portfolio optimization program we announced…While we believe that more than the $2B invested in this platform will drive value for our shareholders, the reality is that we are not getting credit for the total value of the assets in the portfolio today.  As we evaluate our business, we believe that the collective sum of the parts of our platform is undervalued. While the sum of the parts analysis is a nice exercise, it doesn’t mean anything if you don’t monetize it.  Well, that’s what we are planning to do.”

The plan consisted of five pillars:

1) Highlight the private market value of GPRE’s ethanol production assets via divestitures of a portion of their ethanol assets as well as other non-core assets.

2) Reduce debt / eliminate term debt with the sale proceeds.

3) Invest in high-protein animal feed process technology to take advantage of the secular growth trends in that industry.

4) Reduce controllable expenses by $10-15m on an annual run-rate basis beginning in Q3 2018 and into 2019.

5) Opportunistically repurchases shares with remaining FCF.

Timeline of plan progress:

July 31, 2018 – GPRE acquired the Bartlett Cattle Company for $16m, plus $109m in working capital, increasing GPRE’s cattle feeding operations by 38% to 355,000 head of capacity.  This acquisition dramatically boosted GPRE’s ability to further supply their internal demand for the distillers grains and corn oil they produce, delivering more stable and consistent earnings.

October 10, 2018 – GPRE agreed to sell three of its ethanol plants to Valero for $300m in cash, plus $28m in working capital, representing ~20% of their reported ethanol production capacity.

October 25, 2018 – GPRE announced the sale of Fleischmann’s, their food-grade industrial vinegar operations, for $350m in cash.

November 15, 2018 – GPRE announced the permanent closure of its Hopewell, Virginia ethanol facility, removing unnecessary capacity from its asset base and lowering its cost structure.

November 28, 2018 – GPRE announced the entire repayment of its senior secured term loan, leaving the entire remaining asset base unencumbered from term debt for the first time in the company’s history.

December 12, 2018 – GPRE invested further in its high-protein process business by forming Aquafeed, a 50/50 JV targeting aquaculture producers globally.

To summarize, in the six months since management announced its portfolio optimization plan, GPRE has eliminated the entirety of its term debt by divesting non-core ethanol production facilities and its vinegar operations, and it has reduced the volatility of its earnings by acquiring a cattle feed business, taking total non-Ethanol EBITDA to over 50% of total company EBITDA, yet the stock is 25% lower since the announcement of this transformation.

Valuation –

Ethanol Production Facilities:

Some investors value this segment by making assumptions about capacity utilization and normalized crush margins, and then simply applying a multiple to the implied cash flows.  But the reality is that all ethanol asset sales are negotiated by buyers and sellers in terms of dollars/gallon of capacity. For example, GPRE gives buyers relevant operating and expense data, but does not give revenue or income associated with the assets.  Buyers must make their own assumptions about the prices at which they will be able to buy corn and sell ethanol. The price for GPRE’s ethanol assets recently sold to Valero were valued this way and it’s logical to apply a similar valuation method to GPRE’s remaining ethanol assets.

Non-core facilities –

GPRE is currently in discussions with six parties for the sale of 2 or 3 additional ethanol production facilities that represent ~180m gallons of capacity, or 16% of GPRE’s total capacity.  The specific assets GPRE will likely divest represent “A,” “B,” and “C” quality plants and reflect a similar mix to what they just sold to Valero. It follows that we should expect a similar price per gallon for these assets.  Note that the assets sold to Valero were sold at $0.74/gallon after giving effect to the acquisition from the MLP of the storage/transportation assets associated with these plants.  Before such adjustments the previously sold plants were sold at a price of $1.17/gallon.

At a multiple of 7x base case cash flow, the above valuation implies a crush margin of $0.12 and 90% capacity utilization.  Management has expressed a high level of confidence that these sales will be wrapped up in the next 4 months.

Remaining core facilities –

GPRE will be left with roughly 950m gallons of capacity, but what remains will, on average, be of a higher quality than what was divested.  All things being equal, the overall crush margin will be better after the divestitures than it was before. This is a function of several characteristics of the remaining assets, including suitability for high quality protein production and geographic access to export markets.

Agribusiness / Energy Segment:

Management has guided to 2019 EBITDA of $30-35m.  $40m of working capital financing is tied to this business at LIBOR + 300bps.  Treating the interest expense as an operating expense yields $25-32m in pre-tax income.

Food & Ingredient Segment:

For all intents and purposes, GPRE’s cattle feedlot operations represent the bulk of this segment.  In an effort to further correct the misleading optics of high leverage, management announced on the Q4 conference call their intention to explore the possibility of removing the substantial working capital lines tied to this business off the balance sheet by selling at least 51% of this business into a JV.  These assets always trade on replacement value per head. GPRE owns 355,000 heads, and while a good rule of thumb is $250/head, management believes their cattle could fetch slightly more. Adding the $50-60m in additional equity that GPRE invested into this business in order to access the required working capital lines yields roughly $140m in value for this business.

Green Plains Partners:

I value GPRE’s MLP at its current market price * the units owned by GPRE.  One could argue the market is currently undervaluing the units themselves but I use the current price for simplicity.

On 11/15/18, GPRE announced the closure of its Hopewell, VA ethanol facility.  GPRE originally paid $18m for this facility and management believes that even in the current environment they will get slightly more than that back.  They have already begun the process of liquidating and expect to update the market on this concurrently with an announcement of further ethanol facility sales.

Unallocated corporate expenses:

Corporate SG&A is now run-rating at $34-36m / year, down from $44m a few years ago.

Share count / Net Debt:

I’m using 42.7m fully diluted shares, which includes restricted stock, treats options using the treasury stock method, and treats the convertible notes as debt since they are out of the money.  Out of net debt I have stripped the NCI and working capital lines associated with the MLP, the cattle feelot business, and the agribusiness / energy segment, as GPRE would not have to repay the revolvers tied to those segments in a sale.

Putting it all together:

Material additional upside comes in the form of several free or cheap call options on growth / cost initiatives currently underway:

1) Fluid Quip technology and associated crush margin uplift

GPRE has identified a new technology that will increase the value of the co-products of distillers grains by enabling GPRE to produce a high-protein feed ingredient ideal for the aquaculture, pet food and poultry industries.  The economics of this technology will require a modest capital outlay and add $0.12 to $0.20 per gallon of margin as a starting point to GPRE’s current structure with payback ranging from one to three years.

GPRE is currently installing this technology at its Shenandoah plant and expects it to be operational in the fourth quarter of this year.  Below is an illustrative analysis of the incremental earnings power associated with this technology, easily worth an additional ~$5/share in value today and not included in my above valuation.

2) Opex Equalization Project –

Roughly half of GPRE’s ethanol capacity is currently located in plants using non-ICM technologies, which are less cost effective.  Management has identified a “game-changing” cost saving initiative at these plants that will require a one-time investment of between $0.10 and $0.18 per gallon of capacity, depending on the location, and narrow the existing cost spread of $0.08 to $0.09 per gallon to be almost equal to that of their best plants.

IR has told me that this initiative, which has received very little attention on earnings calls, offers a lower cost per gallon investment with a likely faster payback window than the Fluid Quip high protein feed technology, and management is very excited about it.

Company engineers are currently finalizing the plans to execute the first project to prove to the market this works and will subsequently roll this out to the rest of their facilities.

3) Aquaculture JV –

GPRE recently announced a JV with a feed company targeting the recreational fish marketplace.  Minimal capital from GPRE will be invested (less than 7 figures) and the payback could be meaningful and very fast, and at the very least help GPRE grow their distribution channels for high quality distillers grain.  I think of this as an interesting option to which I ascribe no value.

Catalysts –

- Sale of 2-3 additional ethanol facilities, providing still more proof of the value of these assets even in today’s challenging ethanol markets.  Expected by June.

- Announcement of the sale of 51% of the cattle feedlot operations to a JV partner and the removal of >50% of GPRE’s debt from the balance sheet.  Expected by June.

- Receipt of RVP waiver allowing the unrestricted sale of E-15 fuel year-round in the U.S.  Expected imminently.

- Trade deal with China and the immediate resumption of ethanol exports to China.  Expected within the next 2-3 months but could come anytime.

- Substantial increase to share repurchase authorization or tender offer.  The sale of additional ethanol facilities and a majority stake in the cattle feedlot business would yield ~$200m in proceeds.  The resulting balance sheet would put GPRE in a net cash position with enough liquidity to repurchase over 70% of the current market cap.  Some of the cash is earmarked for the above Fluid Quip technology and Opex Equalization Program mentioned above, but management is acutely aware of the dislocation in the stock and is eager to ramp up share repurchases once these transactions close.  It’s worth noting that the CEO and CFO together bought $2m worth of stock a little over a year ago at prices higher than the current quote. Expected with the sale of additional ethanol assets (June 2019).

- Simplified reporting structure.  On the Q4 earnings call, management indicated a plan to simplify their reporting structure, likely collapsing the Agribusiness / Energy segment into the Ethanol segment.  This will eliminate confusing intersegment eliminations and make the business easier for investors to analyze. Expected with Q1 2019 results.

Conclusion –

While there are currently a lot of moving pieces in this business, in a few months GPRE will have:

- a simplified capital structure with very little debt left on the balance sheet

- higher quality (read: higher margin) ethanol assets than their historical mix

- a more favorable supply/demand balance in the ethanol industry

- diversified cash flow streams from more stable businesses and reduced earnings volatility

- >50% of EBITDA coming from non-ethanol businesses

- more efficient / higher margin non-ICM plants

- a high-protein feed business that substantially increases overall crush margins

- significantly fewer shares outstanding

The current stock price gives no credit for any one of these changes, let alone all of them together, and investors today can acquire this underappreciated collection of assets for less than 50% of tangible book value and pay nothing for several valuable call options on events likely to favorably impact the entire industry and GPRE in particular.

Catalyst

- Sale of 2-3 additional ethanol facilities, providing still more proof of the value of these assets even in today’s challenging ethanol markets.  Expected by June.

- Announcement of the sale of 51% of the cattle feedlot operations to a JV partner and the removal of >50% of GPRE’s debt from the balance sheet.  Expected by June.

- Receipt of RVP waiver allowing the unrestricted sale of E-15 fuel year-round in the U.S.  Expected imminently.

- Trade deal with China and the immediate resumption of ethanol exports to China.  Expected within the next 2-3 months but could come anytime.

- Substantial increase to share repurchase authorization or tender offer.  The sale of additional ethanol facilities and a majority stake in the cattle feedlot business would yield ~$200m in proceeds.  The resulting balance sheet would put GPRE in a net cash position with enough liquidity to repurchase over 70% of the current market cap.  Some of the cash is earmarked for the above Fluid Quip technology and Opex Equalization Program mentioned above, but management is acutely aware of the dislocation in the stock and is eager to ramp up share repurchases once these transactions close.  It’s worth noting that the CEO and CFO together bought $2m worth of stock a little over a year ago at prices higher than the current quote. Expected with the sale of additional ethanol assets (June 2019).

- Simplified reporting structure.  On the Q4 earnings call, management indicated a plan to simplify their reporting structure, likely collapsing the Agribusiness / Energy segment into the Ethanol segment.  This will eliminate confusing intersegment eliminations and make the business easier for investors to analyze. Expected with Q1 2019 results.