Markets & Finance

Too Much Ethanol?


Ethanol stocks take a beating after Banc of America -- seeing huge capacity -– lowers its view on a few names in the group

The U.S. push for more ethanol has been heard loud and clear – an average of 1 billion gallons of new capacity is scheduled to come online each quarter through the fourth-quarter of 2008, according to Banc of America Securities.

That enormous supply threatens to erode ethanol's economic advantages, says analyst Eric Brown, who on May 31 cut the firm's ratings on Pacific Ethanol (PEIX), Aventine Renewable Energy Holdings (AVR), and VeraSun Energy (VSE ) to sell from neutral. He also moved Andersons (ANDE) down to neutral from buy.

"We believe new ethanol supply will depress ethanol's premium to gasoline, drive corn prices higher, and pressure distillers grains values," Brown said in a research note. He pointed out that since January, record gasoline prices have led to 30% expansion in ethanol prices and a 180% increase in production margins.

Brown expects a relentless supply of new ethanol production capacity to lead to a 70% decline in margins by 2009. In turn, he forecasts ethanol production EBITDA margins will decline to $0.22 per gallon by 2009, from $0.76 per gallon.

He also said he expects the new ethanol supply will depress ethanol's premium to gasoline, which has averaged $0.50/gallon historically. He now forecasts average ethanol premiums of $0.24/gallon in 2007 and $0.25/gallon in 2008.

Brown reduced his earnings per share estimates for this year and 2008 for the four companies, as well as his price targets for the stocks, based on lower expected ethanol premiums and lower distillers grains values amid the tremendous new supply.

Shares of Pacific Ethanol skidded 6.7% to $13.22, Aventine Renewable Energy Holdings was off 7.6% to $16.80, and VeraSun Energy lost 8.5% to $15.23. All three of these stocks have tumbled 50% to 60% from their 52-week highs hit last spring. Andersons edged down 2.2% to $39.18 – it's off 28% from its 52-week high hit last June.

Brown, along with some other analysts on Wall Street, have turned a cold shoulder to ethanol stocks. While demand for ethanol is hot as an alternative fuel, analysts worry that too much supply will be coming on the market (see BusinessWeek.com, 5/9/07, "Rising Fears of an Ethanol Bust"). Archer-Daniels Midland (ADM), the largest U.S. ethanol producer, reported disappointing quarterly earnings on May 1, citing higher corn costs. Plus, experts say there aren't enough pipelines running to transport ethanol around the country. Instead, ethanol is transported mainly by railroads, which for the most part run to major metropolitan areas.

McCormack is senior producer for BusinessWeek.com's Investing channel.

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