Fuel Your Portfolio With This Undervalued Energy Company
Adam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Should there be any question that biofuels will play a significant part of the United States’ future? In the first year of President Obama’s first term, the EPA released revisions to the National Renewable Fuel Standard (RFS) program. Among the revisions, the most important to note is an increase in the volume standards for biofuel, with required volume increasing to 36 billion gallons of total renewable fuel in the U.S. by 2022. That’s a 300% increase from 2008 levels.
Last March, President Obama released his “Blueprint for a Secure Energy Future,” in which he explains the plan to increase biofuel production and encourage increased use of biofuels. While mostly focusing on reducing the country’s dependence on foreign oil, renewable fuel will play an important role in doing so.
Despite the mandates and the President’s belief that the industry is crucial to the country’s future, the market outlook is uncertain. Investors fear that affordable private capital will not be available to support any major capacity building for advanced biofuels. The RFS mandates the blending of 15.2 billion gallons of renewable fuel into US gasoline this year with 2 billion gallons from advanced biofuels. With government subsidies diminishing, investors see a shortage in private capital as a problem for the industry.
Warren Buffet said, “Be greedy when others are fearful.” I think this industry presents the perfect opportunity to do just that. I believe the advanced biofuel play in this market is Renewable Energy Group (NASDAQ: REGI).
Price to Book
Price to book ratio is a favorite metric used by value investors like Benjamin Graham and Warren Buffet. The theory is that while the market does a good job of valuing securities in the long-run, in the short-term it can overreact to information and rumors, and push prices down below their true value.
The price to book ratio for Renewable Energy Group (REG) is a miniscule 0.50. Compare this with competitors Amyris (NASDAQ: AMRS) and Solazyme (NASDAQ: SZYM) which sport price to book ratios of 1.96 and 2.05 respectively.
While share prices have dropped across the board for all three companies, it’s interesting to note that year-to-date both Amyris and Solazyme have seen their book value fall 63% and 17% respectively. Meanwhile, REG improved its book value an outrageous 673%. The increase in book value is fueled by the company’s reduced debt position and growing cash reserves.
Having a good price to book value is just the start to finding a good investment. It’s also important for the company to be efficient with its resources and show that it can be profitable.
REG also compares favorably with the competition on efficiency metrics. The company’s ROA over the last twelve months was 22.2%. Amyris and Solazyme have both posted negative returns of 84.5% and 31.2% respectively. Furthermore, this number is improving for REG from 10% at the end of last year and -17.7% the year before.
Additionally, REG has positive operating cash flow, something both Amyris and Solazyme lack. Last year, the company posted operating cash flow of $51.2 million. The company’s ability to generate cash will lead to it further reducing its debt position and improving its value. Meanwhile, its competitors which rely on external funding to continue daily operations, will continue to build up debt. While this shouldn’t be too much of a concern in a growing industry, it’s always nice to have an advantageous debt position.
REG has increased its top line for the fourth year in a row this year already. It’s important to see that revenues do not come at the cost of pricing. Thus, gross margin is a key indicator that the company will continue to grow the bottom line with the top line. Last year, the company had a gross margin of 15.4%, a marked improvement over the prior year’s 10% mark. Year to date, the company’s gross margin is down to 8.1%. This is due to the severe drought across the United States this summer, and not because of discount pricing. I expect gross margin to improve over last year’s number next year.
Fueling Your Portfolio
Searching for diamonds in the rough is how great value investors can beat the market. The biofuel industry has certainly been rough as of late. Despite government initiatives, the market is fearful, so now is the time to be greedy and grab some. Based on valuation, efficiency, and profitability metrics, I believe Renewable Energy Group is a good buy right now.
adamlevy has no positions in the stocks mentioned above. The Motley Fool owns shares of Solazyme. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!