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Weekend Investor
Ethanol Stocks Bust but Stay a Risky Buy
By HERB GREENBERG
March 15, 2008; Page B2

The good news for VeraSun Energy Corp., one of the country's largest ethanol producers: Its most recent quarter beat gloomy analyst estimates.

The bad news: Even with the better-than-expected results, profit for the fourth quarter tumbled 81% as the economics of ethanol (for the time being, at least) remained upside down.

Such is life in what had been the fast lane of an industry that emerged on Wall Street several years ago on a wave of corn-fed momentum after decades of a quiet life back home in the Midwest.


It has since been a classic boom-to-bust stock story, with shares of anything remotely related to ethanol trading at a fraction of what they had been at their highs, which for most was the day they went public during a frenzy that lasted from the summer of 2006 to early 2007.

Analyst Mark Miller of William Blair & Co. perhaps summed it up best on VeraSun's fourth-quarter earnings call this past week when he commented, "This is the first conference call where the stock has traded below book value." The same could be said for the other major ethanol pure plays: Aventine Renewable Energy Holdings Inc., Pacific Ethanol Inc. and US BioEnergy Corp., which is about to merge with VeraSun.

Mr. Miller, in noting the below-net-worth value, wondered whether management had anything to say about the stock's slide, since it implied "you are not going to earn your cost of capital...." Chief Executive Don Endres, who founded the South Dakota company and whose family has been in farming for generations, responded that he believed "there is a lot of misinformation that's out there" that has scared small investors, which he believes is "unfortunate, because this has so much potential."

That, as you might have heard, is subject to much debate. Ethanol's from-out-of-nowhere boom was tied almost exclusively to its use as a replacement to methyl tertiary-butyl ether, a gasoline additive that had been proved to be a carcinogenic groundwater pollutant. "These guys IPO'ed when corn was $1.80 to $1.90 [a bushel] and ethanol was $4.50 a gallon because of a shock to the system: The momentary disconnect when MTBE fell off," says Ian Horowitz, an analyst for Soleil Securities. "If I'm Valero, I don't care what I have to pay for a replacement product, I just know I have to get it in. It wasn't a pricing decision."

Now, with corn at $5.64 a bushel and ethanol at about $2.60 a gallon, he says "it's all digested and worked through," which means ethanol becomes just another commodity. Modern refiners typically can produce about 2.8 gallons of ethanol from a bushel of corn. Like any commodity, Mr. Horowitz adds, ethanol is dictated by its own set of variables over which it has no control: oil, corn, natural gas and the spread between ethanol and gasoline.

There also are uncertainties over future government mandates for the use of ethanol, subsidies to refiners for using ethanol, the possibility that tariffs on imported ethanol will be reduced or eliminated and a host of other concerns that have cropped up lately.

"There are a lot of emotional issues people raise," Mr. Endres, VeraSun's CEO, told me by phone. Ethanol, he says, is now "10% of the fuel industry, so we're up on the radar of a whole lot of groups that have a large amount of resources that they can use to push against us."

He believes that other worries, such as high corn prices and overcapacity, will work themselves out in the next year or two. "We're forging new ground and a new world in energy prices," he says. "We believe this is a new business opportunity."

Maybe it is, but a bigger question is whether at these prices ethanol stocks are the bargain they appear to be. Soleil's Mr. Horowitz -- who was publicly dubious of most ethanol companies before they went public -- doesn't think they are. He believes a safer approach is through diversified agricompanies such as Archer Daniels Midland Co. or Andersons Inc.

If ethanol goes bad, "it implies some other part of their business is working very well," he says. "They don't care if they're making money in biodiesels or ethanol." Too risky, they no doubt realize, to bet the farm on.