Tying VeraSun's future to a 'whipping boy'

To gauge Wall Street's opinion of ethanol, look no further than VeraSun Energy Corp.

Of the 19 analysts who have recommendations on the stock of the Brookings, S.D.-based ethanol producer, five had "buys," two had "sells" and 12 recommended holding it.

Their price targets for the stock, now at about $6, range from $3 to $10.

The company's second-quarter report this month was full of good news: Earnings of 15 cents a share, far outpacing analysts' expectations of 2 cents a share; revenue of more than $1 billion, up nearly sixfold year-to-year; and expansion plans back on track to become the industry's biggest ethanol producer by year's end.

The news boosted the stock price, but days later shares slid after the company announced a $750 million shelf registration that has the potential to dilute share value.

What gives? Analysts' views on VeraSun have as much to do with their expectations for the corn ethanol industry as with the company itself.

And for the industry, investors are divided about whether the volatile finances and politics around the emerging technology will break in its favor or not.

To Joseph Gomes at Oppenheimer, that means important economies of scale, including cheaper rail rates for ethanol shipments. Gomes also likes VeraSun's approach to building production plants fairly uniformly, so efficiencies discovered at one can easily spread across the system. Its acquisition in April of St. Paul-based US BioEnergy is another plus for scale to Gomes, who rated VeraSun as "outperforming" and set the $10 target price.

But analyst Michael Cox at Piper Jaffray in Minneapolis is concerned about the debt behind all that growth at VeraSun. Debt levels are rising and operating cash flows remain negative, a vulnerable position for a company with small margins, Cox said. Another sign of strain was VeraSun's shelf offering this month, which looked like a move to raise cash to pay down debt, he said.

'Externalities'

Cox's major concerns have to do with the corn ethanol marketplace, where producers have been pinned between cost and price pressures. VeraSun reported margins as low as 8 cents a gallon in June, a number that went negative for some producers. The record corn prices of nearly $8 a bushel, caused in part by spring flooding in Iowa, caused VeraSun to postpone opening three new plants at the time. On the plus side, the August forecast for this year's corn crop is a stronger-than-expected 12.3 billion bushels. That knocked corn down to the $5-a-bushel range, before a run-up last week to more than $6.

Still, VeraSun has opened two of the three delayed plants, and it expects to open the third, in Welcome, Minn., this quarter. At Oppenheimer, Gomes sees those as promising signs, with VeraSun out front and ready to benefit in a marketplace due for consolidation. Cox still isn't sanguine about the margins, and because he expects interest to grow in cellulosic (non-food-based) ethanol, for now he's more bullish on diversified agribusinesses. Cox put a "sell" rating on VeraSun, and a $3 target price.

Upholding mandates

Politics has played an unusually powerful role in the ethanol industry. To encourage growth in renewable energy, the federal government has mandated that nationwide production of ethanol reach 36 billion gallons by 2022; 15 billion of those gallons must be corn-based, up from 6.5 billion last year. Texas challenged the mandate, but failed, which effectively ensures a growing marketplace for bio-fuels, and that means stronger prices.

But politics is battering ethanol, too, according to analyst Kevin Calabrese at Argus Research Corp. And that's reason enough for him to rate VeraSun a "hold." The company is well run, and its margins are improving, Calabrese said.

"But ethanol has emerged as the whipping boy, blamed for everything from food shortages to the price of oil. So, I'm staying put until I see some clarity about what's going to happen," he said.