Green Plains Wrestles With Weak Ethanol Margins in Q1
Ethanol leader Green Plains (NASDAQ: GPRE) significantly curtailed production in the first quarter, but not even that could blunt the effect of historically weak margins in the industry. The business lost money in its ethanol segment and struggled to make up the difference elsewhere. The result: a gross margin of just 0.7%.
Management expressed confidence that the worst is now behind the American ethanol industry and promised to increase utilization rates across its manufacturing fleet to over 90% in an effort to reduce per-gallon operating expenses. It also introduced a new, 18-month initiative that could enable Green Plains to achieve operating expenses of just $0.24 per gallon. Can investors have confidence that better days are ahead?
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By the numbers
Green Plains kicked off a portfolio optimization plan in 2018 that delivered quick results. The ethanol leader divested manufacturing assets and its vinegar business, then used the proceeds to repay a $500 million term loan. That significantly improved the balance sheet and left the company with only about $200 million in convertible debt, which is especially important for improving financial flexibility in the low-margin ethanol industry.
The reduced asset base, coupled with significantly reduced production runs in Q1 2019, doesn't create a smooth comparison to last year. However, weaker margins in Q1 2019 played a significant role, as evidenced by the fact that profit declined more than gallons sold.
While nonethanol segments typically offset poor performance for the core business, Green Plains waded through unusual weakness in its cattle feedlot business. The company sold 127,000 head of cattle in Q1 2019, compared to 137,000 in the prior-year period. Severe winter weather events and weak margins drove the decline, although the business believes the headwinds will be temporary. Management projects $50 to $60 EBITDA per head in the second half of this year.
Weak margins aren't really news for investors at this point, but the company is looking to do what it can on that front. Green Plains has linked up with ICM, an engineering firm that specializes in ethanol-manufacturing optimization, to drive its segment operating expenses to $0.24 per gallon of ethanol produced over the next 18 months. That would make it one of the lowest-cost producers in North America. Considering ICM's technology and know-how produce 8.8 billion gallons per of ethanol globally each year, investors should have a high degree of confidence in the new initiative.
As for the previously announced technology upgrades aimed at increasing protein production, there's a little more uncertainty. The first ethanol facility to use the technology is expected to boot up the improvements in Q4 2019 and additional projects could be introduced in 2020. While management thinks focusing on higher-quality protein production could drive $0.12 to $0.15 per gallon improvement in EBITDA, the current timeline suggests it will take years to learn of the program's success.
The road ahead will be challenging
Investors might expect operations to continue to struggle for the foreseeable future. The plan to run facilities at full throttle to more evenly distribute operating expenses across a larger number of gallons could backfire if selling prices don't increase from near-historic lows. Given the political factors dictating prices, there's a good degree of uncertainty regarding the direction of market fundamentals. The new partnership with ICM is a big step toward more profitable ethanol production, but it's going to take time to implement. Therefore, investors will need to remain patient if they want to be committed to the ethanol leader.
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