Bio Fuels sector
Alternative energy sectors such as solar and wind energy are pretty well established. But in bio fuels the entrepreneurial creative destruction is running full blast. This is where creativity is at a premium and not barriers to entry, although capital to start pilot plants is always a significant hurdle.
There is a great diversity of possible ressources to make the fuel : corn, sugar cane, algae, animal fat, wood by-products, etc...
The final energy product varies from technology to technology, ethanol produced from corn is corrosive, making it difficult to convey it through metallic pipelines. Even the storage tanks of gas stations have to be replaced with composite materials that are not corroded by the ethanol additives to standard car fuel. ZCL composites (ZCL-T) is said to be an interesting stock for that matter. They produce fiberglass storage tanks that are not subject to ethanol corrosive effects. The stock has increased 6X in 5 years. PE of 49 is rather high but so is EPS growth of 32% per year in the last 3 years making a relatively reasonable PEG of 1,5. Price to book of more than 4 is also high. Dividend has grown 29% in the last 3 years to reach 0,10 $ but the yield of 0,9% is still minimal with a 11$ stock price. The analyst consensus is that ZCL should be a strong buy.
Tricast is not compelled to buy in at current ratios. There is talk of further acquisitions and the management seems to be adept. Our problem is that the ethanol story might be more complex than what we think. The diversity of non-corrosive ethanol sources might decrease the need for composite storage tanks. The tank buyers might adopt a wait and see attitude to see what technology will become the standard. There might be a backlash from the environmental lobbies that are already saying that ethanol from food sources is not a neutral technology regarding green house emissions.
That is probably why the cellulose file for producing ethanol is being considered by small R&D ventures but also by large agro-food businesses such as Archer Daniels Midland, (ADM-N)
ADM (33$)
At 21,3 B $ market cap ADM is certainly not a start-up. Dividend yield of 1,39% is not really exciting. The PE ratio of 10 is at its lowest since 5 years. Price to book at 1,9 is nice to look at for a business of that size and the Price to cash flow at 7,46 is quite attractive too. The PEB is 19 which is inferior to our trigger ratio of 22,5. At 33,49% the EPS growth gives a PEG of 0,29 also a good bargain sign.
Debt to Equity is 0,47 which is a bit higher than a 0,2 safer norm.
Why such bargains?
Most probably the pressure of lower ethanol prices that are lowering EPS estimates for 2007 and 2008. Still 2009 earnings estimates average 3$. Let say that the PE ratio would come back to a more normal level of 15, the stock should be worth 45$ in the next 2 years. The highest PE in the last 5 years was 26 and the sector norm is close to 21, so were not blowing too much wind in the expectation baloon. Still the undervaluation of the stock is closer to 30% than our 50% trigger buying rule.
Is there some development that might give us more incentives to look at this stock with a more favourable eye?
On September 27th ADM announced its joint-venture with Conoco for a next generation biofuel project where biocrude would be produced from cellulosic materials such as wood or corn husks. The move looks logical because corn prices have doubled since last year while ethanol prices went down 25% from 2$ to 1,50 $ from January to September. The R&D project should cost 10 M$ per year for the next 5 years a respectable sum. More important the risk is shared with an energy firm with all the mass refinery know-how. It is a strong signal that this technology has enough potential for two titans to do joint research projects, considering the not so favourable odds of joint-ventures. The goal is of course to produce biofuels that can be supplied through the actual pipeline infrastructure.
Of course the reseach is long term so it should not be bringing any value to the stock in the near term. The price fall has been brought by the start-up of large refining capacity all at once, bringing a 57% increase in industry capacity in 2007. Citigroup expects ethanol capacity to increase by another 49% in 2008 but the growth will come down to a more mature 13% in 2009 where prices will stop to fall.
There is a great diversity of possible ressources to make the fuel : corn, sugar cane, algae, animal fat, wood by-products, etc...
The final energy product varies from technology to technology, ethanol produced from corn is corrosive, making it difficult to convey it through metallic pipelines. Even the storage tanks of gas stations have to be replaced with composite materials that are not corroded by the ethanol additives to standard car fuel. ZCL composites (ZCL-T) is said to be an interesting stock for that matter. They produce fiberglass storage tanks that are not subject to ethanol corrosive effects. The stock has increased 6X in 5 years. PE of 49 is rather high but so is EPS growth of 32% per year in the last 3 years making a relatively reasonable PEG of 1,5. Price to book of more than 4 is also high. Dividend has grown 29% in the last 3 years to reach 0,10 $ but the yield of 0,9% is still minimal with a 11$ stock price. The analyst consensus is that ZCL should be a strong buy.
Tricast is not compelled to buy in at current ratios. There is talk of further acquisitions and the management seems to be adept. Our problem is that the ethanol story might be more complex than what we think. The diversity of non-corrosive ethanol sources might decrease the need for composite storage tanks. The tank buyers might adopt a wait and see attitude to see what technology will become the standard. There might be a backlash from the environmental lobbies that are already saying that ethanol from food sources is not a neutral technology regarding green house emissions.
That is probably why the cellulose file for producing ethanol is being considered by small R&D ventures but also by large agro-food businesses such as Archer Daniels Midland, (ADM-N)
ADM (33$)
At 21,3 B $ market cap ADM is certainly not a start-up. Dividend yield of 1,39% is not really exciting. The PE ratio of 10 is at its lowest since 5 years. Price to book at 1,9 is nice to look at for a business of that size and the Price to cash flow at 7,46 is quite attractive too. The PEB is 19 which is inferior to our trigger ratio of 22,5. At 33,49% the EPS growth gives a PEG of 0,29 also a good bargain sign.
Debt to Equity is 0,47 which is a bit higher than a 0,2 safer norm.
Why such bargains?
Most probably the pressure of lower ethanol prices that are lowering EPS estimates for 2007 and 2008. Still 2009 earnings estimates average 3$. Let say that the PE ratio would come back to a more normal level of 15, the stock should be worth 45$ in the next 2 years. The highest PE in the last 5 years was 26 and the sector norm is close to 21, so were not blowing too much wind in the expectation baloon. Still the undervaluation of the stock is closer to 30% than our 50% trigger buying rule.
Is there some development that might give us more incentives to look at this stock with a more favourable eye?
On September 27th ADM announced its joint-venture with Conoco for a next generation biofuel project where biocrude would be produced from cellulosic materials such as wood or corn husks. The move looks logical because corn prices have doubled since last year while ethanol prices went down 25% from 2$ to 1,50 $ from January to September. The R&D project should cost 10 M$ per year for the next 5 years a respectable sum. More important the risk is shared with an energy firm with all the mass refinery know-how. It is a strong signal that this technology has enough potential for two titans to do joint research projects, considering the not so favourable odds of joint-ventures. The goal is of course to produce biofuels that can be supplied through the actual pipeline infrastructure.
Of course the reseach is long term so it should not be bringing any value to the stock in the near term. The price fall has been brought by the start-up of large refining capacity all at once, bringing a 57% increase in industry capacity in 2007. Citigroup expects ethanol capacity to increase by another 49% in 2008 but the growth will come down to a more mature 13% in 2009 where prices will stop to fall.
posted by Pierre Castegnier @ 8:01 AM
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