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Pacific Ethanol's Aventine Acquisition Begins To Pay Off


Ethanol producer Pacific Ethanol's share price has surged over the last six months as rising ethanol prices and a continued ethanol price premium have caused operating margins to rebound.

The company's outlook is attractive due to strong domestic and international demand, the backstop provided by the U.S. biofuels mandate, and a favorable corn harvest forecast.

The company's shares are no longer undervalued relative to future earnings, however. New investors should require such a discount given the share price's historical volatility.

Current investors are encouraged to maintain their positions, but new investors should wait for a better buying opportunity before initiating long positions.

Ethanol producer Pacific Ethanol's (NASDAQ:PEIX) long-suffering shareholders have been granted some relief in recent months. The company's share price, which fell to a 2-year low in January as the price of petroleum plunged, has more than doubled in the subsequent six months and is approaching its 12-month high (see figure). In April, when the share price was trading for $4.46, I categorized the company as an attractive long investment opportunity on the grounds that its recent capacity expansion would translate into earnings growth as ethanol operating margins rebounded. The share price is 48% higher now, and while operating margins remain relatively low, the capacity expansion is already proving to be accretive. This article re-evaluates Pacific Ethanol as a long investment in the wake of its share price run-up and the Q2 earnings report's release.

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Q2 earnings report

Pacific Ethanol reported Q2 revenue of $423 million, a result that was 86% higher YoY and beat the consensus analyst estimate by $40 million. The company achieved record ethanol sales of 233.2 million gallons as the quarter marked the first Q2 period in which the Aventine capacity was included. Its production volume increased from 47.5 million gallons to 122.5 million gallons YoY, with the balance falling under its third-party sales program. The average ethanol sales price declined slightly from $1.76/gallon to $1.72/gallon YoY. Co-product sales increased by 84% over the same period in response to higher-than-expected prices, however, contributing to the solid revenue beat.

The company's cost of revenue increased from $221.4 million in Q2 2015 to $405.2 million in the most recent quarter, due to the higher production volume. While large, it should be noted that the acquisition's benefits are already showing up in the earnings: cost of revenue per gallon of production in the most recent quarter was $3.31/gallon, down sharply from $4.66/gallon YoY. While CBOT corn prices were higher on a YoY basis, the close proximity of the acquired capacity to the Midwestern markets caused the company's average corn cost to fall by 14% over the same period.

Pacific Ethanol's gross profit rose from $6.3 million YoY to $17.7 million YoY on the combination of higher gross margins and production volumes. This increase was partially offset by a sharp increase to interest costs by 580% over the same period to $6.5 million. It should be noted that this was a one-time occurrence resulting from Q1's uniquely poor operating conditions, which caused the company to capitalize its interest during the quarter so as to minimize its cash expenditure. Net income came in at $4.7 million, up from $0.7 million YoY, while diluted EPS increased from $0.03 to $0.11 over the same period to beat the consensus estimate by $0.14. The improved EPS result was especially notable given that the company's weighted shares outstanding increased by 70% YoY due to the Aventine acquisition, again indicating the expansion's accretive nature.

EBITDA came in at $20.4 million compared to $5.4 million in Q2 2015. EBITDA per gallon of ethanol produced increased by 55% over the same period, from $0.11/gallon to $0.17/gallon. The industry-wide average crush spread rose from $0.17/gallon to $0.21/gallon, or an increase of 24%, indicating both Pacific Ethanol's weaker initial position in the West Coast as well as the benefits of its expansion into the Midwest. The company ended the quarter with total cash of $31.7 million...