Little Known Ethanol Developer Could Be Multi-Bagger Cash Cow
By David J. DesLauriers
20 Nov 2007 at 10:53 AM GMT-05:00
resourceinvestor.com
TORONTO (ResourceInvestor.com) -- Vitality Products Inc. [TSXv:VPI] which closed today at 49.5 cents has seen its share price rise and fall sharply on a couple of occasions in the last 6 months.
This is largely because the TSX Venture Exchange has hindered Vitality in its ability to tell its story properly. Ridiculous clarification press releases like this one, which the company was forced to release in August, demonstrate the impossible battle that the company has faced in spreading the good word about its developing business. The good news is that the net result for new investors now is a bargain entry price that otherwise wouldn’t exist.
Your correspondent has spent tens of hours talking to and meeting with management who have been working on this project every day for the last 18 months, and we are convinced that there is an exciting and substantial business growing in Vitality under the stewardship of an experienced and real management team.
Indeed, had the company been given the opportunity to press release its positive news flow, Vitality shares would probably be changing hands right now at a valuation more in line with their comparables - or 3 to 4 times today’s close price.
Here’s the story.
Ethanol Plant
Vitality intends to build a 100 million-gallon/year ethanol plant in Whatcom County, Washington State. VPI will be the only ethanol producer in this area with the majority of existing plants sitting in the Midwest’s Corn Belt.
This location is ideal and superior for a number of reasons which we will explore in more detail later, but including and not limited to, and in no particular order:
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Highest prices for ethanol in the U.S.; ship locally rather than shipping from Midwest;
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Right near BP Refinery; four local refineries;
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Near deep water port;
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Rail Access throughout area;
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Friendly permitting environment;
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Proximity to cheap (almost free) cellulistic feedstock right across the border in BC (pine beetle devastated forests that the BC government will literally pay you to haul away).
Contracts
Vitality has a letter with J. D. Heiskell Corporation securing all of the corn feedstock needed for a 100 million-gallon/year plant.
The company also has a letter for purchase commitments from British Petroleum for all of their ethanol production.
VPI is working closely with Burlington Northern to create a rail loop to transport directly from its proposed site in Washington State.
Vitality has engaged two of the biggest ethanol plant builders (design, engineering and construction) in the country and will soon choose which will be retained to build its ethanol plant.
The company is working with a large Omaha group that has raised the money for 25% of the ethanol plants that have been built in the U.S.
VPI is able to fulfil the onsite natural gas requirement at Whatcom, and is currently working on its water and steam needs.
Management
Tom Bartz who is project Chairperson has over 20 years of experience in the petrochemical industry. Mr. Bartz began his career in 1983 with Exxon. From 1988 to 1993 Tom was part of the M&A team at BP and in charge of converting Mobil to BP throughout the Western U.S., helping Costco create a gasoline program, and as a global technology team member was the innovator of downstream petro at that time. After a stint as manager of wholesale marketing and business development at Tosco, creating a hypermarket spot market supply and marketing engine for America’s sixth largest oil company, Mr. Bartz moved to Tesoro.
There, between 1997 and 2000, Tom, as VP of Retail led on the acquisitions of Shell Anacortes, BHP Hawaii, and many other asset purchases. Tom also created the retail and alliance marketing engine at Tesoro and the 20 year / $26 billion partnership with Wal-Mart (Mirastar Brand). Mr. Bartz was directly responsible for $980 million P&L and 1,400 employees.
Bill Grant, President and CEO of Vitality, was past President of Nabob Foods Ltd., and past Vice-President of Standard Brands (now RJR-Nabisco). Bill is formerly a Director of Norsat International, Potters Distilleries, FraserFund Venture Capital (VCC) Corp., and past Chairman and Director of the Canadian Manufacturing Association and is a current Director of PACE.
Bill is also President of Gold Star and has built over $100 million worth of resorts in the same county where Vitality intends to build an ethanol plant. We see this as a huge value add in the sense that Mr. Grant already has a very solid relationship with all of the permitting people in the county having created jobs and tourism in Whatcom County. This is very important.
David Randle, an experienced marketing and product development specialist with over 30 years experience in consumer product marketing in Canada and the United States will further the development of consumer and commercial marketing and sales programs for the company's existing approved natural nutraceuticals and condition specific formulated products.
Cash Cow Earnings 2010
Vitality is poised to make a huge amount of money here not only from ethanol, but an even bigger revenue source is going to be the co-products associated with the ethanol.
Here is the back of the envelope math.
VPI currently has 24 million shares fully diluted and is currently raising another 5 million shares at 60c per share with a full warrant, for a total of 34 million shares fully diluted.
The CAPEX on the ethanol plant is $200 million of which about half will come from the issuance of Vitality equity - probably in the next 2 to 3 quarters. We believe that this money can be raised at C$1.00 so lets add 100 million shares for a grand total of 134 million shares.
In just over two years, or for fiscal 2010, based on the company’s 100 million gallon per year ethanol plant will start to throw off huge net earnings.
Profits from the production of 100 million gallons of ethanol are projected at $28 million using negotiated and contracted corn prices of $3.20 per bushel and ethanol prices in Washington State of $2.20 per gallon.
Profits from the government tax credit of 51 cents per gallon (the blending credit) are $43 million based on the blending of Ethanol 85.
Profits from the production of 302,500 tonnes of Co2 are $3 million.
Finally, net profits from the production of 626 million pounds of dry distiller grains (DDG) which are another co-product of the ethanol production are $14 million at the low end (more on this in a second).
This means that with $88 million in net profit, and 134 million shares fully diluted under our scenario, VPI would produce 66 cents per share in earnings.
So the question is what multiple do ethanol producers generally attract? This is difficult to assess in the context of the current market given the decline in ethanol plays across the board. For instance several producers that we reviewed have forward P/E ratios of 40X-50X but current P/E ratios of 8X-10X.
We believe that the truth rests somewhere in between - when one looks at the charts on these stories before their massive declines which began in July, they were trading at about the mid-way point in their 52 week ranges and had had a few normal quarters. At that point they averaged around 20X earnings. See Aventine [NYSE:AVR] or Pacific Ethanol [NASDAQ:PEIX] as prime examples.
So let’s cut it in half for VPI (the only Canadian listed pure play ethanol story to our knowledge) and we still see it at a potentially 10 bagger plus over the next two years.
But there are two factors that could make this number much better.
Potential Monster Co-Product Upside
We use an after-tax $14 million as co-product earnings for Vitality in 2010. This number could actually be as high as $187 million.
The company has been in discussions with various government departments and organizations that have specified that an FDA approved plant can sell DDGs for as much as 60 cents per pound, as opposed to the 7 cents per pound without the approvals that we are using in our forecast.
Vitality continues to pursue discussions to investigate what is involved with garnering these approvals, and the markets which will pay 60 cents per pound. Recently appointed Dave Randle, who has been consulting with the company for the past year, has over 30 years worth of experience, contacts and know-how in this exact area.
We should have the answer in a couple of weeks, at which point Resource Investor will be sure to issue an update to readers on Vitality, whose target price may have to be upped substantially (by a multiple) if this comes to pass.
This calls for a watching brief.
Cellulistic Blue Sky
One of the many attractive features about Vitality is the choice of location - Washington State.
The U.S. government is throwing $400 million at R&D towards alternative fuels. A healthy portion of that is being put towards research into cellulistic feedstock.
Industry estimates are that within 2.5 to 5 years the use of ultra low cost (if you’re in the right area) cellulistic feedstock will become a viable feedstock in the production of ethanol.
When this happens, VPI will be perfectly situated to grab the pine beetle devastated trees from British Colombia for next to nothing - and margins will explode, earnings right along with them.
The $28 million that we project as net earnings for VPI on ethanol production from corn in 2010 could well turn into $128 million if the input switches, in say, 2012, to cellulistic feedstock. Big money.
Ethanol Story and Technology
There is not room here for a full blown examination of the macro economics of the ethanol market and the reasons why ethanol plants being built with the latest technology and at a critical mass size, plus flexible to shift to cellulistic feedstock without massive CAPEX will thrive, but here are a few points:
Some say that ethanol doesn’t save energy, and there are a host of other complaints. But the reality is that ethanol is like VHS/Beta - Beta may have been the better product, but the wave was with VHS. Ethanol is here to stay.
The government mandate is for major expansions in ethanol production, and a reduction of dependence on foreign oil. If corn spikes, they will simply find a way to increase incentives to ethanol producers to keep them very much in the black. They want ethanol producers in the U.S. and are mandating usage in every state and a six-fold increase in production over the next 14 years.
There are currently 1,400 gas stations in the U.S. offering Ethanol-85. Approvals are coming for pumps that are not affected by ethanol’s corrosive attributes, and incentives are being put in place to get more of them installed. Thousands of new gas stations will become ethanol end-users over the next couple of years.
At the same time, at least 40 of the 132 ethanol plants currently in operation in the U.S. are inefficient, obsolete, high cost, or poorly operated by co-op farmers who were looking for a market for their product. These will all shutter in the next couple of years, as they won’t retain the ability to compete.
One of the reasons that ethanol stories have taken a beating is because corn prices have risen. Many continue to project that they will rise or remain buoyant. Over the last 18 months ethanol recoveries per bushel of corn have risen 40% offsetting the rise in corn prices. There is no reason with the amount of R&D work being done that this will not happen again between now and the time that VPI comes online.
For Vitality specifically, because of its co-product business, the company is well protected from price swings. Ethanol prices are also higher in Washington State that in any other part of the country - and corn can be hedged in the futures market.
Conclusion
Vitality is a company with a market capitalization of C$10 million that in two years could be generating C$88 million in earnings.
Even if you risk and discount all of the projections this looks like a stock and a story that should be C$2 or $3 either now, or in 3-6 months as word gets out and the company is able to press release some of its advances towards production. That makes it a 4 to 6 bagger from here. The company still has a tight share structure with a float of less than 10 million shares and as the name gets out it could start to move nicely.
Our 2010 C$6.60 target assumes a P/E multiple that is half of what we think will be typical in the sector when it normalizes, and does not take into account the absolutely massive blue sky of the co-products business (we will know shortly), or the way that Vitality has positioned itself to capitalize on virtually free feedstock as technology continues to improve. Either of these things could turn this into a C$20+ stock over the next 36 months, in our opinion. There are not too many other names that we can say that about.
The author is long Vitality Products Inc., in accordance with the conflict and disclosure policy. |
