Pacific Ethanol: Taste for Leverage

Pacific Ethanol(PEIX:  Nasdaq) just received an extension to pay back a creditor only just three months after having renegotiated terms.  The action may make balance sheet conditions the first thing on investors and analysts minds when the company reports financial results for the June quarter on July 31^st after the market close.  There is likely to be more than just a few questions about solvency during the conference call to discuss financial results of the company in the June quarter.  

The news actually sent Pacific Ethanol shares higher.  Nonetheless, the stock of this storied ethanol producer has seen better days.  Presently the Pacific Ethanol shares trade well under a buck.  This is a long way from the stock’s historic pea on May 8, 2006, when a trader bid $4,672.50 for a PEIX share.  Of course, that figure reflects two reverse splits in 2011 and 2013, so at the time the peak stock price was actually quoted as $44.50. 

Those were heady times for renewable fuels companies.  Ethanol production had reached four billion gallons per year.  Bill Gates reportedly bought 25% of Pacific Ethanol shares, drawing crowds to PEIX as well as other ethanol companies.  Trading in ethanol companies led to the publication of an article entitled “The Ethanol Illusion” in the November/December 2006 edition of the Harvard Magazine, in which the author asked “Can we move beyond an energy policy running on hype and hot air?”    

Pacific Ethanol’s public filings tell us that there were 31,447,706 shares outstanding on May 10, 2006.  That means Pacific Ethanol’s market capitalization was near $1.4 billion at the peak share price.  Fast forward to today, with 49,868,433 shares outstanding and a share price near $0.56, the company’s market capitalization has collapsed to $27.9 million.

The other thing that has changed for Pacific Ethanol from those early days is the company’s capitalization strategy.  The company ended the March 2019 quarter with $96.4 million in long-term debt on its balance sheet, with another $143.1 million in debt due within the next twelve months.  The long-term debt totals include a credit line for the company’s Kinergy Marketing subsidiary.  As of March 31, 2019, there was approximately $70.2 million was outstanding on the facility, leaving $21.8 million in available credit.  The balance of the $241.4 million in debt is a mix of term and revolving loans for sister subsidiaries. 

The debt-to-equity ratio was 0.78 at the end of March 2019.  This compares to a debt-to-equity ratio of 0.09 at the end of March 2016, when the only debt on Pacific Ethanol’s balance sheet was a $3.3 million loan related to the acquisition of a grain facility in 2003.   Thus Pacific Ethanol relies to a much greater extent on debt than back in the frothy days of the ethanol market. 

It appears management has gained a palate for leverage, but the aftertaste may not be so pleasant.  At the beginning of the year, management announced plans to reconfigure its balance sheet and improve liquidity.  The company petitioned its revolving credit line lender for more credit by increasing the amount of accounts receivable eligible to use as collateral.  The company also sought to get a little more wiggle room for cash management by decreasing the minimum amount of working capital required under one of the term loans.   Now that same lender has extended the payment deadline to November 2019, for payments that had been due in February and May.  The lender also agreed to temporarily waive altogether terms related to working capital accounts as well as other financial covenants.

The road ahead will not be smooth for Pacific Ethanol.  Last week the company also received a ‘love’ letter from the Nasdaq Stock Market, giving notice that the shares do not meet the minimum price requirement to remain listed.  Pacific Ethanol will have until January 20, 2020, to get its stock back up above the $1.00 mark. 

The ethanol industry has had its share of ups and downs.  The industry is in another low period and profits have been flagging.  Antagonistic trade talk by Donald Trump earned a boycott by one of ethanol’s most important customers  -  China.  On the plus side the fate of the E15 fuel standard that encourages the use of ethanol appear is more certain than a few months ago.  What is more, most watching the China-U.S. discussion expect some sort of agreement to come about.  Resolving Pacific Ethanol’s balance sheet difficulties should keep the company viable in what is has become a more viable industry.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.