PSB Monthly Issue February 2013
February 2013
There are several commonly discussed themes that have come about from Obama winning a second term.
Of course, we hear plenty about taxes and the deficit. Gun control also makes headlines frequently.
However, what many don’t realize is how the Obama administration is extremely pro renewable energy.
In fact, the government just increased the required use of several types of renewable fuels for 2013 – fuels such as biodiesel.
The new EPA standard requires the production of 1.28 billion gallons of biomass-based diesel fuel, up from 1 billion gallons in 2012. Other forms of biodiesel are also seeing an increase.
Why’s the EPA so keen on these increases?
A big part of the reason is the government wants to replace corn-based ethanol with other types of biofuels.
You see, there’s been quite a backlash against using corn as a main feedstock for biofuels. It tends to distort the price of the commodity, and can raise food prices for everyone.
That’s great news for biodiesel, which not only meets the EPA guidelines, but also can be made from many different types of feedstock.
What’s more, the market for biodiesel is already huge – at over 54 billion gallons.Clearly, there’s huge opportunity for growth for companies in the biodiesel space.
One such company is Renewable Energy Group (NASDAQ: REGI).
Name: Renewable Energy Group Ticker Symbol: REGI Market Cap: $225 million Recent Price: $7.40 PSB Rating System 4.8 Stars Raging Revenue: (4.8 stars) Revenues increased 26% year over year this past quarter. With the increased government mandate on biodiesels, sales should continue to rise. Beautiful Books: (4.6 stars) REGI has $88 million in cash and a solid current ratio of 2.9x. The company has plenty of cash and cash flow to cover its debt obligations. Stellar Structure: (5.0 stars) Institutional ownership is off the charts at 94.5%. That doesn’t leave much room for insider ownership, but they still hold 1.3% of the float. Valuation Verification: (4.9 stars) REGI is trading at just 1.2x earnings, 8.9x projected earnings, and 0.67x book value. Meaningful Milestones: (4.7 stars) REGI is the largest biodiesel company in the country and continues to benefit from EPA regulations. The company is aggressively expanding its production capacity. |
THE BIODIESEL BUSINESS
Renewable Energy Group produces biodiesel for the US and Canada. The company focuses on converting natural fats, oils, and greases into advanced biofuels.
REGI is the largest biodiesel producer in the US. It has a production capacity of more than 225 million gallons, with more on the way. That includes six plants in production and three partially completed. Plus, the company also has several important customer relationships already in place.
Here’s what we like about REGI…
First off, Renewable Energy owns its entire vertical. They have a fully integrated biodiesel platform – from start to finish. The company handles everything from the R&D to feedstock procurement to distribution.
That means the company’s entire business model is almost entirely controlled by the company itself. There’s far less of a chance of something unexpected occurring and derailing REGI’s expected production for any given quarter.
And that’s not all…
REGI’s biodiesel is ready to be used off the shelf. Its drop-in-fuel is compatible with existing diesel infrastructure. Nothing has to change for the product to be used – customers just grab it and go.
What’s more, Renewable Energy’s biodiesel can be produced from a wide range of feedstock types. These include used cooking oil, soybean oil, inedible corn oil, edible tallow, and choice white grease.
The benefit of having such a diverse group of raw materials to choose from is that the company can focus on (and shift to) using the materials that are the least expensive. And, they can do so without sacrificing the quality of the product.
Finally, as I mentioned earlier, with the government pushing the use of biodiesel, there’s built-in demand for REGI’s products. And, it’s not going to go away anytime soon.
In fact, there’s pretty much a guarantee that biodiesel demand will only increase in the coming years.
Now let’s take a look at the numbers…
THE NUMBERS
REGI’s vast potential can be easily seen by looking at the company’s most recent quarterly results.
Quarterly revenues hit $323 million, a 26% year over year climb. That’s on the strength of 62 million gallons of biodiesel sold – up 40% year over year. Higher production capacity was one factor contributing to the company’s revenue growth.
Adjusted EBITDA came in at a $2.3 million loss. However, the loss is primarily due to accounting for risk management positions. It’s not the sort of thing that we’d expect to see moving forward. Not to mention, the company posted positive cash flow from operations to the tune of $6.2 million.
Moreover, REGI boasts a strong balance sheet.
The company holds nearly $90 million in cash compared to $76 million debt. Plus, current assets are a solid 2.9x current liabilities. With that kind of cash holding, REGI is in a strong position to make savvy acquisitions should the opportunity arise.
INVESTMENT RISKS
As with any investment, REGI does have a few risks.
The biodiesel industry does have a fair bit of competition. If other companies take a portion of REGI’s business, revenues and income could fall.
Also, if a better alternative to biodiesel comes out, consumers could switch to the alternative, hurting REGI’s business.
Finally, if Congress or the EPA make any changes to current regulations, it could also impact the revenue and profit potential of REGI.
POTENTIAL RETURN OF 100% OR MORE
Despite a proven business model, built-in demand, and strong revenue growth, REGI is extremely undervalued by the market.
With a price to equity (P/E) ratio of just 1.2x, REGI is trading well below the industry average right now. The industry trades at far higher 12.7x.
But that’s not all…
The shares are trading at just 8.9x projected earnings, 0.67x book value, and 0.21x revenues. Any way you slice it, the stock looks to be severely mispriced by the market.
Now, we don’t expect REGI to go up 1000% overnight. However, it’s very reasonable to assume, given the price ratios, that the stock could double.
With the government strongly in favor of biodiesel usage and REGI’s continued growth, the company is clearly headed in the right direction.
Based on our analysis, we see REGI trading up over $14.80 a share. Buy REGI shares now for potential gains of 100% or more!
ACTION RECOMMENDATION
BUY Renewable Energy Group (NASDAQ: REGI) up to $8.15 per share.
Recent price is $7.40
Use a stop-loss of $6.25 on this position.
Don’t forget your position sizing and stop-loss rules.
Despite the challenging fundamentals, savvy investors should not be ignoring natural gas. Yes, it’s been a rough road for the commodity many think will displace oil as the country’s most popular source of energy.
If you had invested in natural gas a year ago, you’d be down roughly 11% today. (Although, if you invested in it a month ago, you’d be up over 4%.) Nevertheless, ignore natural gas stocks at your own peril.
The long-term opportunity is simply too lucrative to brush aside. While it would be ideal for the country to only have to rely on renewable energy resources, it’s just not going to happen anytime soon.
In the meantime, cheap, abundant, and locally produced natural gas is the obvious successor to oil.
Of course, there are problems to overcome before natgas production companies become a shoe in for most investors’ portfolios.
We are seeing an extreme natgas inventory glut right now for one. What’s more, fracking has come under fire for significant environment concerns. Finally, the efficiency of converting and transporting natural gas has been questioned.
Okay, so those issues are all important. And, they need to be addressed.
Here’s the thing…
The issues with natural gas are almost entirely short-term in nature.
The glut in natgas inventories will diminish once there are more widespread options for its use – such as a transportation fuel. Regarding fracking, the industry appears to be working towards cleaner solutions – with nontoxic fracking chemicals being developed by companies like Haliburton (HAL).
Moreover, infrastructure costs and conversion technologies are in the process of being improved. The more important natural gas becomes, the more resources will be spent on improving the business chain.
That being said, many natural gas producers are trading at rock bottom prices. With the commodity super cheap and demand at lower levels, the industry has suffered in terms of stock prices.
But, that’s exactly when we should buy. If we wait until natgas is all the rage, it will be too late. Now’s the perfect time to snap up a solid, natural gas producer trading at bargain basement prices.
That’s why we’re recommending Crimson Exploration (NASDAQ: CXPO).
Name: Crimson Exploration Ticker Symbol: CXPO Market Cap: $139 million Recent Price: $3.17 PSB Rating System 4.6 Stars Raging Revenue: (4.9 stars) CXPO posted a 6% year over year gain last quarter. For a company still in the development stage, that’s great news. Beautiful Books: (4.2 stars) The company’s debt isn’t nearly as high as others in the industry. Plus, they have plenty of cash flow and access to a revolving loan. Stellar Structure: (4.8 stars) Institutional ownership is very strong at 52%. Moreover, insiders own a solid 19%. Clearly, the smart money has a lot invested in CXPO. Valuation Verification: (4.5 stars) CXPO is well off its 52-week highs. Not to mention, the shares are trading below book value. That’s almost always a sign of mispricing. Meaningful Milestones: (4.7 stars) Crimson’s management is shifting their focus to produce more liquids. A heavier weighted liquids portfolio will help with cash flow. As of this past quarter, liquids now make up over 50% of production. |
THE NATURAL GAS PRODUCTION BUSINESS
Crimson Exploration is engaged in the exploration, development, and acquisition of natural gas and crude oil, primarily in onshore regions of the US. The company currently owns and operates properties in Texas, Louisiana, Colorado, and Mississippi.
CXPO primarily produces natural gas, however it does drill for crude oil. As of the most recent data, the company’s estimated total proved reserves were approximately 162.7 billion cubic feet of natural gas, 3.7 million barrels of oil, and 2.5 million barrels of natural gas liquids (NGLs).
NGLs are a nice bonus to the CXPO’s drilling operations because they trade at a substantial premium to non-liquefied natural gas. Moreover, producing crude oil is a good way to generate stable cash flows while the natural gas market develops.
Essentially, the more liquids Crimson produces at this point in time, the better.
As a matter of fact, that’s exactly what Crimson management is focusing on in the short-term.
The company is transitioning towards a liquids-heavy production profile. Between crude oil and NGLs, CXPO should generate enough cash flow to develop several of its most important properties.
Management is also shrewd enough to limit their capital expenditures to the amount of free cash flow generated. They aren’t trying to rush to profitability. They’re going for an intelligent path to growth.
Crimson’s management also uses significant hedging against production. As such, they aren’t likely to experience any significant downside surprises.
All in all, it’s easy to see why Crimson is headed for success. Management is doing things the right way.
THE NUMBERS
With a production and exploration company like Crimson, profits aren’t something investors should focus on. The majority of operational cash flow will be reinvested in the company’s properties and equipment.
The key to picking a good production company is to find one already producing positive cash flow from operations. Plus, it helps if the company isn’t completely buried in debt.
On those fronts, CXPO looks to be in very good shape.
In the most recent quarter, revenues climbed 6% year over year to $30.8 million. The number was boosted by the increased focus on liquids production, which rose 49% from the same period last year.
As I mentioned before, profitability isn’t all that important right now for Crimson. While the company has losses, it’s not far from profitability. In fact, one analyst has the CXPO becoming profitable in 2013.
Meanwhile, the company is consistently operating income positive. Interest on debt and hedging activities are the main reason CXPO isn’t showing a profit just yet.
In regards to debt, Crimson has a decent looking balance sheet for an early stage production company.
You see, many production companies have a ton of debt – in the billions. Now, CXPO does have $241 million in debt compared to no cash to speak of. However, in comparison to peers, that’s hardly a red flag.
Moreover, none of the debt has a short-term maturity. And, Crimson has a $100 million revolving loan available. That’s also the reason the company doesn’t need to carry cash on hand.
From a financial perspective, that’s about as good as a company in Crimson’s situation is going to look.
INVESTMENT RISKS
If other forms of energy become as accessible as natural gas, it could slow demand for CXPO’s products.
The potential for higher interest rates could make the company’s debt more expensive to hold and hurt the bottom line.
Finally, CXPO does face a fair amount of competition. If the company doesn’t stay competitive, other firms could draw away business.
POTENTIAL RETURNS OF 45% OR MORE
Despite not being profitable, CXPO is still trading at rock bottom prices.
The shares are priced at just 0.88x book value. That means if the company was broken apart and sold in pieces, it would be worth more than it is now. That’s pretty crazy if you ask us – especially with the company’s huge amount of proven reserves.
Based on our analysis, we could easily see the shares return to their 52-week high of $5.69. That’s a 45% gain. Plus, that’s just our conservative estimate.
If something meaningful happens with natural gas (such as Congress mandating it be used as a transportation fuel), Crimson’s stock could skyrocket.
Buy CXPO shares now for potential gains of 45% or more!
ACTION RECOMMENDATION
BUY Crimson Exploration (NASDAQ: CXPO) up to $3.60 per share.
Recent price is $3.17.
Use a stop-loss of $2.25 on this position.
Don’t forget your position sizing and stop-loss rules.
Here are some highlights from the past couple weeks…
- Five Star Quality Care (FVE), TravelCenters of America (TA), Cobra Electronics (COBR), Nautilus (NLS), Jinko Solar (JKS), Krispy Kreme Doughnuts (KKD), Culp (CFI), and Carriage Services (CSV) have all hit new highs!
- We’re moving Five Star Quality Care (FVE) from Buy to Hold.
- It’s time to Sell our shares in Hawaiian Holdings (HA).
Category: PSB Monthly Issues
