REG’s Rolling Thunder: What did not kill them (falling oil prices), made them stronger

At 8:30am, there’s a standing daily meeting of the key traders in Gary Haer’s sales group at REG headquarters in Ames, Iowa.

And they’re not kidding. Everyone stands. For 15 minutes there’s the rat-a-tat-tat of rumor, fact, competitors, pricing, spreads, the who’s selling what and where, the buying and selling of diesel, renewable diesel and biodiesel across North America.

On most minds this Friday morning, what’s going to happen with corn prices?

The USDA late on Thursday released its annual spring plantings report and it was a shocker. Corn acres up 5 million, wheat down 5 million. Despite high corn ending stocks from last year. Prices are sure to go low. But how low? By day’s end the price would drop 15 cents a bushel, almost 5 percent. That’s good news for REG — they’re the major buyer of inedible corn oil from ethanol producers, which they have figured out how to convert into biodiesel. But how much good news, that will only become clearer through the day.

Meanwhile, the dozens of Bloomberg TV screens and the overhead pricing screens on B100 biodiesel, fossil prices and key REG inputs such as virgin vegetable oils — they are spitting out the numbers, updating nearly every second.

The rat-a-tat-tat continues as the team talks about dealmaking in the market.

“I was up in North Dakota drumming up some business with [omitted], and they had [omitted] come in at -15.” In the parlance of the meeting, that’s15 cents below quoted market price. In a market where wholesale diesel futures are selling at $1.13 per gallon, that’s a gigantic discount. Someone is moving inventory aggressively. The team pauses, takes it in, then the rat-a-tat-tat resumes. Minnesota, California, a terminal here, a customer there.

It’s been a couple of years since we visited REG and the difference is palpable. The company has become a little ADM, rather than a big Amyris or TerraVia. You see the trading desks at the bigger ethanol operations like Green Plains — relatively massive and certainly lively trading ops. But it’s not something we’ve seen in companies like REG. It used to be a company you could safely describe as a biodiesel company, just as you could safely think about biodiesel as a market for the soybean oil byproduct of a soymeal crush.

But no more.

The old biodiesel paradigm gone by

The problem with biodiesel companies, for a long time, has been the volatility of raw material prices and energy prices.

Biodiesel has long been America’s favorite advanced biofuel, but they don’t call the spread between soybean prices and biodiesel prices “the crush spread” for nothing. You can get crushed. Favorable economic winds can turn on you lickety-split, leaving you with upside down economics (high input, low output prices) and working capital that burns faster than firecrackers on the 4th of July.

More than a decade ago, biodiesel was an answer to a problem for soybean growers. Their soymeal had been approved and successfully trialed as livestock feed, and orders were up, up, up. But after the soy was crushed to make meal, the oil piled up, and after a while there’s no place to store it, and dumping is neither eco-friendly nor economically viable. Now, you can run a diesel engine on straight veggie oil, but it’s gummy. But throw in some methanol and a sodium-based catalyst under heat and pressure, and you break the oil molecule into pure B100 biodiesel and a glycerine by-product. The technology is complex enough, but costs less than a dollar a gallon for the capex.

Then, soybean oil was trading at something like 10-11 cents a pound, or around  dollar a gallon for the raw materials in a gallon of biodiesel, and energy prices were far higher. And an industry was born.

Back then, there were a lot of companies that wanted to become what REG has become today. A multi-plant, multi-feedstock, multi-product producer with operations across the US and now reaching into Europe.

Fast-forward to 2008/09, when soybean oil prices skyrocketed as high as 70 cents a pound, and the easy good times were over. Plenty of producers went idle.

REG, however, found the answer in a technology so critical that even today, on a public plant tour, they don’t like to talk about it. It’s a FFA stripper. This takes free fatty acids, which are difficult to process, out of alternative feedstocks like fish oil, choice white grease, yellow grease, brown grease, and inedible corn oil. The technology allowed REG to manage its input costs through supply diversification — and with a superior price structure, came a series of mergers and acquisitions that brough the company to 11 plants today, worldwide.

It’s not a license to print money, biodiesel. The company made $50 million last year and without the December 2015 renewable of a $1 per gallon biobased diesel tax credit, might have slid into the red with the collapse of oil prices which began in Q4 2014.

Three legs to the REG stool

1. Diversification. The company is diversifying everywhere you look. The afore-mentioned raw materials. Through the recent acquisition of LS9 (now REG Life Sciences) and Dynamic Fuels (now REG Geismar), the company has diversified on the product side.

We expect to see a first commercial product from Life Sciences in 2016/17 — a fragrance product that can be manufactured at commercial-scale at the company’s plant in Okeechobee, Florida. Perhaps as importantly, LIfe Science’s feedstock is sugar — for now, think corn sugars (dextrose), although any source of sugar is technically acceptable; it comes down to price.

We also note that Minnesota and Iowa, where REG operates, are the first states to put in renewable chemical producer’s tax incentives. Iowa’s legislation expected to be signed this week by Governor Terry Branstad.

Meanwhile, Dynamic Fuels is a going concern, although two fires since acquisition have set back the commercial schedule.

2. Flat management structure. With 600 employees, the expectation is the kind of hierarchy that begins to stifle innovation. But REG keeps it flat — 30-40 person teams at individual plants, divided into 4 shifts of 7-10 people. Around 130 at HQ, most of whom are in trading or financial operations. There are just a handful at the VP level, and decision-making is quick.

3. Good outlook for biobased. Who’s said there’s no green premium? REG’s average selling price was $2.69 in 2015 — compare that to the afore-mentioned $1.13 futures price for diesel. CEO Dan Oh told investors, “The regulatory clarity and growth trajectory EPA provided last year with a multi-year RVO will grow biomass-based diesel beyond two billion gallons by next year, and effectively already has when you consider carryover RINs.”

The rap on REG

1. Biofuels companies are not Wall Street darlings on the equity side. From our POV, we wonder at that. Her’s a company that debuted at $10 after its 2012 IPO, and is trading as of last week at $9.48 despite awful energy prices. And is making money in a down market, and building market share.

Yet, we see an astonishingly low PEG (price/earnings to growth ratio), at 0.29, that led Zacks to highlight REG last week as an undervalued stock.

2. Size matters. The company isn’t big enough yet, or diversified yet, to have convinced investors to pay attention. That’s the sub-$1 billion market cap problem, combined with REG Life Sciences and REG Geismar offering limited revenues to date — so, there’s an awful lot of dependence on biodiesel in the stock price.

So, the question for the investor is to pick a date when those concerns have been addressed, but the rest of the market hasn’t woken up yet. The first announce of a significant offtake and product development deal on the chemicals side, that’s your target. Could be something in the Q1 earnings call.

3 big news items

1. Expansion in life sciences. Last week, REG started expansion and upgrade of the laboratory at the company’s Ames, Iowa headquarters to further enhance renewable chemical related biotechnology research, development and commercialization. The lab expansion will include the installation of fermentation equipment and significant analytical capabilities. Upon completion, full-time positions will be added to focus on commercialization and integration of products to be developed by REG in South San Francisco into production and delivery platforms.

“This expansion is simply one of many examples of REG’s commitment to innovation and economic development in Iowa and in particular Ames which is a cornerstone of Iowa’s Cultivation Corridor,” said CEO Dan Oh.

2. Acquisition in biodiesel. Two weeks ago, the company completed its acquisition of Sanimax Energy’s 20 million gallon nameplate capacity biodiesel refinery located in DeForest, Wisconsin. REG paid Sanimax $11 million in cash and issued 500,000 shares of REG common stock in exchange for the biorefinery and related assets. REG may also pay Sanimax up to an additional $5 million in cash over a period of up to seven years after closing based on the volume of biodiesel produced at the plant, which is now called REG Madison. Using the same REG patented and proven high free fatty acid processing technology as REG’s Seneca, Illinois plant, REG Madison produces biodiesel from lower cost, lower carbon intensity feedstocks.

3. Building the capital stack. REG Energy Services secured a $30 million line of credit from Iowa-based Bankers Trust, the company last month, The line is a one-year credit facility, with an accordion option to expand to $40 million, subject to customary conditions. “This credit line gives REG Energy Services additional capital to expand our blended fuel offerings and add to our already expansive distribution network,” said Chad Stone, REG Chief Financial Officer. “It also frees up capital allocated to the business from other sources. We are very grateful to Bankers Trust Company for seeing the strength of this part of our business and committing these funds to allow us to further grow.”

The Digest’s Take

Over in the world of materials and products, we see a rush to divest. Consider, for example, DowDupont, which will emerge as three companies in distinct segments, out of two diversified companies. But in the agricultural space, they’re generally sellers, not buying raw materials from growers.

So, companies like REG are going the other way, diversifying. Back then, one product, heading for many. One input, oils — now oils and sugars, plus a diversified set of waste oils. Back then, one technology, transesterification. Now, a suite of them ranging from hydrotreating to fermentation.

So, we see it as a little ADM, with bigger margins and growth prospects for some time to come, well positioned. Inherently more diversified than a TerraVia or Amyris on the technology and raw materials side.

Meanwhile, we note that ADM is trading at almost exactly the same price-to-EBITDA ratio as REG, and on a price-to-revenues basis. That’s the “we’re so big and been around so long” premium that benefits diversified plays in uplifting raw materials into finished products.

So, how big is big enough where REG will get a bump based on a superior growth outlook? $1 billion market cap might just do it. Keep an eye on expansion into Europe — and, with the expansion into corn sugars, given that they’re into corn oil in a big way, keep an eye on opportunities with corn protein.