REX next one to do a PEIX-like move...
New Investment Idea - REX American Resource Corp.
Our first pick in the ethanol sector was Pacific Ethanol (PEIX) where we enjoyed huge gains in very short order, and while that train has left already1, we have identified what we feel is an excellent opportunity to continue to ride the bull market in ethanol. Although today's investment idea makes a valid case for the longer term investor, we are seeing this as a shorter term trade opportunity first and foremost.
(1We still think PEIX is undervalued on a long term basis and are currently waiting for an opportunity to re-enter)
When we bought Pacific Ethanol, we also started looking at the sector as a whole and we were surprised of our findings. Give or take, about 70-80% of all ethanol plants in the U.S. seems to be either privately owned or in the hands of blue chips and companies that have more than ethanol production in their portfolio. That's not really what we are looking for as we want as much exposure to ethanol as possible.
That basically left us with REX American and Pacific Ethanol as the best choices on the top of our list. Since we made >150% in Pacific Ethanol and that Q4-report-trigger played out really well, it's now time to move that cash into REX American which has their "Q-report-trigger" just around the corner.
Key facts for REX American Resource Corp. (NYSE: REX)
Shares Outstanding:
| ~8.14 Million (Fully Diluted 8.18 Million)
| Market Cap:
| 418 Musd (@ US$51.35/share)
| Cash on Hand:
| 93.4 Musd (Oct 31, 2013)
| Debt:
| 88.4 Musd (Oct 31, 2013)
| Enterprise Value:
| 413 Musd
| Large Shareholders:
| Insiders 28%, Institutions and Funds
| Website:
| www.rexamerican.com
| Latest Presentation:
| REX American Presentation, Jan 2014 (pdf)
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A truly high quality company
REX American has a long track record of not only being a low cost producer (they managed to persevere through difficult years without diluting shareholders), they have also repurchased shares in the open market in the last five years and continue along that path. Besides being in perhaps the best resource sector right now, REX American has an impressive 28% insider ownership which provides us as investors a greater confident that management will continue to act in the best interest of shareholders.
REX American, through their partly owned ethanol plants (see image), produces 255 Million gallons of ethanol per year. REX is a low cost producer and has always enjoyed higher margins than its peers.
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Triggers - As this is foremost a short term investment, one needs a trigger (or four)
1) We are making no secret of the fact that this is foremost a short term trade for us. REX American's fiscal year ends in January and it's their Q4 numbers that is our firsttrigger for this trade. Last year, they reported Q4 and Full Year on March 28th and we expect a similar timeline this year as well (approximately three weeks away).
2) The second trigger as we see it is an even stronger Q1 -14 than its Q4 -13. Since REX's Q4, ethanol's spot price ($2.30/gallon) has outperformed the small rebound in corn and whatever REX American's Q4 numbers are, they will be seriously beaten when Q1 is announced. We bet this will be apparent to the market and the stock will be re-rated accordingly.
3) The third trigger would be the announcement of a dividend. This is not at all too farfetched and should be a reality during 2014, but will it be announced now?
4) A fourth great trigger for the ethanol sector as a whole, is China. They recently announced "a war on pollution" and a great and easy way for them would be to start blending ethanol into their gasoline. If this were to be announced, the whole sector would be a roaring 'Buy' which is another reason for us to own REX American now that we sold all of our PEIX.
"Premier Li set goals to lower energy consumption, reduce emissions, shut down 50,000 coal furnaces, minimize vehicle exhaust fumes and boost alternative energy sources."
* China declares 'war' on pollution (CNN Money, Mar 6)
We are very confident about triggers 1 & 2, but the last two triggers are more "up in the air" so to speak and are considered bonuses.
Q3 earnings of $1.21/share, what about Q4?
Before we get into our number crunching conclusions, we need to explain that it's not very easy to try to predict future earnings of an ethanol company as we don't have all the parameters needed to come up with a number close enough to the truth. That being said, we have tried to be cautious in our assumptions which makes us believe that we will be surprised to the upside rather than the other way around.
Last quarter, REX American reported earnings of $1.21/share and Q4 should improve significantly from that. Playing with the Q3 earnings a bit and based on Monday's close of $51.35, REX American currently trades at P/E 10.6 (51.35 / 4.84 (1.21 x 4) = 10.6).
REX American paid on average $6.24/bushel for its corn in Q3 (Aug-Oct) of last year, which now has dropped all the way to the $4.40 level in Q4. Although ethanol prices also came down a bit in this period, they didn't drop as much as corn did and therefore the margins have improved significantly. This is the main driver for our thesis that REX American will report a great Q4 and that this will drive share price higher in the short term.
REX American managed to sell their ethanol at a premium to average prices in Q3, but we are not sure if this was the result of some smart forward selling or if this will repeat itself in Q4. We have assumed that REX sold their ethanol at an average price of $1.90/gallon which with the drop in corn prices would give them a crush spread of 33 cents/gallon (compared to 3 cents/gallon for Q3), a remarkable change.
We think it's fully possible that REX American will improve their EPS to $2.15-2.20 in Q4, but again, we would rather be surprised to the upside and therefore we assume they will make net profits of $2/share in Q4. That would equal $8/share on an annualized basis and by using the current P/E ratio of 10.6 (see above), that would in theory give us a share price down the road of ~$85. We understand it's never this simple, we are just pointing out possibilities and speculate where REX could end up longer term.
We might be a bit off in our assumptions so here are two different scenarios if we are 10% off in "both directions". This will be a tool to get a better feel for where to take short term profit after the report is out (or before for that matter). We will use the P/E of 10.6, same as in the example above:
* Scenario #1, net earnings come in at $1.80/share: 10.6 x 7.20 (1.80 x 4) = $76
* Scenario #2, net earnings come in at $2.20/share: 10.6 x 8.80 (2.20 x 4) = $93
Final words and our expectations
To put an $85 target (65% upside) on a short trade in REX American is not what we are doing. We always try to be a bit conservative and rather have the market surprise us on the upside. This being said, we don't feel this coming record quarter is priced in and we expect to see a share price of at least $65 after earnings are released. If we are correct in our thesis, we still have a 27% short term upside on a trade that will last us about a month. Annualize those gains and you will come up with a truly astonishing number. We really feel this is a conservative stance with a lot of additional upside left. More important, around the current $50 share price, we see little risk to the downside (assuming ethanol and corn remains at today's prices).
REX American has been buying back ~4.3 Million shares in the last five years (8.18 Million fully diluted today), and that's all good. But we would not be surprised to see a small dividend announced. The company is already held by institutions and funds, but if a dividend would be announced, that would add extra fuel to our thesis and the $65 target would have to be revised.
REX American's Q1 (Feb-April 2014) should be even stronger than Q4, so we are not hesitant to hold on to our shares if this trade doesn't go according to plan. Also, given the fact that no "Wall Street Headlines" are talking about the bull market in ethanol yet and the fact that pure ethanol plays are scarce, we feel that REX American is the ethanol play to go with in the near term.
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