Rex American: An Ethanol Producer Poised For Development (NYSE:REX)

Thesis

Rex American (NYSE:REX) is an ethanol producer run by sound operators, having by no means misplaced cash within the final decade regardless of unstable commodity cycles. That is in distinction to different publicly traded ethanol producers who’ve money-losing years often. REX is additionally one of many few ethanol producers that may reap the benefits of subsidies from the Inflation Discount Act (‘IRA’), probably making their earnings energy considerably higher sooner or later. We estimate REX has about 50% upside.

Background

The first use of ethanol is as a biofuel mix with gasoline to decrease carbon footprint. At the moment, ethanol makes up ten p.c of the gasoline pumped into automobiles nationwide. Roughly 15B gallons of ethanol and 150B gallons of gasoline are consumed per 12 months within the USA throughout 130k fuel stations. The first enter for ethanol is corn. About 40% of the corn produced within the USA is used to make ethanol!

The ethanol business grew from roughly 1.5 billion gallons of home annual ethanol manufacturing in 1999 to about 15B gallons by 2022. This was as a result of 2007 Renewable Gas Normal that was enacted to scale back the US’ dependency on overseas oil, cut back gasoline costs, and decrease carbon emissions. The quantity that which ethanol is blended with gasoline doesn’t lower gasoline effectivity in proportion and thus makes automobiles much less carbon emitting. Moreover, corn absorbs CO2. Though there’s plenty of forwards and backwards on if typical biofuels are higher for the atmosphere, farmers are a protected class and taking out the RFS could be catastrophic to farmers nationwide. This can be a political stance that doubtless neither get together will undertake for a very long time. The bigger risk to ethanol is technological obsolescence from electrical automobiles.

The EPA at the moment units mandates below the RFS and refiners/importers are anticipated to purchase both ethanol or a Renewable Identification Quantity (‘RIN’) to fulfill mixing necessities.

Supply: EIA

Trade Capability

America ethanol business consists of 199 vegetation in 25 states with an annual capability of roughly 18 billion gallons. The most important participant is POET whose ethanol manufacturing capability is near 2B gallons a 12 months or about 7x that of REX. Though there’s some worldwide competitors, the US continues to be the dominant ethanol producer on the planet. Brazil, Canada, India, South Korea, Netherlands and China are the biggest importers of ethanol.

Ethanol costs are affected by quite a few issues: From business provide to gasoline costs to RIN costs to regulatory choices to corn costs. Crush spreads decide the profitability of ethanol producers, this being the distinction between the price of a bushel of corn (divided by the yield) and the promoting worth of ethanol. Provide is comparatively inelastic; the ethanol business is chronically oversupplied whatever the period of unprofitable years. That is as a result of excessive possession of ethanol vegetation by farmers who haven’t any different use for the corn that they produce. They merely can flip off ethanol manufacturing, retailer their corn, and look forward to extra worthwhile years. Given how aggressive the business is, ethanol producers look to provide different area of interest derivatives which are extra worthwhile similar to specialty alcohols, excessive protein feed and so on.

REX

REX has roughly 270mm gallons of ethanol capability and sells a number of byproducts similar to Dried Distiller Grains. It has majority management over the services One Earth and Nu-Gen together with minority curiosity in a number of different vegetation. REX pivoted into ethanol manufacturing from retailing within the early 2000s when the RFS was enacted (a lot of the identical administration continues to be round as we speak). Coming from retailing, administration realized their greatest benefit in a commodity market could be on the shopping for aspect. REX owns these vegetation alongside farmers, is subsequent to 2 main railroad traces giving them entry to extra markets, and is subsequent to grain elevators. In consequence, REX often pays beneath market costs for corn and may entry the very best greenback worth for his or her ethanol and byproducts. On high of this REX has state-of-the-art Fagen/ICM vegetation.

Due to these causes, REX has at all times maintained profitability whatever the ethanol commodity cycle. Beneath is a graph depicting their profitability vs two publicly traded rivals.

Alternatives

Carbon dioxide is without doubt one of the major byproducts of ethanol manufacturing. Usually, this fuel is launched to the environment nonetheless the tax credit put forth by the IRA incentivize firms to seize and retailer CO2. There are two credit the IRA put forth which are straight relevant to REX. These are the 45Q and 45Z credit. The 45Q was already an current credit score that utilized to carbon dioxide that was captured and saved, nonetheless, the IRA bumped up the credit score from $45/ton to $80/ton. The 45Z applies to decarbonized fuels.

Carbon Sequestration

Not like most firms who are actually dashing to get the requisite allowing to pipe compressed CO2 into reservoirs, REX has been engaged on the allowing for the final 4 years to have the ability to use a effectively positioned 4 miles away. REX additionally has the capital construction to take action, whereas different rivals are laden with debt. REX’s unique intent was to reap the benefits of the older 45Q credit score. REX has to date drilled 7k foot check wells, accomplished the seismic testing, run simulations, and picked up over 160mm information factors. The allowing is notoriously troublesome to acquire and topic to plenty of politics. CO2 pipelines endure from NIMBY and pipeline allowing is troublesome. Not too long ago South Dakota regulators denied a allow filed by Navigator for a CO2 pipeline and North Dakota regulators rejected Summit’s CO2 pipeline allow.

Economics of Carbon Sequestration

The theoretical max variety of 45 credit an organization like REX would obtain could be $1 per gallon of ethanol produced. To qualify, the decarbonized ethanol must be produced after 2024 and offered earlier than December 31, 2027. (The 45Z gives two cents per gallon for each level beneath 50 on the Carbon Depth rating of a manufacturing facility. In technical jargon it means lower than 50 kilograms of carbon dioxide equal per million British thermal models).

REX is planning capital expenditures of roughly $150mm for everything of the challenge which incorporates growing capability to 200mm gallons per 12 months at their One Earth facility. REX will produce 500k tons of CO2 at this manufacturing degree. As soon as the allowing is achieved, the development of the ability and pipeline is anticipated to be accomplished by July 31, 2024. If REX will get the Class VI allow to retailer 90mm tons of CO2, it additionally desires to be the reservoir hub of alternative for different ethanol producers close by.

Proudly owning the pipeline will make the economics profitable for REX. Assuming that REX can obtain half the theoretical max worth for the 45Z credit, REX can see a windfall of $400mm between 2025-2027, together with $40mm per 12 months from 2028 to 2032. Combining the 2 yields $600mm {dollars}. That is assuming no further income from different ethanol producers. An necessary distinction between the 45Q and 45Z is that 45Q credit are eligible for direct fee from the US Treasury. 45Z then again is a tax credit score that must be monetized both by means of offsetting earnings or transferability of credit to different entities.

Capital Allocation

One of many causes we had been drawn to REX was their disciplined capital allocation (REX solely has 5 folks at their headquarters!). As an alternative of pursuing quite a few novel initiatives like their rivals to chase margins which hardly ever pan out, REX has as a substitute chosen to conservatively enhance capability at their vegetation, repurchase shares at discounted costs, and is now pursuing carbon sequestration. This has resulted in an organization that’s worthwhile, has decreased shares by 40% at a median share worth of $16, and at the moment additionally has virtually $300mm in money.

“I have watched a lot of companies buy back their stock at the highs and then when it gets to the lows they have no money left to buy back their shares, we are the exact opposite. When the stock is going up, we leave it alone. When it’s coming down, we are there to support the shares, stabilize the stock and whoever is saying – make a market for the people who don’t want to sell their shares.” Stuart Rose

Dangers

1. Repeal of the IRA: There’s regulatory danger that will result in the repeal of the IRA. This is able to lead to all of the carbon subsidies to be retracted,

Mitigating Issue: We imagine that is unlikely because the IRA supplies incentives and doesn’t impose onerous circumstances on business gamers. In consequence, it’s a money seize for all events and can doubtless proceed to have bipartisan help.

2. Execution Danger: REX nonetheless must receive class VI allowing and subsequently construct out compression models together with a pipeline to reap the benefits of carbon credit. All of those duties are complicated and novel processes to REX.

Mitigating Issue: REX administration has confirmed themselves to be prudent operators and has been engaged on the allowing and constructing out of the plant and pipeline longer than most ethanol producers. We imagine they’ve a excessive chance of capitalizing on the carbon credit come 2025.

3. Declining Ethanol Utilization resulting from EV: EV penetration might be a persistent headwind to the ethanol business. Sarcastically, one other sponsored business could possibly be the dying of ethanol as a biofuel.

Mitigating Issue: Ethanol doubtless has different future use circumstances similar to aviation gasoline. Sustainable Aviation Gas (‘SAF’) demand is forecasted to achieve 7B gallons by 2030. It takes about 2 gallons of ethanol to provide 1 gallon of SAF which might enhance ethanol demand by 15B gallons.

Valuation

REX generates a normalized FCF of $35mm per 12 months. Add onto this the $250mm of money and Treasuries it has and REX trades at round honest worth. Considering the $150mm of capital expenditures to develop its OneEarth facility to have the ability to sequester CO2, there’s a variety of outcomes. Conservatively, the carbon credit are value about $500mm discounted again to the current worth. Including the additional earnings that REX can have from further capability might be one other 5mm to REX’s earnings energy. Mixed, we estimate the honest worth for REX is about $1B or about 50% upside.

INVESTMENT DISCLAIMERS & INVESTMENT RISKS- Previous efficiency isn’t essentially indicative of future outcomes. All investments carry important danger, and it’s necessary to notice that we aren’t within the enterprise of offering funding recommendation. All funding choices of a person stay the particular duty of that particular person. There isn’t a assure that our analysis, evaluation, and forward-looking worth targets will lead to earnings or that they won’t lead to a full loss or losses. All buyers are suggested to completely perceive all dangers related to any form of investing they select to do.