Best stock to invest in – REX American: Culturally Frugal | Alternative Energy Stocks

Best stock to invest in

by Debra Fiakas CFA

Among the surviving public ethanol producers in the U.S. is REX American
Resources
(REX: 
NYSE).  Based in Ohio, REX American is an ethanol fuel producer
with owned nameplate capacity near 215 million gallons per
year.  Additionally, the company distributes by-products of the
ethanol production process, including distiller grains and non-food
grade corn oil.  REX has full or partial ownership in six
ethanol production plants located in the Ohio, South Dakota,
Illinois and Minnesota.

The company relies on corn feed stock for its dry milling ethanol
production process.  Like any other ethanol producer, that puts
REX American in a vulnerable position if corn prices rise faster or
to an egregious high level relative to fossil fuels, which help
determine ethanol selling prices.  This is called the ‘crush
spread’.  REX uses forward commodity agreements to lock in raw
materials prices as well as ethanol selling prices.  However,
these fixed price contracts typically do not last more than three or
four months.

REX management has done a fairly good job of handling the ‘crush
spread’.  In the twelve months ending April 2017, the company
recorded $466.7 million in total sales, providing $34.0 million in
net income or $5.16 per share.  Importantly, the company turned
17.9% of each revenue dollar into operating cash flow.  The
strong cash conversion rate has helped build cash balance at the end
of April 2017 to $181.9 million.  With no debt, REX American
has one of the strongest balance sheets among companies in the
ethanol sector.

REX American stands out among small-cap companies  – 
habitually profitable, naturally cash generative and capital
conservative.  However, we do have some concerns about
management’s ability to act decisively or to take bold or aggressive
action in their market.  The balance sheet is fully capable of
supporting debt to finance acquisitions or new build ethanol
production.  However, there are no concrete plans for such
expansion.

Cash assets are now greater than the book value of the Company’s
property plant and equipment.  Management’s investment plans
are increasingly under scrutiny.  While management describes
plans to expand capacity, these are very small investments relative
to the total cash resources.


Although the management team might not be as culturally agile as
most small, innovative companies, the REX American group can be
admired for its conservative nature.  Conservatism has helped
build a frugal operating structure that generates strong operating
cash flows.  In the end it is shareholders who benefit from
management’s penchant for staying the course with proven strategies
rather than taking bold actions.
At a price-earnings ratio of 21.3 times the current fiscal year
consensus estimate, the stock appears priced well above its peers in
the ethanol industry.  This should give investors pause. 
The ethanol industry is subject to considerable uncertainty, which
is not supportive of premium valuations.  For example, in
November 2016, the U.S. Department of Environmental Protection
announced the 2017 requirement of 15.0 billion gallons for
conventional renewable fuels.  This equals the statutory
requirement.   Despite this action well before the end of
the calendar year, the ethanol market did not benefit from the
expected certainly but was instead roiled by a temporary moratorium
imposed by the Trump administration.

REX shares are rated at Trim by Crystal Equity Research given that
fundamental valuation is at an egregious premium that may not be
sustained.    The stock has shown considerable
strength in trading in recent weeks.  Should the stock go
through another retreat, tradings might be tempted to add to overall
positions.


Debra Fiakas is the Managing Director of
Crystal Equity
Research
, an alternative
research resource on small capitalization companies in selected
industries.

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. As of the date of
this article, Crystal Equity Research has a Trim rating on REX
shares.

Best stock to invest in

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