Description

Thesis
 
Renewable Energy Group (“REGI”) is the largest U.S. biodiesel producer and undeniably the cheapest stock I’ve come across in my professional investing career.  On 2-14, the Company disclosed that it would be receiving a $210Mn cash payment from the US government, equivalent to 50% of its current market cap.  The stock price was unchanged.  Post-payment, REGI’s EV will be $430Mn, implying that it is trading at just 1.4x my 2018 EBITDA estimate ($300Mn, 140% above the consensus $125Mn EBITDA estimate).  My 2018 FCF estimate is $236Mn, implying that REGI’s forward unlevered FCF yield is 58%.  This seems too good to be true, so why does the opportunity exist?  First, this is an illiquid company only covered by three analysts at small firms.  Second, the former CEO, who was replaced by the Board in 2017, made two bad acquisitions (since rectified) that obfuscated the attractive fundamentals of the core biodiesel business.  Third, biodiesel is an extremely difficult business to understand given its complex subsidized-nature (as an example, the industry operated at break-even throughout 2017 due to the very high likelihood of a year-end cash credit from the government, which happened).  My fair value estimate is $60/share (361% upside), derived by applying a 10x multiple to my $6/share ’18 FCF estimate.  Note that the only other public biodiesel company is Neste (Finland-based), whose biodiesel business trades at an implied 18x EBITDA vs. 1.4x for REGI.  A similar multiple would imply REGI’s fair value is $141/share (985% upside).
 
Industry Background
 
REGI is the largest U.S. biodiesel producer (~20% market share).  Biodiesel is a subsidized form of clean energy with demand underpinned by the Renewable Fuel Standard (“RFS”).  The RFS is a mandate that will be implemented through 2022.  In November 2017, the EPA finalized the 2018 biodiesel volume requirement at 2.1Bn gallons, implying a 7% CAGR over the trailing 5-year period.  Go-forward volumes will be determined on annual basis, with the preliminary ’19 target also set at 2.1Bn gallons.  I’m highly confident that this number at the very least represents a floor considerable given the mandate’s bipartisan support.  What better test to have than EPA Administrator Scott Pruitt, a critic of the agency itself who is trying to revive the coal industry, reaffirm the initial 2018 biodiesel mandate.  Unlike ethanol demand, which is currently stalled at 10% (a level that auto companies say will damage car engines), the biodiesel blend is <5% and represents a meaningful source of potential growth for farmers. 
 
RFS – Biomass-based Diesel (D4), Bn Gal
 
2014A     2015A      2016A      2017A       2018E      2019E
1.63         1.73         1.90          2.00           2.10          2.10      
 
In an extremely positive development, in December 2017 the ITC voted in favor that U.S. biodiesel producers were “materially injured” by imports of Argentinian and Indonesian biodiesel.  With final duties of 72% applied, these imports will be completely knocked-out of the market for the next 5 years (note that imports have already dried-up).  I do not believe investors fully comprehend the implications of this decision.  Imports have represented a meaningful portion of total U.S. biodiesel supply, with Argentina and Indonesia alone accounting for 20% of total supply.  As a result of these volumes exiting the market, I estimate that “the call on domestic supply” must increase from 1.7Bn gallons in 2017 to 2.2Bn gallons in 2018 (shown below).  According to the EIA, total domestic biodiesel capacity is only 2.2Bn gallons, implying a utilization rate of 100%.  You don’t need to be Adam Smith to realize that 2018 margins should be materially higher than the trailing 5-year average.
 
Biodiesel S/D Forecast                        2016A      2017A       2018E         
 
Demand:
   Biomass-based Diesel (D4)               1,900       2,000         2,100   
   Other                                                      587         869            883
   Total                                                   2,487      2,869         2,983
 
Supply:
   Call on Domestic Supply                     1,568       1,758         2,220
   Imports                                                1,330          777            777
   Total                                                    2,898       2,535         2,997
 
Variant View
 
Due to its scale and feedstock advantage, REGI has consistently generated a profit throughout its history as a public company.  The majority of biodiesel is made by “mom and pop” producers which use expensive soybean oil.  REGI, however, uses animal fats (as a result of significant investments) that trade at a substantial discount, thereby driving its consistently stable margins.  The following graph on the left shows that this feedstock spread has averaged $.24/gal since 2012.  As shown on the right, overall EBITDA/gal has averaged $.46/gal over this period (reflecting additional scale benefits).  With 430Mn gallons of internal production, this equates to $200Mn of annual EBITDA, implying a ~2.2x EBITDA multiple. In light of the this, and the fact that margins should be materially higher post import duties, the $125Mn consensus estimate simply makes no sense.
 
REGI's Advantage: Animal Fats - Soybean Oil Spread ($/gal)

2012      $.41
2013      $.25
2014      $.09
2015      $.28
2016      $.22
2017      $.18
2018      $.40

REGI's Adjusted EBITDA ($/gal)

2012      $.50
2013      $.70
2014      $.51
2015      $.15
2016      $.30
2017      $.58

I believe this opportunity exists due to the complex nature of how biodiesel producers make money.  Unlike ethanol, which is subsidized via a RIN, biodiesel has both a RIN and potentially a biodiesel tax credit (“BTC”) in any given year.  Making matters even more complicated is the fact that certain years have a BTC that is retroactive.  As an example, throughout 2017, the entire industry operated at break-even levels due to the high likelihood that a BTC would be retroactively applied.  Last month, Congress made this official and wrote REGI a $210Mn check for 2017.  Optically, this may appear as though the industry is reliant on support from the government (the thought being that without a tax credit, REGI wouldn’t have generated any money).  However, while it’s true that the industry is subsidized, REGI’s aforementioned cost advantage should enable it to generate a profit ever year.  Said differently, biodiesel operates like any other commodity industry where the price is determined by the marginal cost.  If I’m a mom and pop producer and know a large tax credit will be applied at the end of the year, I’m going to factor that into how I price my biodiesel throughout the year. Conversely, if I know a credit isn’t coming, I’m going to price my product to make a small profit throughout the year. REGI will make money in either scenario.
 
Path Forward
 
Due to the decline in Argentinian and Indonesian imports, biodiesel margins currently sit at record levels.  As shown below, I estimate that REGI’s current EBITDA margins are tracking 5-year highs (~$.70/gal).  Assuming 430Mn gallons sold, this implies ~$300Mn in FY18 EBITDA, 140% above the $125Mn consensus estimate.  Importantly, Congress has stated that there will be no BTC in 2018.  Thus, even while I believe REGI would make money regardless of the form of subsidy, this dynamic will force producers to not price gallons at a loss throughout the year (i.e., REGI will make a healthy profit every quarter).

REGI's EBITDA ($/gal) Margin Tracker

1Q16      $0.19
2Q16      $0.05
3Q16      $0.22
4Q16      $0.44
1Q17      $0.34
2Q17      $0.03
3Q17      $0.04
4Q17      $0.40
1Q18      $0.58
Current   $0.66 

There is considerable company-specific upside as well.  REGI’s share price has been flat since its 2012 IPO, underperforming its closest competitor Neste by an astonishing 350% over this period.  Two ill-advised acquisitions explain a large chunk of this.  The first acquisition (“LS9”), was a loss-making ($20Mn annually) life sciences business with minimal overlap to the core biodiesel business.  The second acquisition (“Geismar”) was a renewable diesel facility that spent more time going on fire than actually producing biodiesel in its first two years.  In July 2017, the Company announced the resignation of the CEO responsible for these deals.  Since then, Geismar has been consistently operating above nameplate capacity and the Board is engaged in a strategic review process for LS9 (already stating that they will not be burning any more cash in this business).  Collectively, these deals spent ~$300Mn of capital, equivalent to 60% of its current market cap.
 
Valuation
 
As shown below, REGI is trading at just 2.2x EBITDA / 34% unlevered FCF yield when assuming trailing 5-year average margins.  However, based on my projection for industry utilization to hit 100%, I believe that ’18 margins should approximate 5-year highs (note that current spot margins are already at this level).  Assuming this scenario, REGI is trading at just 1.4x EBITDA / 58% unlevered FCF yield.

                                                     5-yr Avg          5-yr High

Internal Gallons (Mn)                           430                  430
EBITDA/gallon                                    $.46                 $.70
EBITDA ($Mn)                                    $198                $301

Interest Expense                                  $13                  $13

Cash Taxes                                            $2                     $2

Net CAPEX                                           $50                  $50

FCF ($Mn)                                           $133                $236

YE17 Cash                                            $78                  $78

YE17 Debt                                           $286                $286

'17 Tax Credit (1Q18)                           $210               $210

LS9 (50% Book Value)                          $75                  $75

Net Cash ($Mn)                                     $77                  $77

Shares (Mn)                                            39                     39
Share Price                                           $13                   $13

Market Cap                                          $507                 $507
Enterprise Value ($Mn)                        $430                 $430

Unlevered FCF Yield                           34%                     58%

EV/EBITDA                                         2.17x                  1.43x

Disclaimer

I hold a position in this security. While I believe this is an attractive investment, this does not represent investment advice.

Catalyst

·              Investors realizing that there is an actual public company trading at 1.4x unlevered FCF

·              Significant earnings beats on underlying biodiesel margin strength