PersonalFinance and Health Today

Ethanol Shifts Share Prices Into Overdrive

Ethanol Shifts Share Prices Into Overdrive

By SCOTT KILMAN
April 13, 2006; Page C1

Wall Street is pumped up about ethanol.

The gasoline substitute emerged as a grass-roots investment movement last year, with farmers raiding their savings to build plants that convert corn into the renewable fuel. Now mutual-fund managers and well-heeled investors are grasping for any stock with the slimmest connection to ethanol.


With soaring gasoline prices, the spot price of ethanol -- an alcohol-based alternative fuel that is blended with gasoline -- has doubled over the past 12 months to about $2.65 a gallon. The Bush administration has been plugging ethanol in recent months, saying it could help break America's crude-oil addiction. Adding to the froth, billionaire Bill Gates has become an ethanol booster.

"It looks like a rush to me," said Elif Acar, a credit analyst at Standard & Poor's, which rates the ethanol industry as "speculative."

"I'm not sure the long-term prospects are being weighed," she said.

U.S. ethanol makers are either small parts of sprawling companies, start-ups or private concerns. So investors are flocking to a few stocks, sending their prices soaring. So, where does an average stock picker get in, since everyone is elbowing for a narrow doorway?

At the top of the heap is Archer-Daniels-Midland. Even though ethanol generates only about 5% of its revenue, shares in the Decatur, Ill., grain-processing titan have climbed about 50% so far this year, swelling its market value to more than $24 billion. In New York Stock Exchange composite trading at 4 p.m. yesterday, ADM's shares were at $37.39, up 84 cents, or 2.3%.

The run-up is largely because it is the biggest and most seasoned ethanol maker in a fledgling and fragmented industry. ADM produced about one billion gallons of fuel ethanol last year, roughly a quarter of the industry's production. It also plans to build a corn-to-ethanol mill in Columbus, Neb., capable of making 275 million gallons annually, eclipsing the capacity of its closest rival.

Hoping to cash in on investor interest, VeraSun Energy, of Brookings, S.D., and Aventine Renewable Energy Holdings, of Pekin, Ill., the second-largest and third-largest ethanol makers, respectively, both filed two weeks ago with the Securities and Exchange Commission to launch initial public offerings of their shares. The fourth-biggest producer is Cargill, the closely held commodity-processing titan in Minneapolis, which has plans to expand rapidly.

Impatient, some investors are snapping up shares of companies that merely have ethanol in their future. The stock of Andersons, a Maumee, Ohio, company with interests in grain, fertilizer and rail cars, began jumping two weeks ago as investors realized that it recently acquired stakes in three ethanol plants that are currently under construction. Since March 27, the market value of Andersons has swelled by about $145 million, or 28%, even though it has invested just $36.1 million in its ethanol holdings.

"Considering how fast the industry is growing, there just aren't that many places for investors to go in ethanol yet," said Neil Koehler, president and chief executive of Pacific Ethanol, an ethanol distributor that posted a net loss of $9.1 million in 2005 on sales of $87.6 million. The stock of the Fresno, Calif., company has nearly tripled since it announced in November that Mr. Gates, chairman of Microsoft, intends to invest $84 million in its plan to build five ethanol plants on the West Coast, giving him a 28% stake.

There are downsides. Ethanol makers, which generate about 3% of U.S. motor fuel, can do little to hedge their risks. They have a hard time passing along any rise in the cost of corn -- their single biggest expense in making the fuel -- because the price of ethanol is largely tied to the price of gasoline, since ethanol is primarily valued for its ability to substitute for the petroleum-based fuel.

That, in turn, is tied to the price of crude oil, which is currently high -- trading at close to $70 a barrel -- but difficult to forecast.

Wall Street, though, is mostly optimistic. For one thing, President Bush signed an energy act in August requiring the oil industry for the first time to use some renewable fuels to make motor fuel. The annual mandate grows to 7.5 billion gallons in 2012 from four billion gallons this year.

The energy measure also gave a sideways boost to ethanol. The measure denied the oil industry liability protection for a gasoline additive called MTBE, which many states are banning because of groundwater-pollution concerns. So oil companies are switching to ethanol, which, like MTBE, raises the amount of oxygen in gasoline so it burns clean enough to satisfy U.S. air-pollution standards. The switch could increase demand for ethanol by roughly two billion gallons annually, beginning this year, say ethanol executives.

By late January, a boom seemed under way to some stock analysts. Archer-Daniels-Midland reported that strong ethanol prices helped profit for the fiscal second quarter ended Dec. 31 rise by 17%, far in excess of Wall Street estimates. ADM also divulged that it has been diverting so much corn from its sweetener business to ethanol production that soft-drink companies had been forced to swallow stiff price increases for high-fructose corn syrup.

ADM has yet to capitalize fully on the recent run-up in ethanol prices. It sells much of its production under six-month-long contracts. Going forward, ADM should be able to lock in higher prices. "ADM has at least two years of growth ahead of it, unless gas prices collapse," said John McMillin, an analyst at Prudential Equity Group in New York. Mr. McMillin has ADM rated as "overweight," meaning he expects the stock to outperform the average of all the stocks he covers. He doesn't own any ADM shares, nor does Prudential Equity Group do any investment banking for ADM.

But the lofty price of ADM shares has some analysts concerned that the stock is attracting energy-oriented investors who might have unrealistic expectations for a company that is still mostly a maker of food ingredients, usually a thin-margin business.

Christine McCracken, an analyst at FTN Midwest Securities, worries that ADM's share price -- which is more than 20 times the average estimate of its per-share earnings for the fiscal year ending in June -- is getting too rich for a commodity processor. Over the past five years, ADM's shares have traded at 12 times its per-share earnings when profits were peaking. What's more, the shares of ADM's peer group are trading at a multiple of 13.5.

"I don't see it," said Ms. McCracken, who doesn't own any ADM shares, which she rates "neutral," essentially meaning hold.

Some economists are wondering whether the ethanol industry is growing so fast that it could be faced with a glut before too long. According to the Renewable Fuels Association, the ethanol trade group, 33 new plants are under construction and nine existing plants are being expanded. At this rate, the industry will have the capacity to make more than what Energy Department economists figure is needed for several years.

For ADM's part, Chief Executive and Chairman G. Allen Andreas figures the ethanol market has the long-term potential to grow to 15 billion gallons annually as the oil industry looks for ways to stretch capacity and the auto industry offers more vehicles that can run on an 85% ethanol blend.

Write to Scott Kilman at scott.kilman@wsj.com

posted by MobyGrape @ 7:54 AM